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LME Warehousing and Aluminum

In 2010, Goldman Sachs bought Metro, a metal warehousing company which operates under the regulations of the London Metal Exchange (LME).  We bought this company as an investment.  We are not involved in the day-to-day management of the company and do not consider it a strategic business.  Under the rules governing its purchase, we have to sell it within ten years from the date we bought it.

In recent weeks, there has been additional focus on metals warehouses as certain end users have complained about the long wait times to get aluminum out of LME storage.  In light of those concerns, we are making certain suggestions to improve the LME system and are taking unilateral action to help any end users who have metal in the queue at Metro warehouses. 

While the LME has various rules for its metals warehouses, they operate like any other warehouse.

  • The warehouse operator does not own the metal stored in the warehouse.  It merely stores metal on behalf of the ultimate owners.  Those owners, not the warehouse operator, direct where the metal is sent, whether it’s to purchasers, other warehouses or elsewhere.  
  • If you store goods in a warehouse, the owner of that warehouse can’t transport your goods to another warehouse unless you direct it.  It’s not his property.  And, the metal sitting in the warehouses is not Metro’s metal. LME warehouse companies are actually prohibited from owning metal or trading on the LME.
  • When a lot of customers want to get their property out of the warehouse at the same time, a line forms.  This is no different in the case of metal warehouses.
  • During the financial crisis, warehouse companies played the important role of allowing metal producers, who are often unable to adjust immediately to changes in demand, to sell excess metal to buyers who stored the metal in the face of weak consumer demand.  During this period, LME warehouse companies also received significant quantities of metal owned by market participants that were seeking immediate liquidity for their inventories.  As a result, large amounts of metal built up.
  • In general, without the warehouse system, producers would be less effective in managing their production. Without the ability to store metals, various market observers have stated that metal production would likely fall to such an extent that several smelters could shut down.
  • With low interest rates, many investors bought metal who believed that they could sell it at a pre-determined future date for more than the cost of storing it.  In other words, a straight forward carry trade.
  • After inventories had grown in the warehouses, many market participants sought to retrieve metal primarily for the purpose of implementing new carry trades at warehouses outside the LME system, which offered lower storage rates. This resulted in the creation of the queue. 
  • The overall delivered price of aluminum is down nearly 40% since its 2006 peak levels.  
  • It’s important to remember that the LME system does not represent the global supply of aluminum.  LME inflows and outflows generally represent less than 5% of total aluminum annual production.

While we don’t have any control over the governance of the LME system, we are suggesting the following changes and taking the following steps to address any concerns that the warehouses are limiting the supply of aluminium:

  1. Supportive of Recent LME Proposal to Reduce Queues.  Goldman Sachs supports the recently proposed rule change by the LME that is intended to cut existing queues by increasing substantially the amount of daily net outflows of metal at large LME locations.
  2. Priority System for End Users.  While more than 95% of the aluminum that is used in manufacturing is sourced from producers and dealers outside of the LME warehouse system, end users should not have to wait unusually long times to get the metal they store in warehouses. We suggest that the LME establish a system to prioritize end users so that they always have access to a minimum load out rate. Today, all customers in the queue are treated equally on a first in, first out basis.
  3. Providing Aluminum for Delivery in Exchange for Metal in the Queue.  In light of the concerns that end-users have raised about their access to aluminum they are holding in warehouses, Goldman Sachs is contacting end users to offer to swap any aluminum currently in the queue for immediately available aluminum so that they have access to the metal they need to make or package their products.
  4. More Disclosure and Transparency.  We support enhanced disclosure at the LME, including with respect to who owns the warrants for metals and to designate by broad market participant category who is in the queue.  We agree with Alcoa’s recent statements that enhanced disclosure will ensure that the LME continues to be the best source of price discovery for aluminum.