Cornering Copper
There’s generally one event that comes to mind when people think of individuals attempting to corner a commodities market: the famous Hunt Brothers and the unraveling of Silver Thursday.
But starting only a short while after that, a young man named Yasuo Hamanaka would attempt to accomplish a similar feat, and, over the course of seven years, he would similarly fail.
Let’s talk about Mr. Copper.
The Early Days
Yasuo Hamanaka begins his copper career working for one of the oldest and most prestigious corporations in Japan: Sumitomo Group. Sumitomo was established in 1615 by a Buddhist monk (Sumitomo Masatomo) and as soon as it was incorporated began mostly functioning as a copper refining and smelting business. Sumitomo’s guiding principles are as follows:
I guess gratitude and trustworthiness are subjective.
After being hired for the copper physical settlement side of the Sumitomo trading desk, Hamanaka becomes known for his ruthless, successful trading practices. But there is a problem: despite being ruthless, Hamanaka’s trading is quite poor. He is already losing Sumitomo money and hiding it when he’s upgraded from being the head of physical copper settlement to the head of all copper trading — physical, futures, miners, everything.
A Plan is Hatched
As previously discussed in WorldCom and The Fraud That Was, most large-scale frauds don’t start out that way, but take one step in the wrong direction that subsequently compounds. In this case, the compounding problem was Hamanaka’s losing trades that he was hiding from his supervisors. He needed to win, and to win would require a hail mary the likes of which had rarely been seen.
So in 1989 he meets with a fellow copper aficionado, R. David Campbell, and they determine a way to game the copper market. Unfortunately for David, his employer at the time isn’t interested in the scheme, however, fortunately, there’s an easy solution: David Campbell will strike out on his own!
And so he does. In 1993 Campbell forms his own copper merchant company, called Global Minerals and Metals Corp. with the express intent and purpose of creating false demand for copper with his partner-in-crime, Yasuo Hamanaka.
Without any knowledge of how metals trade it can seem almost impossible to untangle the web of deception that occurs, but here’s the breakdown:
Global, as an unknown startup, is unable to assume the large lines of credit necessary to propagate the scheme, so Campbell seeks out a director at Merrill Lynch to open an account in the name of Sumitomo, with capital acquired by Sumitomo wires, but with trading authority denominated to Global.
Through this mechanism, Global is able to create massive long exposure to copper via futures contracts on the London Metal Exchange (LME) and pushes the price of copper up.
The problem with pumping the price of any asset is the inevitable dump. To mitigate their exposure to this sure thing, Campbell and Hamanaka devise a plan that allows them to, without having to move copper (which can get extraordinarily expensive fast), unwind their position. In its simplest terms, the concept looks something like this:
Now, they still find themselves unable to fully unwind their massive positions so they devise a secondary scheme: they create a story that makes it sound as if there is suddenly a huge uptick in demand for copper in Q4 of 1995. Sound simple, almost stupid? Yes.
The fraud continues to grow in size and scope.
In a weird and difficult to conceptualize move, Global and Sumitomo form a “buy-sell back arrangement” with Merrill Lynch. Again, without getting into the weeds, this arrangement allows Global and Sumitomo to appear as if they are accepting large, physically settled copper contracts, while in reality these contracts are being sold back to Merrill Lynch prior to exercising, held until after settlement, and then a new contract with different terms is sold to Global and Sumitomo.
This circular contractual agreement (Commodity Inventory Purchase Obligations or CIPOs) is actually invented by Merrill Lynch in 1991, only a few years prior to the Sumitomo Copper Affair, and is not widely understood or utilized (similar to CDOs circa ’07-’08) while Campbell and Hamanaka use it to perpetuate a wide-scale fraud. Merrill Lynch ends up providing nearly a half billion dollars to the two traders.
At this point two men, Hamanaka and Campbell, control large swaths of the physically settled copper market, either through contracts, contracts controlled through Merrill Lynch, physical copper held through Sumitomo, or real and imaginary copper held in a single Zambian copper miner and smelter. This is when the magic happens.
Hamanaka and Campbell begin to withhold their copper from the market, driving the price of physical copper up, and then subsequently driving the price of futures contracts up. It’s all going according to plan.
Until…
In late 1995, the CFTC notices strange movements in physically settled copper and its price. An investigation is started and its conclusive:
You can see the jump in price of copper followed by its cratering in the chart below:
Takeaways
On the list of worst trades of all-time, Yasuo Hamanaka’s attempt to corner the copper market currently ranks number eight.
But it isn’t widely remembered or discussed, like the story of credit default swaps or Bill Ackman’s spotty trading record. There’s, likely, a variety of reasons for this, ranging from complexity of the fraud (possibly even more complex and layered than credit default swaps) to the quick silence and payment of fines by both Sumitomo and Hamanaka.
Regardless, the point I keep reflecting on personally is how complicated and difficult to comprehend the entire affair is. It took me weeks to fully understand exactly how Hamanaka got away with this, and I’m still left scratching my head: How did he hide this from superiors for years? Did some of his bosses know his trading practices and turn a blind eye? What were the ramifications for other traders in the copper space?
Besides numerous remaining questions concerning a fraud almost three decades old, I also am thankful to see an example of financial fraud that sounds conspiratorial, that is purposely obfuscated to make skeptics sound unreasonable, and made completely opaque to confuse even industry insiders, but was still discovered and shuttered. There’s a lot of frauds out there now and I hope they suffer similar fates.
Stay skeptical, friends.