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"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:
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.