Goldman’s Expansion in Metal Warehousing Paying Off

Goldman Sachs‘ (NYSE:GS) foray into the metals warehousing business with the purchase of Metro International in February 2010 has proven to be a good bet. Warehouse inventories of metals continue to be at record highs bringing some gains to the bank. ^[1] Other players in the commodities trading industry like JPMorgan (NYSE:JPM), Glencore (LON:GLEN) and Trafigura have also purchased warehousing firms over the past year as banks and traders increasingly view these assets as a ‘recession hedge’. ^[2]

We have a $164 price estimate for Goldman Sachs, which is at a 20% premium over its current price.

Metal Warehousing is a classic acyclic business

The demand for storage facilities of metals such as aluminium and nickel traded on the London Metals Exchange (LME) increases with a fall in global metal demand. In 2010, metal stockpiles held in depots registered with the LME swelled to 6 times their levels in 2007 – bringing in unprecedented storage revenues from clients who stockpile their metals in warehouse locations. Through its purchase of Metro International, Goldman Sachs now owns the biggest warehouse in the LME system and hold a quarter of the aluminium stored in the metal exchange’s facilities. ^[3].

Goldman charges 42 cents to store a metric ton of aluminium in its facilities for a day, which translates into $150 in annual revenues for every metric ton it stores. ^[1] With millions of tons in storage, the industry is expected to rake in $1 billion in storage revenues each year. Goldman Sachs which is estimated to hold 900,000 tons in its facilities can make $138 million in revenues from its storage business alone. ^[3]

The LME limits the quantity of metal that leaves any of its depots and Metro benefits significantly from this. Customers have to wait for 7 months before they can accept a delivery and for this entire period they have to pay the storage charges and other fees.

Metal customers’ uneasiness could result in a change in regulation

Coca-Cola, a significant aluminium consumer, has complained to the LME that the strategy of warehouses to limit metal outflows with no such limits over the inflow, combined with the charge and fees collected in the process is making physical delivery of the metal very expensive. ^[3] In response to such complaints, the LME commissioned a study which recommended that larger warehouses such as Metro must release a higher minimum quantity of reserves each year. Presently, all warehouses have to meet a minimum release limit of 1,500 metric tons of metal each day – regardless of their holdings.

However, with huge stockpiles in place and with strong cash incentives being offered by warehouses to metals suppliers to use storage facilities, we expect the warehouse business of Goldman Sachs to continue to rake in strong revenues in the near future.

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1. Commodities Beckon Banks, Wall Street Journal [↩] [↩]
2. Goldman and JPMorgan enter metal warehousing, Financial Times [↩]
3. Wall Street Gets Eyed in Metal Squeeze, Wall Street Journal – Yahoo Finance [↩] [↩] [↩]