Ah, those mysterious ‘fixed income, currency and commodities’ divisions at banks like Goldman Sachs. They do so well, yet we never know exactly how much which bit is making or how.
Well, we’re pleased to report a little more light can be shed on these matters now.
As Reuters columnist John Kemp explained on Wednesday, since their conversion to bank holding company status last autumn, Goldman Sachs and Morgan Stanley are required to file quarterly statements about their consolidated financial condition using a form Y-9C.
This means, for the first time, we — the humble public — can take a look at the quality and type of assets being held on investment-bank balance sheets. Regarding commodities, Kemp reports:
For the commodities sector, the Form Y-9C data confirms just how dominant the big two commodity banks remain despite strong challenges from other participants.
While it does not include the commodity-related activities of banks based outside the United States, including Barclays (which acquired the commodity trading assets of Lehman Brothers last year) and Royal Bank of Scotland (which has a joint venture with Sempra Energy ), it does reveal just how far Goldman Sachs and Morgan Stanley are ahead of the rest of the pack.
It also reveals how much more important OTC and swap markets have been compared with the more visible activity in exchange-traded futures and options for the two dominant banks.
Those positions can be viewed on a handy spreadsheet compiled by Kemp here.
Kemp interprets the numbers as follows however:
At the end of June, the four major banks owned commodity inventories valued at $8.1 billion — with JP Morgan Chase ($3.5 billion) and Morgan Stanley ($3.3 billion) reporting the largest holdings and Goldman Sachs a much smaller stock ($0.7 billion).
While the holding is relatively small (equivalent to less than 120 million barrels of oil) and nowhere near the vast stockpile that many critics accuse them of hoarding, it is likely that much more was carried in off-balance sheet vehicles, removed from the balance sheet prior to the ending of the quarter, or effectively controlled but not owned through swap deals with merchants, distributors and producers.
And particularly notes the following:
The Form Y-9C data underscores the massive importance of the bilateral swaps market to the commodity banks (including commodity index deals structured as total return swaps with pension funds and other institutional investors, as well as hedging transactions with producers and merchants). Goldman Sachs reported $223 billion in gross notional swap transactions outstanding, and Morgan Stanley $315 billion worth.
However, while Kemp suggests $8.1bn is not a great sum for the four banks to own in inventories, we would argue that is relatively misleading. It’s still a very significant sum for the commodity world. To compare, crude inventories for the whole of the US (excluding the strategic petroleum reserve) amounted to 337.2m barrels last week according to EIA data.
Furthermore, it’s the optionality that those physical holdings give banks that’s important.
As well as being profitable in their own right, physical-commodity trading gives banks critical information on flows which can enhance their decision making processes on the OTC swap side. It’s the commodities equivalent of flash orders - a crystal ball into the fundamental world.
If something happens operationally – ie, a refinery shuts down or there is an explosion in Nigeria — chances are the banks’ physical operators will hear about it first, way before any hedge funds could possibly hope to. That information can then be used to gain advantages on the swaps and derivatives side, where the real money is most likely made.
In essence, the data underpins just how important the physical commodity game is to banks.
Although on a side note, it also reveals that Goldman Sachs is increasingly focused on fund-flow money operations, most likely maintaining a small physical presence to gain some insight into the fundamental picture as well as the right to those all-important exemptions to position limits on commodity exchanges.
Related links:
Presenting the physical loophole – FT Alphaville
GLG goes physical - FT Alphaville
Financials are keen to keep their hands on physical trades - FT
The curious case of Goldman Sachs’ liabilities – FT Alphaville