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Goldman Sachs and JPMorgan's Aluminum Game Unravels


When commodity prices were soaring, big banks made moves to capitalize, especially on aluminum. Now, the banks' lucrative aluminum strategies are falling apart.

Since the financial crisis of 2008, Wall Street has undeniably morphed into something that is perhaps unrecognizable to everyday investors and traders. With government regulators attempting to keep a closer eye on the actions of market makers, big banks, and the Street's heaviest hitters, these institutions have found that some of their most profitable strategies have started to unravel.

One of these key tactics involved the once lucrative metals business. But since the days of the commodity bull market are now slowly disappearing, stagnant markets combined with new government regulations have put some of Wall Street's biggest plays in somewhat of a pinch.

Losers in the Aluminum Game

When commodity prices were soaring, many of the world's biggest banks took significant measures to capitalize on essentially all corners of the raw materials market. Aluminum, for example, became a big ticket item for banks, which found they could easily control the supply, demand, and ultimately price of the heavily-used industrial metal.

Prior to recent regulations, banks like JPMorgan (NYSE:JPM) and Goldman Sachs (NYSE:GS) spent billions of dollars investing in the aluminum market. The firms were able to create a significant bottleneck in the market, limiting the volume that aluminum producers were willing to sell to the metal's primary users, such as brewers and soft-drink makers. The banks did this by offering aluminum producers cash, rent discounts, and other incentives to keep the metal in storage rather then sell to the market.

But after industrial aluminum users began to complain to the exchanges that warehouses had artificially limited the supply and drove up prices, the US Senate began taking a closer look at the bank's aluminum game.

The Domino Effect

In addition to regulatory scrutiny, the banks' once lucrative aluminum strategies slowly began to unravel as warehouse storage costs and increasing inventories began to outweigh the incentives they had once provided. And as JPMorgan and Goldman Sachs realized their incentives no longer worked, the firms began to pull back.

In recent months, shipments to London Metal Exchange, or LME, warehouses have taken a steep tumble; the LME group reported shipments falling 79% in the first 19 days of August from two months prior. With more of the metal coming back into the market, the charge for immediate delivery has fallen more than 7% from the record high in July. And following the rules of basic supply and demand, aluminum prices have also become lower.

Investors should also be keeping a close eye on the London Metal Exchange in the near future as the exchange tries to push its proposal to reduce long wait times for aluminum buyers, which could go into effect in April of next year.

Follow us on Twitter @CommodityHQ

Editor's note: This article by Daniela Pylypczak was originally published on Commodity HQ.
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