The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders (16 page)

It was Andurand’s first extended hiatus in five years, and he planned to spend it in high style. His rented villa, a fifteen-bedroom monstrosity a mile or two outside of town, had been booked months in advance for £150,000—not including the £50,000 broker’s fee. It came with a full household staff, a tennis and volleyball court, gardens, and a 25-meter pool—the same length Andurand had struggled with as a college swimmer in Toulouse. A long gravel driveway led to the square cul-de-sac that fronted the house, behind which was a comfortable sitting room and spacious kitchen. A staff prepared meals and kept things tidy.

Thinking he might drive his luxury car around the relatively serene roads of Provence, where accidents and vandalism were less likely than in London, Andurand had shipped his Bugatti to the outdoor garage at Sarrians, which had space for numerous vehicles. Once there, however, he worried about the impact of the gravelly local roads on his low-slung car, and opted to drive his Porsche Cayenne instead.

Only a week into the trip, Andurand was restless. His kickboxing consultants were calling and e-mailing constantly with issues. He and Slyusarenko were unhappy with the cook at the house, who prepared dishes like salads and lamb chops without flair. They were also miffed at the château’s owner, an elderly man who
was staying nearby while Andurand and family used his larger house and who visited almost daily—as did the owner’s large, lame dog, a chocolate lab that liked to sun itself by the burbling outdoor pool. The office area wasn’t properly equipped, and Andurand lacked adapters to power his British-made gadgets in France. Even the inexpensive outdoor furniture bothered him.

Andurand couldn’t help but miss trading. Since shuttering BlueGold, the crude market had entered free fall, with Brent contracts trading as low as $88 after having been priced at $125 as recently as March. It was the most pronounced swoon in prices in several years, and one that Andurand swore he had seen coming.

“Just after I closed, oil went down 30 percent, and I’d been short for months at BlueGold,” he said while reclining by the pool one evening. “Where demand is flat and supply is going up 1.5 to 2 million barrels per day, and Iran is threatening to blow up the world, you need to cut production. You should only get excited,” meaning, poised for a rise in crude prices, he added, “if you’re going to have a long, ongoing war.”

He spent the next few months preparing to launch his new hedge fund. Depending how well the fund-raising went, he was willing to put up to $100 million of his own money into the business, but he hoped some of his old investors would support the new venture. To help attract them, he had offered to forgo his own cut of the new fund’s profits until they made back any money they’d lost at BlueGold—a move known in the hedge-fund business as transferring the high-water mark. It was a tough standard to meet, but money managers at
Citadel, the large Chicago fund group, had recently done it, and Andurand figured he could too.

Over lunch at Ladurée, the tearoom at Harrods, in late September 2012, he appeared tanned and rested from a recent vacation along the Italian coast. He had already secured a single $100 million account for his new company, Andurand Capital, he explained, and planned to start trading that cash within a couple of days.

The oil market had had a volatile week, with a sharp move downward that took traders by surprise. Andurand, however, had not been following the news of late and had no theories yet on what had happened. He said he’d probably read the latest crude research over the weekend in preparation for Monday.

“I need to start making some money again,” he said with his most modest smile. A few months later, he was back in front of a terminal on Brompton Road.

D
uring the summer of 2011, officials at the London Metal Exchange
got an unexpected complaint from The Coca-Cola Company. The amount of physical aluminum in storage was piling up, said a representative of the soda maker, and, along with it, so was the expense of buying the metal for beverage containers.

The culprit, as Coke saw it, wasn’t simple supply and demand—in fact, there was plenty of aluminum sitting in warehouses. It was the shrewd tactics of Goldman Sachs, the bank that owned a network of metal-storage facilities in the Detroit vicinity, where waiting times for extracting aluminum were longer than ever. Every day those metal bars sat idle, Goldman’s warehouse company effectively drove up the premium amount that aluminum producers could charge for delivering supplies to beverage-packaging factories, a cost that amplified the expense of the actual metal and, thus, the prices Coke and others paid for soda cans.

“
The situation has been organized artificially to drive premiums up,” said Dave Smith, Coke’s head of strategic procurement, at an industry conference that June. “It takes two weeks to put aluminum in, and six months to get it out.”

Smith, a midlevel executive, was speaking somewhat out of turn. Despite its complaints with the warehousing system—which industry participants considered to be a market of last resort when aluminum supplies were tight—Coke had tried to keep its concerns about Goldman behind the scenes. More than a year earlier, eight players had complained privately to the London Metal Exchange, or LME, the obscure London metals bourse that set the benchmark price for aluminum, zinc, copper, and other important nonprecious, or base, metals that were key in manufacturing. The U.S. warehousing system that the exchange oversaw was so inefficient that it was hurting corporate profits, they had argued.

The Midwest premium, the regional U.S. rate for getting metal from a seller to a buyer, was a cost imposed on Coke and other manufacturers in addition to the cash, or spot price of aluminum, which was by then bouncing back from its lowest levels in some time. Aluminum prices had
increased 13 percent since the beginning of 2010,
when Goldman had paid half a billion dollars to acquire Metro International Trade Services, the metal storage business based in Romulus, Michigan. Bought relatively cheap at a time when commodity prices were low, Goldman took on Metro as a way to broaden its suite of physical commodity holdings, which had become an important complement to its derivatives trading in London and the U.S. Around the same time, it had also bought
coal-mining assets in Colombia.

In addition to the revenue those investments offered it, they presented Goldman with the possibility of a free look at what was happening on the physical side of commodities through ground-level operations. Tweaking existing contract trades in a commodity based on feedback from colleagues who worked in the physical
markets was by then commonplace in banking. “We had pipeline capacity all over the place and we would call up and say, ‘How’s gas flowing this morning?’” remembers a trading manager who worked for years at one of Goldman’s competitors. If flows were weak, he added, “We’d go, ‘Oh, we’re not going to get the pop we thought, so let’s reposition.’” Still, Goldman spokespeople consistently denied that employees familiar with Metro’s business operations shared information about it with internal traders.

Goldman wasn’t the only one dipping into the physical commodity world, a cornerstone of companies like Glencore, which called it the “industrial” business. JPMorgan, never much more than a rounding error in Wall Street’s commodity business before, spent $1.6 billion that year for a significant portion of the European company RBS Sempra Commodities. The deal brought JPMorgan a firm called Henry Bath & Son, a two-century-old metal warehousing company that was the late 1800s’ answer to Glencore, a copper shipper, seller, and storer with immense market power and global reach. The same year as the Metro and Henry Bath acquisitions, Glencore itself bought the metal-warehousing division of Pacorini Group, the Italian commodity trader, whose storage locations spanned the globe from the Netherlands to Hong Kong. In fact,
nearly all the world’s private warehouses were being snapped up at the time by large multinational commodity companies. Broadly speaking, the bet was that metal traders would stock up on physical product while prices were relatively low and hold their stocks until the market improved, generating steady rental incomes for the warehouse owners in the process.

The new metal-warehouse owners quickly proved right—and had huge stacks of metal bars to prove it. The nine hundred thousand tons of aluminum Metro stored in its Detroit facilities when
Goldman bought it in 2010 were growing daily. Meanwhile, incentive fees Metro paid to hedge funds, physical commodity traders and other tenants—usually one or two hundred dollars per ton each year—encouraged them to leave the metal there for longer periods. The longer the waits for aluminum, the more Alcoa and other producers of the metal, such as the Russian company Rusal, could charge Coke and other aluminum users; they knew the bottler couldn’t afford to wait months or a year for warehouse metal, so it was forced to pay up for open-market transactions instead.

In 2011 Coke was joined publicly in their complaint by Novelis, a company that provides rolled aluminum to the manufacturers that make beer cans, aluminum foil, cars, and consumer electronics. By then, LME officials had already been studying the economics of storage.
Their survey found that queues were indeed growing, and that commodity buyers were unhappy. With waits for aluminum from Detroit stretching as long as seven months, the LME that July mandated a new minimum “load-out” rate, or the pace at which the metal was required to leave storage facilities, of three thousand tons—double what it had been before.

For the aluminum buyers, it was a pyrrhic victory. While the new requirement was double what it had been before, stockpiles in Detroit were nevertheless on their way to
1.5 million tons and a sixteen-month queue for removal.

For Goldman Sachs’s president, Gary Cohn, the aluminum warehousing trade was a bit of déjà vu. Two decades before, in the early 1990s, he had moved to London to help expand Goldman’s commodities business, a onetime New Orleans coffee trader that was known as J. Aron & Company. While in London, Cohn
stumbled upon a lucrative aluminum trade that involved storing huge amounts of the metal until prices in the market allowed him to sell at a profit.

Cohn had already discovered some blind spots in J. Aron’s existing business. Having started his career as an independent silver trader on the raucous floor of New York’s Commodity Exchange, or Comex, a place made famous by the Eddie Murphy movie
Trading Places
in 1983, Cohn had some experience with trading floors. J. Aron, which Cohn had joined in 1990, had a long history with contracts on precious metals, commodities it had traded for years. But in contracts with which it had little prior experience, such as cattle and hogs, Cohn and his colleagues—who had just launched the Goldman Sachs Commodity Index in 1991 to track
eighteen different raw materials—were wading through new and uncertain territory. (Ownership of the Goldman Sachs Commodity Index transferred to Standard & Poor’s in 2007; the index is now known as the S&P GSCI.)

Shortly after the GSCI began trading, Cohn arranged to purchase cattle in Colorado to test out the physical commodity underlying one of the contracts the index was now buying on a regular basis. As part of their experiment, Cohn and his boss flew in a small plane over their cattle’s ranch to inspect the goods—only to find the animals starving to death as they stood stranded in several feet of snow. Eyeing the scene, Cohn’s boss told him to sell the physical cattle positions the minute he got back to New York. Cohn agreed it was a bad trade, and the suffering of the animals left a minimal impression.

Metals were also somewhat virgin territory. The LME was the home market for two of the GSCI’s components, aluminum and zinc, and Goldman was giving big-volume orders to its brokers
there monthly, as customer contracts on these commodities were rolled forward and replaced by new ones. But after examining the prices that Goldman was getting on its LME roll trades month after month, Cohn—who had little contact with the London floor traders except over the phone from New York—worried that he was getting fleeced.

J. Aron was “the low-hanging fruit,” he recalls. LME traders were “just waiting for me to come in and roll my contracts. These guys [were] buying yachts off me.”

Cohn, who was planning an early 1992 move to London, threw himself into the LME’s world, where base-metal prices were established through five-minute buy-and-sell sessions in a red-seated inner circle on the trading floor known as the Ring. It was a more stately version of his beloved Comex pits, with traders using elaborate hand signals and multiple phones and speaking in British, rather than Brooklyn, accents.

As Cohn studied the LME’s base-metals markets, he noticed something strange going on with aluminum, which was one of its most active futures markets: it was in deep contango, a situation in which the future price of aluminum was far higher than its cash price. This meant that GSCI investors were constantly paying extra money simply to stay in the same futures trade as they replaced their existing near-term contracts with new ones each month.

Commodity traders in the futures markets were using contracts, as opposed to actual, physical stocks of copper, aluminum, or oil, to express their view of the future price of raw materials. In other words, they were buying or selling bets on what they thought would be the price of aluminum down the road rather than actual, physical metal slabs. But every futures contract had an expiration date, and as that date neared, the holder had a choice:
either take physical delivery of the aluminum, or roll the contract forward and replace it with a similar futures contract dated farther out.

When markets were in backwardation, meaning the commodity contract connected to prices in the near future was cheaper than the present, or spot, price, the only cost to the roll was the fee the investor paid Goldman for changing the contract over from one month to the next. But when the market was in contango, the investor was paying not only the brokerage fee, but also the difference in price from, say, January futures to February futures—a figure that, in a deep contango scenario, was growing ever higher.

The aluminum markets were at a crossroads then. Oversupply around the world had depressed prices. The Soviet Union had just collapsed, and Russians were eager to amass hard currency in exchange for commodities (a dilemma that traders like Marc Rich & Co. helped them solve by buying aluminum on the cheap and reselling it to users who didn’t particularly need it). An international squabble was developing over how to handle the problem, and the price of aluminum was spiraling.

Cohn realized it would be cheaper to take delivery of the aluminum than roll a futures contract forward. But doing so would mean breaking a long-held tradition of leaving the logistics of transporting bars of metal and barrels of oil to the professionals who actually used them. Sourcing and shipping a commodity like crude oil was elaborate enough that many futures traders would never bother with it. And storing metal until somebody else wanted to turn it into cans or cars was also a highly nuanced endeavor with its own rulebook.

He dove into the world of metal storage and financing, visiting warehouses and researching metal insurance. “I spent a month
sort of due-diligencing a trade that took me thirty seconds to figure out,” he says.

Convinced of the potential profits, he took the idea to one of J. Aron’s senior managers, Lloyd Blankfein. Blankfein, a former gold salesman, was dubious.

Cohn was insistent. He had thought through every issue, he told Blankfein, and this was a “riskless” opportunity. Cohn would hedge every potential problem he could find—interest rate movements, currency movements, anything that could hurt the trade’s performance—and would definitely make money. Blankfein told him to run an experiment using no more than $300 million, a substantial portion of
the firm’s $4 billion in capital during that period.

The following Monday, Cohn bought $100 million worth of physical aluminum—about a hundred thousand tons. Even with all the homework he had done, and despite his boasts to Blankfein, he honestly expected the potential profits to vanish as a result of a sudden physical price drop, a surprise hike in storage fees, or some other unforeseen complication. But the following day, nothing had changed much, so he bought another $100 million of metal. The next day, he bought another $50 million. By Friday, when the spread, or difference, between what he would have spent to roll the contract forward and what he was actually spending to store the metal was still intact, he knew he was on to something.

A few months later, Cohn relocated to the UK. There he secured Goldman a membership on the LME, and eventually, a seat on the board. He continued taking physical delivery of aluminum, stockpiling it in storage facilities in the Dutch city of Rotterdam. He also began calling the firm’s aluminum-producer clients, seeing if they wanted to sell down their physical inventories; many
were happy to oblige. Goldman Sachs was relieving them of excess metal and helping them to free up cash without tipping off the rest of the market. Meanwhile, its physical aluminum holdings offset the futures it sold in the markets, giving Goldman what amounted to a neutral position.