30 September 2011

The Anglo-American Precious Metals Derivatives Duopoly: Quarterly OCC Report

The US Office of the Currency Comptroller (OCC) issues a Quarterly Report on the Derivatives exposure of US Banks and Trust. The report, including historical archives, can be found here.

The report includes "all insured U.S. commercial banks and trust companies as well as other published financial data." So obviously it is not comprehensive of private funds, and banks without a US subsidiary presence.

The archives go back to 1998, but it is quite clear that the report is not so interesting prior to the repeal of Glass-Steagall and the Gramm-Leach-Bliley Act, also known as the Commodity Futures Modernization Act of 2000.

The report shows that JPM has about 80 percent of the gold derivatives in the world on its book, with HSBC holding the other 20 percent.    And in other commodities, JPM holds a similar position as well as part of their overall $78 trillion derivatives book which is heavily dominated by interest rate and credit derivatives.  But hey, that's without netting, right?  Oh yeah, counter-party risk.

JPM is not just Too Big to Fail.  It IS the market.  And 95% of their transactions are still OTC.

Just for the sake of perspective I did include a chart from the 2Q 2000 report here which shows both the total derivatives exposure, leverage and concentrations, and the gold market in particular. 

Notice that some of the players are no longer with us, and of course there is the big combination of CMB and JPM, when the houses of Morgan and Rockefeller combined after this report was issued to become the leviathan of international banking. 

At that time Chase Manhattan Bank was the biggest player with about $14 Trillion in nominal derivatives with a leverage to total assets of about 43.  The gold market was a three way split amongst Chase, Morgan and Citi, with Fleet grabbing some scraps.

This is for the derivatives gold market among commercial banks.  At that time the silver market was dominated by a non-bank, the now almost infamous AIG. 

As Ted Butler relates in December, 2003:
"Here's how AIG got to be the biggest trader in the silver market. When Drexel Burnham Lambert went bankrupt in 1989, the DBL Trading Group was purchased by AIG, and became the AIG Trading subsidiary, which currently operates out of offices in Greenwich, Conn. You may recall DBL Trading was the subsidiary involved in the temporary gold loan default with the central bank of Portugal at that time.

Before moving over to AIG, the DBL Trading Group worked at Goldman Sachs (J. Aron) in the early 1980's, and before that began at ACLI (A.C. Leon Israel). For the sake of full disclosure, and in an interesting coincidence, I worked at Drexel Burnham Lambert in Miami, for 10 years until 1986, but had no involvement, whatsoever, with DBL Trading."

I include this not only for historical interest, but also to remind you that the derivatives market is only one facet of the markets overall, albeit a growing one that is still about 95% Over The Counter and unregulated. It also still does not include the futures markets in this data.

Here is an overall chart from the June 2011 Report. One thing that immediately jumps out is that JPM now has a total nominal derivatives position of about $78 Trillion. That's a lot of nuts.

The other unmistakable point is that besides the increased concentration, the nominal leverage of Goldman Sachs at 537:1 is that of a hedge fund and not a commercial bank or trust. Even Morgan Stanley is running at a modest 26:1.

By the way,  in a bit of non-metals related gossip, I hear that Mackie Messer is strolling the downtown area, and might be looking to put a blade between the ribs of Meier Schmul with the objective of having one less investment bank in the market, in addition to the fine pickings from the collateral corpses.

Who can really know such things? Not so many as think they do perhaps. But it is good to know who and where your friends are, and with whom they are associating. Just ask Herr Fuld.  Oops, Mistah Kurtz, he dead. John Paulson?

The leviathan JPM, uber bank of Rockefeller and Morgan, holds 80% of the gold derivatives in the world, with HSBC having the rest. HSBC was founded in the British colony of Hong Kong and is now headquartered at Canary Wharf London.

At this sort of concentration you do not have a size advantage, you ARE the market, with all that it implies in terms of knowledge of positions et cetera, at least concerning derivatives. In the non-gold precious metals JPM's derivatives are a more modest 69%.

How important are derivatives to gold and the metals? Not so much, unless you consider it important to know who is hedging what positions and future supply. And it also helps to manage some of the largest non-derivatives positions such as large ETFs for example.

But some might conclude that between them the Anglo-Americans have the gold market in hand.

JPM holds quite a derivatives position in 'other commodities' as well, presumably non-precious metal. Inconsequential thinkgs like food and energy. That makes the commodities boss at JPM, Blythe Masters, Der große Macher in anyone's book.

As general rule of thumb, if you are the House in any game, you should not be able to also sit at the table as a player, internal confidentiality agreements notwithstanding. It really is just that simple.

You should be taking money on a transactional service basis and net zero exposed. And if you can't do that and make enough money, then you need a new business model.

And the notion of commingling this sort of business with insured bank deposits and Federal Reserve subsidies is insane.

Any major commodities player needs to be compact enough to wrap up in a carpet and get rolled out the door, sans bailouts, should conditions require. Even a big player like Enron or Refco.

One cannot help but wonder if some of these mega banks have not become so interwined with government as to be in a virtual partnership in their implementers of fiscal and financial policy, which is a dangerous development indeed.

"Oh the shark has pretty teeth dear,
And he bears them dripping red,
A sharp knife has Macheath dear
And when he flicks it you are dead."