We were subject to congressional hearings this week on the appropriateness of bank owned physical commodity infrastructure. We have spoken of the criticism by industry regarding the holding of captive physical stocks of metal in LME warehouses. Industrial end users have complained loudly at the cash premiums they must pay in order to get prompt metal, a premium they say is inflated due to the persistent steep contango in metals such as aluminum and zinc. Congress is seeking to crack down on ownership of LME warehouses by banks such as JP Morgan and Goldman Sachs, just as these very firms seek to divest themselves of their ownership interests. We suspect that this divestiture has less to do with congressional oversight, and more to do with the eventual narrowing of the contango. Owning a warehouse is only lucrative to the extent that physical holders are paid to store the metal. What made these hearings interesting was what was not discussed, namely the involvement of ETF’s into these commodity markets. While there was much discussion of the role of banks in the skewing of fundamental pricing, there was not much talk of the involvement of the public (via ETF’s) into what has heretofore been the purview of traditional producers/consumers. The influence of these ETF’s was seen throughout the year in the gold market where massive liquidation by the gold ETF has exacerbated any and every selloff.
While we understand that the growth of ETF’s and the financialization of commodities is something we all must live with, we do question the introduction of these products into markets which are very thin and highly fragmented. Much like congress however, we fully expect that regulatory scrutiny of “inappropriate” ETF’s will appear only after some kind unforeseen market event.