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If you are long commodities in any form - and most people are whether they know it or not - this headline from the WSJ has to make you at least eye the exit:
I've been doing this for a long time and while I may not be the smartest guy in the game, I've learned a few things along the way. One of them is that whatever the big banks and investment banks are doing a lot of probably isn't a good place to park the grocery money. And they are now doing a lot of commodity trading:
A group of 10 large banks"”including Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Citigroup Inc., Bank of America Corp. and Barclays PLC"”saw their commodities revenues increase by 55% in the first quarter, according to Coalition, a firm that analyzes the performance of investment banks. After a disappointing 2010, commodities was the fastest-growing segment in banks' fixed-income businesses in the first three months of this year, even though it still accounts for just 7% of banks' total fixed-income revenues, Coalition said.
Commodities trading is a bright spot for institutions that face new regulatory clampdowns on practices that previously fattened bank profit margins, such as trading with their own capital and slapping customers with hefty "overdraft" fees. Oil is up about 10% so far this year, settling at $100.29 a barrel Wednesday, and commodities such as gold and copper are close to all-time highs.
Hasn't anyone in Washington, D.C. heard of unintended consequences? How about down at the Marriner Eccles building? If Dodd-Frank takes away one source of revenue and profit, the banks will just find another area of the economy to exploit. Between Dodd-Frank and the Fed's heroic efforts the banks cost of capital is essentially nil so if they hit it big in the commodity pits, the profit margin is pretty attractive. With lending in the tank, why not take a shot?
Some of the revenue is generated from helping corporate customers hedge their commodity risks. That is a legitimate activity for a bank or investment bank but it is also a direct consequence of Fed policy. QE II weakened the dollar which led directly to increased commodity volatility. Increased volatility attracts speculators which further exacerbates volatility and increases the demand from corporations to hedge. This increased hedging activity ties up corporate capital that could have been put to more efficient uses like buying equipment or God forbid, hiring some workers. One also has to wonder about the advice being dispensed by a bank that is speculating in a market where clients want to hedge. And yes, the banks are speculating:
Lehman went under in September 2008, and Mr. Frase joined J.P. Morgan in October 2008. He is known in the oil-trading community as a "sustainable earner," said one person familiar with J.P. Morgan's commodities group.
A J.P. Morgan spokeswoman said Mr. Frase declined to comment.
Some notable trades that worked well for Mr. Frase's group in the first quarter included one on the widening spread between Brent and Nymex crude oil"”the two benchmark prices"”which helped return about $38 million in the first quarter. J.P. Morgan also made money on fuel oil and Asian oil markets, according to people familiar with the matter.
The desk took a hit in early May when commodities were sold off broadly, giving back some of its gains.
All I can say is I hope the banks have improved their risk control procedures. How long before we learn of a new Brian Hunter (Amaranth) or Nick Leeson (Barings)? How long before we get to test those Too Big To Fail procedures in Dodd-Frank?
Maybe it's different this time and the banks won't blow themselves up in the commodity pits like they did trading the much less volatile sub prime mortgage market. If you believe that, I've got some land for sale down here just west of Miami.
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