Yesterday, I mentioned that the massive purchase of cocoa that took place yesterday in London reminded me of the attempts to corner commodities markets in the late 1800s. Today, the UK’s Telegraph makes it explicit. Citing unnamed experts, the paper reports that “it was very unlikely that a chocolate company, such as Nestle or Kraft, or even their suppliers, would buy such a huge order in one go and that is was probable that one or a number of speculators, possibly hedge funds, had attempted to corner the market.”
Then MSN reported that the hedge fund actually has a name. It’s Armajaro, both a global cocoa broker and the operator of several hedge funds. Later Wall Street Journal Online reported that BNP Paris Bas and nine other brokers took possession of the cocoa. Ah, confusion. That’s what a corner is all about.
Wow, it’s like in the days of the robber barons.
So let me fill you in on what ‘cornering the market’ means. In a traditional corner, a speculator (or hedge fund) buys up as many futures contracts as possible. The same speculator buys up the real commodity. The aim is to trap all those traders who agreed to deliver the commodity at the future date. Those poor suckers can’t settle their positions, except by purchasing the real commodity. But since all or almost all of the commodity is now owned by the speculator, the other traders have no option but to purchase the commodity at the prices the speculator sets.
As William Cronon points out in his marvelous book Nature’s Metropolis. Chicago and the Great West: “A cornered market was a painful and expensive reminder that … paper contracts were ultimately backed by real grain” (p. 127).
In the current case seems a bit different. Still, the corner seems to have been successful. On the last day of trading, the July cocoa contracts commanded a premium of £260 over September contracts. In other words, the Armajaro earned £260/ton on 240,100 tons. That amounts to profit £68.4 million.
Since that neatly wipes out almost all cocoa stored in warehouses registered with the LIFFE exchange, September contracts will surely increase in price. Apparently, Amajaro or BNP Paris Bas or whoever else is behind this are betting on that increase. According to MSN, September usually leads to a price increase since chocolate makers increase production for the Christmas holidays while the new crop from producing countries has not come in yet.
For now the cocoa sits in warehouses in Hamburg, Rotterdam, Antwerp, London and other places. As another trader quoted by MSN pointed: “The question is: what happens to those stocks? Are they going to be marketed? If not, it becomes terrifyingly bullish.”
In other words, all Armajaro has to do it sit on its cocoa and watch prices increase even further. Who said that the cocoa markets were boring.