With US stock and bond markets slumping, Wall Street banks have increasingly been counting on surging commodity markets to help their bottom lines. Even oil, once seen as a risky investment, had lately joined gold in some investors’ eyes as a “safe haven” play.
But wild swings in crude oil this year, even as prices approached a record high of near $140 a barrel, actually hurt Wall Street banks in the Q2. Goldman Sachs and Morgan Stanley -- ranked No. 1 and No. 2, respectively, among US investment banks -- reported this week thinner receipts from commodities in three months to May versus the previous quarter.
Both Goldman Sachs and Morgan Stanley indicated that their second-quarter commodity revenues were hit by volatility in energy markets, as crude oil prices dropped from $100 a barrel at the start of the year to below $90 in February, then jumped again to around $130 at the end of May. “We took contrarian bets in the energy sector,” Morgan Stanley’s Chief Financial Officer Colm Kelleher told Reuters. “We felt it was the right trade. It didn’t work.”
Wall Street banks generally don’t give details of their commodities trading or returns, but analysts estimate that commodities investments by banks and major institutional investors swelled from about $13 billion to $260 billion in five years. Goldman’s CFO David Viniar said market talk about the bank’s Q2 commodities results was “way overblown”. Goldman’s commodities business, the largest among investments banks, is widely watched, along with that of Morgan Stanley.
Both run divisions that ship crude oil and own other viable hard assets in commodities. “They are significant oil merchants who have to hedge bets on both the physical market and futures,” said an analyst familiar with the physical commodity operations of the two banks. “There are many moving parts to their game and the volatility in oil prices makes it harder for them.”
Other US banks with sizeable commodities businesses, such as Citigroup, JP Morgan Chase and Merrill Lynch, have yet to report Q2 results. But any further slackening in commodity earnings could disappoint investors who had come to think of the asset class as an avenue to lift earnings at institutions still writing down billions of dollars on mortgate related assets. “I would have expected commodity operations to have been one of the bright spots for banks, given their involvement in fewer IPOs and mergers now,” said Peter Beutel at Cameron Hanover, an oil trading advisory in New Canaan, Connecticut.
Analysts said stakes for investing in commodities had gone up immensely with this year’s 40% jump in oil prices. Banks, whipped by the credit crisis, were more cautious. “Because prices have gone so high, a lot of banks have started lightening their load in proprietary trading of oil,” said Mark Waggoner, President at Excel Futures in Huntington Beach, California. “If you look at the chart for oil prices, you’ll see the market is overbought. So do banks want to take more risk in an overbought market? I think not. They aren’t invested the way they used to be and because of that, their returns aren’t as high,” Waggoner said.
Others noted that commodities remain a risky bet for investors. “The commodities business is essentially and inherently volatile,” said Matt McCormick, analyst at Bahl & Gaynor Investment Counsel Inc, in Cincinnati, Ohio. “To think of it as a safe haven under any circumstances is to play with fire, particularly if you look at the potential demand destruction now for oil and energy commodities from the way their prices are trading.”
Goldman said in its Q2 earnings report that its risk for commodities had doubled from a year ago. The bank’s average daily Value-at-Risk (VaR) for commodities reached $48 million in the Q2 to May 30, up from $38 million in the Q1 and $24 million in the quarter to May 25 2007. The VaR for commodities sums up the potential loss in value that a bank trading commodities may face over a one-day time horizon owing to adverse market movements.
Morgan Stanley’s VaR growth was relatively modest, reaching $39 million at the end of the Q2, versus 38 million in the Q1 to February 29 and $34 million in the Q2 to May 31, 2007. Lehman Brothers, another Wall Street bank that reported Q2 results this week, said its commodities VaR rose $1 million from the Q1 to $12 million. (Reuters)