The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders (2 page)

Throughout the bubble in commodities, a core group of traders were siphoning much of the profit. They were industry veterans who, like Pierre Andurand, used a combination of strategy and heft to play the markets to their benefit. Along the way, their bets that commodity prices would rise had the ability to move markets upward, and their bets that prices would fall, the opposite. For the most part, they weren’t manipulating prices by hooking up with fellow traders to orchestrate group decisions, nor were they buying physical commodities to constrict supplies while collecting money by betting that the futures prices would go up, a classic commodity swindle known as cornering. But their intimate knowledge of nuanced industries, their access to closely held information, and their enormous resources gave them tremendous advantages that few others had. And even when they bet wrong, they were still so rich and well connected that they could usually return the next day and begin to make their money back.

It was an industry of optimism, peopled by wealthy, focused traders who were not afraid of an occasional setback. Some had absentee fathers whose gaps they longed to fill with power and money, some were simply more comfortable with risk than their counterparts. After all, commodities were an area in which the market swings in a given day could be exponentially greater in size than the typical moves in stock or bond markets.

“When you trade commodities, you realize really quickly that markets can do anything,” explained Gary Cohn during an interview in Goldman’s sleek New York corporate offices one day in 2012. “So I love when I sit there with guys who say, ‘that would be
a three-standard-deviation move,’” that is, a shift in market prices that was three times as great as the typical one would be—as if that notion should come as a shock to the listener, he added: “In commodities, we have three standard-deviation moves in a day.”

Commodity players can appear pampered, even lazy. Maybe they spend half the summer in Provence or Nantucket, working remotely from a Bloomberg terminal in their home office while their kids are minded by a live-in nanny. They might piddle away a serious investor meeting talking martial arts, move a long-scheduled international appointment just days in advance, refuse to take a view on the markets, or be too busy grouse-hunting in Norway to answer a couple of questions about the crude-oil business. All of the above happened with people interviewed for this book. But when it comes to trading raw materials, they are a shrewd and indomitable lot, and, at least for the moment, the contracts they trade are still so loosely regulated that the correct combination of money and skill creates irresistible opportunity. That’s why I am only half-joking when I call them the secret club that runs the world.

In BlueGold’s prime, it had several hundred competitors in the hedge-fund business, each of varying size. Commodity hedge funds, typically based in London, Greenwich, or Houston, picked one or more raw materials they understood well, then made a business of trading in the related contract markets. Their investors, usually a combination of larger money-management firms and wealthy individuals, presented them with billions of dollars to trade. There were many winners, but
John Arnold, a onetime Enron trader who went into business for himself after it folded, did the best of all; his natural-gas-focused hedge fund, Centaurus Energy, generated 317 percent returns in 2006. Several years later,
Arnold retired, a billionaire at the age of thirty-eight. He became a philanthropist.

Prodigies like Arnold were the superstars of the industry, commanding respect as a result of the enormous sums of money they’d made. Andurand, who generated 209 percent returns in 2008, was in there too. But few hedge-fund traders were quite that accomplished. The rest of the commodity-trading hierarchy was topped by the large, multinational brokers involved in every single aspect of commodity harvesting and trading, from extracting the coal out of Colombian mines to hiring massive cargo ships to move them to Singapore while hedging the future price of coal as it was transported. Those companies, based largely outside of the U.S., had a long and sordid history of doing backroom deals with shady politicians, flouting international trade and human-rights laws, and engaging in tax dodges, pollution, even, allegedly, child labor. The big players in the industry were companies like Glencore and Trafigura, and their founding father was the American fugitive Marc Rich. Other parts of the commodity business feared their aggressive approach to business, given that they transacted with parties with whom the majority of the business world feared to work.

But their scope and sheer manpower helped them understand tiny regional discrepancies in the price of oil and other goods, allowing them to source commodities more cheaply and sell them at a premium. That process generated tens of billions in profits. “This is off the record,” or at least it has to be anonymous, one industry analyst told me, before describing one of the companies, because he didn’t want the subject of his comments “to be blowing up my car.” Many investors and even other traders had reservations about the international trading houses. But the
comprehensive approach taken by Glencore and others, helped by a creative use of corporate regulatory havens, had given them elite status in certain commodity markets and made their executives exceedingly wealthy.

Most hedge-fund traders sat somewhere in the middle of the totem pole. In the larger scheme of commodity trading, they were essentially money changers, pooling other people’s cash to try to outmaneuver the markets, placing bets on where prices would go, and skimming profits off the top of whatever they made when they were right—generally 20 percent of a year’s earnings and about 2 percent of the money investors gave them. A Frenchman who had socialist influences growing up, Andurand considered the physical oil business to be dirty and distasteful, and told me at one point he would never consider taking delivery of an actual barrel of crude. He was just a trader, and although he had an £11 million house near Harrods in London, a customized Bugatti sports car, and a gorgeous Russian wife, he would never attain the sort of riches and power that his counterparts in the corporate commodity logistics business would. He was a mere millionaire, not a billionaire.

Still, Andurand had something others lacked: fearlessness. He traded billions of dollars’ worth of oil contracts in the markets daily, exposing himself to potential losses that many traders couldn’t stomach. Commodity hedge-fund traders talked often about their daddy issues and other insecurities and how they had learned to compartmentalize their financial woes without bringing them home at night. “My wife couldn’t tell you if I had a good day or a bad day—ever,” one Greenwich-based oil trader told me late in 2011. Andurand shared that thinking; he preferred to
spend tens of thousands of euros on a bespoke wedding gown for his fiancée than to acknowledge his setbacks to her directly.

The international banks that dabbled in commodities were lower in the pecking order. In better days, Goldman Sachs and Morgan Stanley took in more than $3 billion apiece in revenue from buying and selling oil, gasoline, copper, and other commodities. They arranged elaborate hedging strategies for airlines dependent on cheap jet fuel, charging fees for their advice along the way, and they lent capital to hedge-fund traders, pocketing interest and fees in return. Sometimes they profited from trading directly with those clients, buying a commodity the client was selling, for instance, and making money unexpectedly when markets moved against that client. But the real money was made in trading for the house—turning their commodity traders into mini-Andurands with purses provided by the bank’s shareholders. In 2008, for instance, two of the best-paid employees at the Swiss firm Credit Suisse were a pair of commodity traders who took home a combined $35 million after betting correctly on the crude markets. Their role was effectively eradicated in 2010 when a new law in the U.S. barred bank employees from trading for the house, prompting them and many of their counterparts to flee to less regulated parts of the industry. But the banks continued nosing around the regulatory margin, looking for ways to optimize their commodity-trading chops, and the Credit Suisse traders simply quit the bank and started their own oil-focused hedge fund.

Lying miserably at the bottom of the commodity-trading power structure were the individuals and corporations that depended on physical commodities—the Coca-Colas, Starbucks, Delta Air
Lines, and small farmers of the world. Those actors were paralyzingly dependent on aluminum, sugar, coffee, and jet fuel for survival, but were, almost without exception, unable to keep up with the commodity traders at banks and hedge funds. Conservative-minded by nature, and loath to use the exotic financial products or fast-moving trading strategies that professional commodity traders employed, they lacked the expertise to game the markets and felt it wasn’t their job to try, anyway. After all, they were selling lattes and airline seats, not risky commodity contracts that required multithousand-dollar down payments. Still, with the prices of many commodities climbing, the companies couldn’t accommodate price shocks, so they often wound up hiring banks to hedge their vulnerability to volatile product markets. The result could include added fees, bad quarters—even potential bankruptcy, if large demands from banks or other trading counterparts for extra cash or collateral became too much to bear.

And if their limited knowledge and power were not enough of an obstacle, these companies and people were also damaged by sleaze in the brokerage business. Twice in the aftermath of 2008, middleman firms that lent money to commodity-contract buyers and sellers to make trades and then finalized them on exchanges failed due to the mishandling of funds, wiping out customer money in the process. One of them, MF Global, was run by Jon Corzine, a former head of Goldman Sachs in the 1990s and later the governor of New Jersey, who at MF used small investor money to pay debts from a side bet on European bonds that had gone bad. The case against him is still cycling through the courts, and it took more than two years for MF Global’s customers to be made whole.

The astonishing wealth of commodity trading’s inner circle was created in near-total obscurity. Because it operated within either
closely held companies that didn’t trade on public exchanges or deep within large banks and corporations, where commodity profits and losses weren’t disclosed separately, the commodity-trading power elite has enjoyed utter anonymity. But if the individual participants in the boom went unnoticed, their impact did not. The commodity market’s sudden growth in volume, and the parallel surge in commodity prices, along with the entrance of public investors such as the California Public Employees’ Retirement System, raised serious questions about whether traders were jacking up the prices paid for commodities by average citizens.

In the United States, where so many people depend on car travel, fuel was an especially charged issue. During the commodity price spikes of 2008,
the resultant $4-per-gallon price of gasoline sparked an outcry in the U.S.,
where members of Congress held forty hearings on the topic in the first half of that year alone. Motorists, trucking companies, and other fuel buyers blamed commodity speculators for driving up prices, and they wanted the government to rein things in. Under intense public pressure, Congress and the Commodity Futures Trading Commission vowed to scrutinize the speculators, who
their own records showed were accounting for a much larger portion of the markets. But the brewing financial crisis and an ongoing political struggle between those in Washington who believed speculators affected commodity prices and those who didn’t made the CFTC slow to act.

Overseas and in the States, the cost of food was another red flag. Food prices had risen during the market boom of the mid-2000s, but the concurrent inflation of home prices and the availability of cheap credit had blunted the impact on consumer spending. In the years after 2008, the price of staple grains like corn, wheat, and soybeans hit all-time highs, making food products costlier, even
unaffordable. Some analysts believed that
grain prices were causing revolution in already-stressed places such as Egypt, which played a pivotal role in the 2011 uprising known as the Arab Spring. And while unpredictable weather, poor crop yields, and a rise in demand were certainly influences, some academics also argued that
commodity indexes like the GSCI were to blame, saying that the structure of those investments, which was to bet over and over again that prices would rise, actually caused such rises to happen in the physical and futures market.

They had a point, as an academic paper published in 2010 later proved. But the clear evidence of causation was still hard to find; even when a connection appeared obvious, the support for the theory tended to be largely anecdotal. Andurand estimates that during that fateful day in May 2011, BlueGold moved the Brent futures market down an additional $2 or $3—exacerbating by up to 33 percent what was already a huge, $10 down spiral in the crude market. Negative headlines about a lawsuit implicating the hedge-fund manager John Paulson, a large holder of the physically backed gold security known as the GLD, appeared to force gold futures down nearly
2 percent on a single day in 2010—a considerable move in a very large market that is difficult for any single party to affect. The idea that there is a connection in both cases is powerful, and likely accurate. But because the impact of market sentiment is impossible to document, we’ll never completely know.

What is clear is that the last decade in commodity trading had a unique impact, both on the market itself and the public’s perception of commodities as a compelling investment. The abundance of new speculators, the meteoric growth of the GSCI and other, similar investment vehicles, and the general ebullience about the supercycle and its implicit effect on raw materials all
made the market’s shifts more dramatic. That volatility created kings in the trading world’s empowered class, and drove other people and companies into financial ruin. The commodities bubble of the 2000s is a snapshot of one of the most extraordinary periods in American finance, providing an object lesson on the role of markets, regulators, and how the money world can sometimes lose its connection to the real one.