Commodity Funds Now the Real Power

The fall of Sumitomo Corp.’s top copper trader, which led to the current copper trading scandal, showed that the speculative funds are now the real power in commodity markets with the weight to overwhelm any “Mr. Big.”

Ironically, say commodity analysts, the cash-rich funds that sold copper and smashed Sumitomo trader Yasuo Hamanaka’s trading position in early June might, back in 1993, have rescued him from earlier, deep trouble. At that time they were buyers.

Meanwhile, some experts believe that the Japanese trader may actually have been close to making a huge killing for Sumitomo at the expense of hedge funds and speculators when the Japanese firm fired him last month.

Traders, bankers and analysts who now suspect this, however, said that only Hamanaka, missing since he was fired, knows the details of his trading book.

One well-informed metals trader suggested that the attempt to squeeze copper prices may have failed only because, even as Hamanaka battled the market, Western regulators who were examining the copper trade persuaded Sumitomo that his trading position was much larger than it had known.

Hamanaka’s tactic for a decade was to influence prices through Sumitomo’s control of huge chunks of copper inventories.

Some traders say he might even have extricated himself from this year’s crisis if he had stayed at his desk and had not been investigated and then fired by Sumitomo last month, allegedly after it lost $1.8 billion, when Western regulators closed in.

But the funds, although comparatively new in the metals market, have learned quickly and have huge resources of cash.

“The funds previously thought that base metal risks were too high versus the returns,” says Keith Murphy, Managing Director of Commodities at J.P. Morgan.

The change in strategy took place in the early 1990s as funds developed relationships with banks and companies who had knowledge about the workings of the London Metal Exchange, which trades copper, zinc, lead and other metals.

As for the muscle, a typical hedge fund has up to 99 members who subscribe to it for between $500,000 and $5 million each, Murphy said.

High-profile big funds such as George Soros’ “Quantum” and Julian Robertson’s “Tiger” have net assets of $11 billion and $7 billion, respectively, he noted.

These funds, with Montreal-based metals dealer Herbie Black of American Iron and Metals, helped bring down Hamanaka, although Soros is said to have given up selling copper--and trying to break Hamanaka’s position--back in March.

Several Sumitomo squeezes on the LME have been identified by traders since the late 1980s.

By hoarding stocks of metal in LME warehouses, Hamanaka was able to force prices higher by squeezing shorts, those traders who sold metal they did not have and were unable to deliver.

There were squeezes in 1988, 1991, and, significantly, in 1993--a year when there were major price fluctuations and talk of massive Sumitomo trades with off-market traders.

Other forces were certainly in the market in that year. It started with prices at a high of $2,305 a metric ton before Chinese selling of up to 500,000 tons sent it to $1,712 in May.

Sumitomo stepped in and squeezed the market in July back up above $2,000. But this led the LME in September to act by restricting the daily premium on prompt copper to just $5.

This cut into potential profits from the squeeze and sent copper into a tailspin to a late October low of $1,613. If these lows had held, some analysts think Hamanaka might have been broken then.

But it was not to be. Enter, say traders, the funds. In late October they watched the global economy begin to pick up and reckoned that this was the bottom of a base metals cycle.

So, late in 1993, they bought copper in strength and fueled a scorching rally that lifted it above $3,000 by year’s end.

In the first month of 1994 they brought $1 billion of fresh money into the LME, while investment houses underscored the rally by issuing warrants based on a basket of metals, which according to some estimates were worth $1.5 billion.

The funds, analysts said, trade with the fundamentals of supply and demand--not against them, as Sumitomo sometimes seemed to do. Typically, they enter a market just after it finds a floor and will exit as it nears a ceiling.

Because of the funds, Sumitomo was probably able to take a back seat, as long as copper stayed high, as it did for most of 1995. But prices well above the cost of production encouraged a rash of new mining projects and the threat of oversupply.

So the funds cashed in their profits and by late 1995 were looking to reenter the market as big sellers. Senior traders said selling started in September when the Soros fund is believed to have sold 500,000 tons.

Hamanaka made what would be his last attempt to support the market. But more selling by funds and others, plus rumors that he was no longer in his job, later confirmed, broke the price.

It dropped from $2,700 in early May of this year to a 2 1/2-year low at $1,745 on June 25.