Are Goldman Sachs' Secret Warehouses Making Aluminum Miners Rich?

"In a rundown patch of Detroit, enclosed by a cyclone fence and barbed wire, stands an unremarkable warehouse that investment bank Goldman Sachs (NYSE: GS  ) has transformed into a money-making machine." So begins a revealing piece from Reuters on the control of worldwide aluminum supplies. 

No one can fault Goldman for seeking out new sources of revenue. Its shareholders demand nothing less. However, the way Goldman is portrayed -- as a miserly hoarder of critical materials -- casts a spotlight on perhaps the least-known part of the supply chain that turns freshly extracted metal into usable products that impact all parts of our lives.

Put on your tinfoil hats
Warehousing is an important element of that chain, holding excess supply when prices sag, and releasing it as values surge. Without warehoused supply, the price of metals would spike heavily in times of increased demand, shutting out manufacturers with fewer resources. But this simple concept, designed to stabilize prices, can be turned on its head when demand can be turned away, and supplies hoarded, through boom times.

Some key points from the Reuters piece:

  • Goldman Sachs reportedly owns 19 warehouses in the Detroit area, which are said to cumulatively store more than a million tons of aluminum.
  • From the beginning of this year through June 30, metro warehouses in Detroit took in 364,175 tons of aluminum, and delivered out 171,350 tons. That represented 42 percent of inventory arrivals globally, and 26 percent of the metal delivered out, according to the London Metal Exchange.
  • U.S. businesses use about 6 million tons of aluminum yearly.
  • Premiums for physical aluminum on the London Metal Exchange, which governs the release of metals from these warehouses, are at record heights.
  • Physical aluminum prices are estimated by one analyst to be $20 to $40 higher per ton than they would be in the absence of the Detroit stockpile.

It's a conspiracy! (No, not really)
Now, this has obvious effects on both the producers and the consumers of aluminum. Alcoa's (NYSE: AA  ) aluminum production in 2010 came in at 3,586,000 metric tons. If we assume that Goldman's warehousing operation added $30 (the median value of the $20 to $40 estimate above) in value to each ton produced, the mining giant realized more than $100 million in additional profits on its 2010 income statement. That's hardly chump change, especially considering Alcoa's huge losses the year before. Let's look at some companies that could be affected by the Goldman warehousing:

Company

2010 Aluminum Production/Consumption

2010 Net Profit

Potential Profit Without Warehousing Operations

Alcoa 3,586,000 tons produced $392 million $284.42 million
Rio Tinto (NYSE: RIO  ) 3,790,000 tons produced $14.32 billion $14.21 billion
Norsk Hydro ASA. (OTC:NHYDY.PK) 1,400,000 tons produced $391 million $349 million
Century Aluminum (Nasdaq: CENX  ) 585,395 tons produced $60 million $42.44 million
Kaiser Aluminum (Nasdaq: KALU  ) 257,100 tons used $14.1 million $21.8 million

Source: SEC filings. Potential profit without warehousing based on estimates of price increases of $30 per ton.

Major aluminum producers make out like bandits under the Goldman warehouse regime. By controlling the process of primary aluminum creation from the bauxite (the ore form of aluminum) mine to the smelter, Alcoa and others ensure that they can sell aluminum to for the greatest return. In some cases, they may produce aluminum products themselves, saving money over the cost of acquiring aluminum ingots on metals markets. Goldman acts as intermediary, storing aluminum for a fee until aluminum users such as Kaiser have a pressing need to use the metal for industrial or commercial applications.  By withholding supply, Goldman crimps Kaiser's ability to turn a profit, but rewards Alcoa, whose ingots appreciate as they sit unused.

Foil-ish final thoughts
While I don't claim these to be exact figures, they do go a long way toward illustrating how artificial supply constraints on raw materials -- in a time of rising demand -- can affect the incomes of companies that build their businesses around those materials. The London Metals Exchange, for its part, disputes any claim that the warehousing operations have unfairly influenced prices. Meanwhile, demand for aluminum is soaring globally; having increased 15% last year, it's expected to rise at least 12% more through 2011. Since regulators are unlikely to throw open the floodgates, it appears likely that primary aluminum producers will continue to benefit from Goldman's hoarding, at the expense of the manufacturers who depend on steady supplies.

Keep track of these mining giants by adding them to your watchlist, as they continue to enjoy higher material prices thanks to the government's favorite investment bank.

Fool contributor Alex Planes holds no position in any company mentioned here. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 17, 2011, at 11:52 AM, TSRAIS wrote:

    Reason Goldman can make money by constraining delivery supplies out of the warranted warehouse is that they can, as a bank, get cheap money from the FRB to finance their off-warrant ingot position, and profit spread between the cash and forward price. The producers obviously benefit by the limitation of the ability to deliver metal out of the warranted warehouse. Therefore, producers & traders benefit by charging a premium for cash delivery over the LME cash price. This is an artificial & unsustainable pricing structure, not a free market structure. It is built on a deck of stacked cards that will eventually collapse when & if future interest rates rise. The artificial pricing structure encourages producers to restart idle smelters, and even invest in new capacity. Thereby adding to an already oversupplied market that will eventually weigh on the future pricing structure. It's another "bubble" ready to burst once the interest rate cycle turns up.

    BY the way this is not just happening in the aluminum market. It's happening across the board in almost all commodities.

  • Report this Comment On August 17, 2011, at 1:38 PM, Brettze wrote:

    Secret warehouses or none, aluminium prices are still tooo low!! just $1.10 a pound.. same as lead and zinc.... aluminium historically was similar to copper in valuation , but copper went up to $4 or higher already. $3 for alumnium is a fair price but heavy industrial users like GE, Boeing, Ford, Coca Cola, etc will lose money if alumnium prices go up just because they are putting way too much money in pensions and benefits for employees. Aluminium producers has same needs for employees too, remember??? and shareholders too.

  • Report this Comment On August 17, 2011, at 1:43 PM, Brettze wrote:

    Our economy is crippling because of questionable energy supplies not only from fossil fuels but also from future alternate energy developments.. Aluminium is an important material for solar thermal energy, but we are not growing solar thermal energy .. We dont have any IPOs for solar thermal energy, yet.... just photovoltaics which is not as powerful as solar thermal energy. Solar thermal energy is measured in BTUs instead of kilowatts, so that is why investors miss the biggest part of solar energy that we can grow.. Most people just dont know aluminium..

  • Report this Comment On August 17, 2011, at 1:53 PM, Brettze wrote:

    Investors still dont want alternate energy to steal business away from fossil fuel producers, because they still put trillons of dollars in fossil fuel assets .. They want to see fossil fuel prices keep going up forever but they already know that high fossil fuel prices harm our economy. Some people are not bothered by high fossil fuel prices at all so their views just dont go in flow with the rest of us who are currently out of work . They just dont understand that it is not the right time to follow supply/demand rules because fossil fuel supplies is not growing as fast as our economy requires. We have no choice but to invest in alternate energy like wind turbines and solar thermal energy. Photovoltaics is important but solar thermal energy can increase energy supplies more powerfully than photovoltaics for the same money. People just dont understand solar technologies... They think that photovoltaics is the only game in solar energy which is not true. Solar reflectors is what we need to increase solar energy immnesely..Aluminium is used in solar reflectors.. Silver can also be used but they are very expensive and limited. Aluminium is nearly as effective as silver way up in high percentage levels way above photovoltaics.. more like 50-75% or better .Again, people just dont understand so nothing changes yet... Our economy just cannot improve much until people understand what it takes to jumpstart our economy again.. It is no longer possible to go back to more oil , natural gas, coal to power our economy up again like in the past... Fossil fuel prices will soar if we try to do that again. we already know that and we just lost confidence while still ignoring solar thermal technologies and continue to dabble with iPads..instead..

  • Report this Comment On August 17, 2011, at 2:04 PM, Brettze wrote:

    Of course, aluminium prices will go higher if we start growing solar thermal energy which many dont want to see happening .. GE, Boeing, Ford will start losing money on higher aluminium prices as they will continue to use more aluminium as slowly as they can get away with.. we avoid aluminium consumption but this behavior realy hurt our economy! People dont want to place great importance on aluminium... Aluminium is as critical as copper , moly, nickel, etc but aluminium is not increasing in demand fast enough to boost our economy. We cannot do without more aluminium , simple as that.. Now we are storing aluminium simply because aluminium producers will sink if they stop producing more.. China is finally beginniing to cut back its own production quotas because of environmental issues .. China has too many aging aluminium operations that is way long overdue for shutdowns.. There will be a shortage of aluminium down the road.. High aluminium prices is not good for everybody but high aluminium production is very good for our economy at decent prices higher than today 's way too low prices at $1.10 a pound which is not enough . It has to be over $2 or $3 . We just cannot pretend to be able to get away with less aluminium consumpiton at ridiculously low prices so to boost balance sheets .. This is phony economics.. with severe consquences for the rest of us.. Time to cut the bull now!

    get aluminium prices up now and start using more of it.. We dont need secret warehouses.. just great products made with aluminium.. We need far more solar energy by reflecting sunlight to heat homes , cook food, dry things, melt stuff. that we used to rely on natural gas inthe past.. aluminium can help stretch our finite fossil fuel supplies and improve fossil fuel price stability in the long run.. It is stil cheaper to pay more for aluminium than to pay far more for depleting fossil fuel assets which investors crave to see happening despite what it is doing to our economy. Investors are not going to try to save us.. They dont care!

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