The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders (17 page)

For more than two years, Goldman built enormous caches of aluminum. Its hoard helped prompt the biggest aluminum price rally the market had seen since 1988. During the years when Cohn was purchasing the commodity, physical market prices nearly doubled—amplifying the value of J. Aron’s stockpiles and creating over half a billion dollars in profit to Goldman over several years.

To be fair, a number of factors worked in Cohn’s favor, including aluminum production cuts that finally occurred after an industry agreement in early 1994. But to some, Cohn’s trade and the resultant impact looked like a corner, that is, an amassing of a physical supply of a commodity intended to jack up its prices. In this case, the stockpile was technically legal. But it still may have helped prompt a price run-up that ultimately benefited the party who was a contributor to the price movement in the first place.

Cohn says he understands why the term “corner” might be used. But throughout the period where Goldman was building up its aluminum store, “we were more than happy to sell it,” he says. “We were making cash aluminum available every day.” It was an argument he would air again twenty years later under different circumstances.

Late in 1994, a few months after his thirty-fourth birthday, Cohn made partner at Goldman Sachs, joining the ruling 2 percent echelon of a
9,600-employee firm. Around the same time, he also received a strange complaint: the metal masses in Rotterdam had grown so extensive that their reflection of the sun was creating
confusion for local air-traffic controllers. Airport officials asked Goldman if it could throw a tarp over its aluminum stash to make navigating the local skies a little easier.

Cohn was promoted further at Goldman, eventually becoming chief operating officer and president of the firm. Along the way, he helped secure Goldman’s spot as a top commodities franchise on Wall Street, second only to Morgan Stanley in breadth and prominence (in industry rankings, they do-si-doed). He promoted the GSCI, encouraged smart house trading, and reviewed Goldman’s forays into physical commodities, from wind energy to iron ore.

But at a time when the banking community was already smarting from the financial crisis of 2008, commodities created additional headline risk. Goldman bore the brunt.

At the time Goldman bought Metro International Trade Services in 2010, Metro was a low-profile company focused on delivering, stacking, storing, and eventually shipping out hundreds of thousands of tons of base metals every day. The company had been around since 1990, when a couple of entrepreneurs bought a single warehouse in Long Beach, just south of Los Angeles. Business was lean, with small tonnages shipping down from metal producers in the Pacific Northwest, and the owners eventually turned to the Midwest, which had a healthier flow of customers. It was the period before Cohn’s lucrative aluminum trade for Goldman, and Russian smelters were still very active.

Toledo, Ohio, had long been the Midwest’s metal-storage hub, but Metro’s owners established a beachhead in Detroit, which had the advantage of rail and water access. Metal ingots were extremely
heavy, requiring numerous train cars or barges to deliver them from producers like Alcoa directly to Metro’s warehouses. By the late 2000s, a single day’s haul required seventy-five trucks. Detroit soon became a destination for aluminum, as well as lead and zinc in smaller amounts. The Los Angeles area warehouse became a copper facility, and warehouses in New Orleans sprung up to house copper and zinc, much of which was shipped in from South America.

In 2008, when the financial crisis hit Detroit’s automakers, Metro spotted a chance for further expansion—into abandoned commercial facilities whose builders had gone belly-up. Toward the end of 2009, Metro bought a huge building in Chesterfield, Michigan, a half-hour’s drive north of Detroit, that had once been a Visteon Corporation plant, before the auto-parts maker filed for bankruptcy (though Visteon later emerged from Chapter 11 in 2010). It would become the largest warehouse in the entire LME system, with 714,000 square feet, mostly of storage space.

By 2010, Metro was storing one to two million tons of aluminum, zinc, and lead in its Detroit corridor, and had leases with about two dozen clients. But, thanks to the restrictive LME rules and the market’s growing penchant for storing metal stocks, Metro’s rental fees—about
40 cents per metric ton per day—were generating more than $100 million in revenue each year.

When The Coca-Cola Company, a longtime investment-banking client that had recently
hired Goldman to advise it on a $12 billion acquisition, initially complained about the escalating storage costs of aluminum and slow delivery times, the firm tried to assuage its concerns. The trouble was the LME system, Goldman argued, which was inefficient and needed updating. Goldman itself was simply following the rules.

Truthfully, shipping out even three thousand tons of aluminum
per day was a huge undertaking. One day in September 2012, a few months after the LME had doubled the minimum load-out rate, the eighteen Metro workers in the Chesterfield plant were very busy. Train boxcars sat with their doors open on the tracks that ran inside the building as workers loaded slabs of metal into them. Because the aluminum was so heavy, the stacks in each car were surprisingly low, filling up only a fraction of the space. Beeping forklifts breezed by as drivers picked up the bars specified by individual warrants, or certificates of ownership, for metal holders who wanted their wares transferred.

Rental fees had risen by that point to about
45 cents per ton per day, generating some $200 million per year in revenue on Detroit aluminum stores alone. Nonetheless, the premiums at work in the Midwest market made the ownership lucrative, explained a Metro executive, especially when aluminum markets were in contango.

“The ownership of metal is a control game,” he said, adding that the markets were easy to squeeze because there were so few units in circulation. Metro’s typical customer was a hedge fund, the executive said, that bought physical aluminum from a producer like Alcoa, shorted it through the futures markets as it was being shipped to the warehouse, and then took ownership of the warrants on the aluminum once they arrived in Detroit. (It was much the same principle that worked for Glencore’s oil marketers, who sourced crude oil from producers in far-flung locations and then shorted crude through the futures market as they waited for the physical shipments to arrive, albeit with more complicated storage and financing fees tacked on at the end.) Then the aluminum-owning hedge fund could sell its warrant to another party, who might wait for aluminum spot prices to rise, locking in a profit.

The LME’s increased load-out rate had done little to assuage Coke and other aluminum users.
Premiums had gone from about 6.5 cents in 2010 to 11 cents by then, and would rise to a record of nearly 12 cents by the summer of 2013.

While Metro was thriving, Goldman’s commodity traders were grappling with a major setback. In 2010 a powerful Dodd-Frank provision known as the Volcker Rule, after former Federal Reserve chairman Paul Volcker, had essentially promised to make the sort of house trading that had launched the careers of Jennifer Fan and Pierre Andurand illegal, forcing the firm to divest itself of some of its most successful trading desks. Although only five or six people had traded commodities strictly for the house at any given time, they had historically contributed as much as 20 percent of the Goldman commodities unit’s revenue—a substantial amount to forgo.

The commodity traders who remained were now focused almost exclusively on the client flow business: the volume-driven endeavor of designing and handling hedging or index trades on behalf of others. Most physical commodity acquisitions were now difficult or even verboten as a result of laws governing bank holding companies to which Goldman was now subject. Metro and the Colombian coal assets had passed muster, but new investment ideas, including an iron-ore purchase commodity traders were keen on, kept getting turned down by Goldman management. Traders and some commodities bankers in London, eager to pursue more entrepreneurial opportunities, felt handcuffed.

Isabelle Ealet, who had befriended Gary Cohn in the early 1990s and given young Andurand his break in commodities in 2000, was by then cohead of the firm’s entire securities division, the only woman to have ever won the title. By 2012, aware of the
angst over failed physical-commodity purchases, she allowed two of her employees to explore selling Goldman’s physical assets—Metro, its network of coal mines, and a few smaller investments. Morgan Stanley was already in talks to sell its commodity division to a sovereign-wealth fund; perhaps there was another market opening at the time.

When word got back to Cohn, he called Ealet on it. “You’re wasting your time,” he told her. Despite the limitations, commodities was an important focus for Goldman, he added. The business wasn’t going anywhere.

September 2013 was the five-year anniversary of the financial crisis, and the major commodity players on Wall Street were still enjoying a unique set of regulatory advantages. Under U.S. laws, Goldman Sachs and Morgan Stanley were allowed to hold assets like refineries and mines that their competitors couldn’t. Goldman’s lawyers believed the firm could hold on to Metro and the coal mines at least until 2020. But their opponents, noting that their emergency transformation into bank holding companies in September 2008 had grandfathered some of their commodities businesses—a situation that JPMorgan, Citigroup, and others did not share—believed they should be selling the assets sooner.

That July,
Goldman was the subject of a tough story on the front page of the Sunday
New York Times
. Citing multiple sources within Metro as well as a person “with direct knowledge of the company’s business plan,” the piece quoted forklift drivers describing days spent shuffling aluminum ingots from one Detroit-area warehouse to another, despite cries in the broader market that the metal queues were overlong. The implication was clear:
Goldman was moving aluminum within its own system as an end-run around the LME’s load-out requirements in an effort to juice profits from storage fees.

Days later, during a Senate Banking Committee hearing, aluminum users testified to the problems of long waits for metal and concurrently rising premiums on aluminum. “Aluminum is our single biggest price risk,” said Tim Weiner, global commodities risk manager for the beer company MillerCoors, because bank holding companies “have created a bottleneck which limits the supply.” He cited as the culprits Goldman’s outsized presence in the Detroit aluminum market and the lack of regulatory oversight at the LME. MillerCoors’s rivals, Weiner added, shared its concerns. A number of senators expressed their outrage over the conditions that Weiner and the
New York Times
had described and, within weeks,
Goldman received subpoenas from the CFTC.

Amid the backlash, Goldman higher-ups held a conference call to discuss their counterattack. But even within the firm’s top ranks, there were misunderstandings about the complex warehousing business. One fundamental question they were discussing was:
if aluminum prices had fallen 40 percent in recent years, how could buyers be complaining about climbing prices? (The answer was that it was the premium charged for aluminum delivery, not the actual price of aluminum, that buyers were complaining about. And anyway, as industry blogs later pointed out, aluminum prices had only fallen 28 percent during the years they were referencing.)

John Rogers, who oversaw Goldman’s press and government affairs, suggested the company put Cohn forward as a public spokesman. “We’ve got the guy that’s basically done more in storage than anybody else,” said Rogers. “Why isn’t he involved?”

Over the next week or so, Cohn and others called aluminum users to discuss their problems with the waits for metal. Goldman knew full well that most of those buyers didn’t participate directly in the Metro warehousing system, which was largely the domain of hedge funds and miners like the privately held Swiss company Xstrata. But if it was aluminum they needed, Goldman told them, it would happily source aluminum on the spot market and provide it—at competitive market prices—in exchange for the user’s preexisting spot in the Metro queue. It was the same principle Cohn had articulated in defending his long aluminum trade from the early 1990s against accusations that he had created a corner.