Andurand wasn’t worried. The oil market was a volatile beast, he knew, and such fluctuations weren’t unprecedented. He’d always played them to his advantage, even awakening one time from surgery to find that Brent had risen $10, just as he’d predicted. He kept chatting with the writer, telling him about his philosophy on trading and how he’d applied it at his hedge fund, BlueGold Capital Management, which had been celebrated for having predicted both the high point and the low point of the crude-oil market in 2008. It was a call that had established the firm as one of the most successful commodity hedge funds of all time.
E-mails from upstairs began flooding in. The Brent drop had widened another fraction of a dollar, then another dollar. Andurand’s team was scouring the trader chat rooms and the Internet for information that would explain the sell-off—a production hike by OPEC? A release of the U.S. Strategic Petroleum Reserve?—but there was none to be found. Meanwhile, BlueGold was losing hundreds of millions of dollars. Andurand couldn’t focus. “Why are you looking at your BlackBerry?” the writer finally asked him.
Andurand ended the meeting and rushed upstairs. His two young traders, Neel Patel and Sam Simkin, were sitting at their computers, looking anxious. Brent futures had fallen several dollars in an hour, and their downward spiral was weighing on other parts of the market too. It was a level of distress the thirty-four- year-old Andurand, who had been trading energy products daily for more than a decade, had rarely seen. He called a few other traders to ask what was happening. He instant-messaged a few more. Nobody had a clue.
Whatever it was, it was bad for BlueGold. Andurand and his partners had used complex trades to build a position three times as large on paper as the $2.4 billion in assets they were managing, and it was set to maximize profits as crude oil prices rose. But if crude fell sharply, as it did that day, it could have been disastrous for the hedge fund.
Andurand turned to his traders. “Sell a few hundred million worth!” he said. “See how the market takes it.”
Clicking their mouse buttons furiously to finalize trades on their computer screens, Patel and Simkin began selling off futures on Brent crude as well as its U.S. counterpart, the West Texas Intermediate, or WTI, oil contract, which was pegged to physical crude oil stored in Oklahoma. Although crude was al- ways subject to its own regional supply and demand issues, jitters about the trajectory of prices tended to play out publicly in the futures markets, where hedge funds like BlueGold made bets on whether prices would stay low or high in the months and years to come.
Unloading a multibillion-dollar set of trades was extremely difficult to do without losing additional money in the process. On a calm day, sale orders comprising large numbers of contracts— each of which was linked to one thousand barrels of actual, phys- ical petroleum—could tip other traders off to the idea that somebody had a lot to sell and prompt them to sell oil contracts themselves. The result was an even further price drop. On a rough day, a large sale could prove an even stronger depressant on prices.
BlueGold’s initial sales on May 5 seemed to worsen the mar- kets. Brent continued falling, and the fund’s traders perceived an added drop whenever they pressed the sell button. A few hours into the rout, Brent was down $6, then $7, with little sign of settling.
But Andurand couldn’t afford to stop. He told the traders to wait twenty minutes before making additional sales, hoping that would let the market calm a bit. It was chaos in their office. Land lines and mobile phones were ringing. Competitors and friends wanted updates and gossip. Was BlueGold collapsing? they asked. Reporters had the same question. Everyone knew of Andurand’s appetite for enormous bets—and his reputation for relaxed risk management.
Brent went down, down, another dollar, another fifty cents, another dollar. BlueGold continued selling. By 7:30 that evening in London, as the U.S. markets dwindled to a close, Brent had fallen almost $10.40 per contract, a historic move.
Andurand, finally able to pause, was in a state of shock. Blue-Gold had managed to sell off $3 billion worth of positions, far more than he had expected they could under such duress. But the firm’s losses for the day were a half billion dollars, and it still had $5 billion invested in the markets, betting that crude-oil would rise.
Andurand’s day that May was the sort of experience that would humble any good trader. But in the world of commodity trading, where a relatively small circle of powerful players take enormous risks gambling on the future price of physical raw materials like oil, corn, and copper, huge market moves and the resultant gains and losses are incredibly common.
“Commodity” is an overused word that in colloquial terms applies to things so widely available—toilet paper, milk, dry cleaning— that they are bought and sold almost solely on the basis of price. In the context of the global markets, physical commodities serve a crucial purpose, however: they are the basic building blocks of agriculture, industry, and commerce. The reason Brent crude oil or the widely grown grain known as number two yellow corn are called commodities—a term that brings to mind things that are easily found and not overly valuable—is that their structural, chemical makeup is the same no matter where in the North Sea they are drilled or in what field they are harvested. Like toilet paper and dry cleaning, those commodities also trade on the basis of price. But price in their case is an outgrowth of a long list of what traders call “fundamentals”: the cost of actually getting the commodity out of the earth, the cost of moving it from its source to a buyer, how many people want to buy it at a given time, how plentiful it is in other locations, and at what price, at that particular time.
Commodities may sound like an esoteric market, but everyone has heard of at least some of them. Gasoline and crude oil are important ones, and copper, which is used in the wiring of iPhones and air conditioners and maintains a minor presence on the U.S. penny (which at this point is mostly zinc), is another. Corn, wheat, and cotton are consumed or worn by almost everyone. Other commodities, such as the element cerium, referred to as a “rare- earth” commodity because of its elusiveness, are obscure—although cerium too is put to work in mundane products like cigarette lighters and movie-projection bulbs.
The practice of gaming out commodity price changes through financial bets—the subject of this book—is believed to be quite old. More than three thousand years ago, Sumerian farmers promised a portion of their harvests in exchange for silver up front. Those agreements, known to modern traders as “forwards,” were memorialized in the first written language, a body of symbols known as cuneiform.
The trading of commodities based on future deliveries persisted for centuries, from ancient Rome to the Italian merchant cities to the Dutch traders who exchanged tulips in the 1630s. Commodity trading came to the U.S. with the British colonists, and was formalized by the opening of the Chicago Board of Trade in 1848, spurring a century and a half of more sophisticated virtual trading by a group of more dedicated practitioners. Eventually, commodity trading became its own dedicated niche. Farmers uncertain of the next year’s crop wanted to ensure that they had a reliable amount of income, even in a bad year, and companies dependent on a certain metal for manufacturing wanted to lock in lower prices in advance to guard against a huge price spike that could erase their profit margins. Over time, additional commodity exchanges opened in the cities that most needed them, and entire companies grew up around the need simply to hedge commodities.
During the 2000s, however, commodity trading became the new fad. Volume and volatility in the commodity contract markets exploded, propelled by a massive influx of both everyday and professional investors. In the “listed” markets, where contracts traded at places like the New York Mercantile Exchange and the Intercontinental Exchange in Atlanta, volume shot from roughly 500 mil- lion contracts per year in 2002 to nearly 2 billion contracts in 2008.
Meanwhile, in the over-the-counter market for commodity contracts, where an array of exotic financial products connected to physical commodities was traded party-to-party by phone and computer (in other words, off the exchange), the total value on paper of the trades outstanding spiked from about $800 billion to more than $13 trillion over roughly the same period. Suddenly, commodity contracts, once a rounding error in the world of tradable products, were all the rage.
Nonetheless, commodity investing was small compared to stocks, bonds, and currencies. Until the mid-2000s, most investors had never seriously considered adding commodities to their individual portfolios, which tended to favor simple, easily traded things like stocks and U.S. Treasury bonds. But something happened to commodities in the 2000s to change their minds: a huge increase in prices and an especially convincing sales job by Wall Street.
Between the early 2000s and the middle of 2008, before the U.S. financial crisis hit, the contracts tracked by the Goldman Sachs Commodity Index, known as the GSCI for short—the commodity equivalent of the Standard & Poor’s 500 Index—nearly tripled in price. (S&P, in fact, bought the index and added its own name to the title in 2007.) Crude oil futures rose three and a half times their earlier levels. Corn futures also tripled. Even gold, an odd- ball commodity because it often performs better when the stock markets fall—and in this case stocks were on fire—nearly doubled.
It was a period of easy money, and the benefits were felt all around, from state pension funds that had added commodities to their investments in order to mitigate their exposure to other, unrelated markets, to individual investors, who had dipped into commodities as a way to make money off of skyrocketing oil prices even though their gasoline was so much more expensive at the pump. Salesmen for the GSCI and other commodity indexes ar- gued that their products were an important way to diversify in- vestment portfolios. An array of new securities that traded like stocks but tracked precious metals like gold and silver had made commodity investing easier for regular people than ever before, and the commodity market’s inexorable upward movement meant that they’d be crazy not to buy in.
“Wall Street did a nice job of marketing the value of having the diversification of commodities in your portfolio,” says Jeff Scott, chief investment officer of the $74 billion financial firm Wurts & Associates. “I don’t mean that sarcastically. And there is value to having certain commodities in your portfolio. Unfortunately, the return composition changed.” In other words, at a certain point the money wagon stopped rolling along.
Until 2008, there were plenty of reasons to like commodities, most important of which was the torrid pace of demand in India and China. Those economies, which were driving up the price of raw materials around the world, were widely seen as the harbingers of what the buzzier banking analysts referred to as a new “supercycle,” a period of sustained world growth the likes of which had not been seen since World War II. There was also a prevalent theory known as “Peak Oil” suggesting that the world’s petroleum supplies were well on their way to being tapped out—a situation that would make crude oil, the engine of so many economies, frighteningly scarce. Both hypotheses augured a continuing climb in the price of oil.
But during the second half of 2008, the belief in higher com- modity prices vanished. Like stocks and bonds, commodities were roiled by the financial crisis in the U.S. The main commodity index plummeted, and crude-oil contracts sank to a fraction of their record high of $147. Underlying their sudden drops amid volatile times in the market was a broader story line: the whole commodity craze had by then begun to fizzle.
Throughout the bubble in commodities, a core group of traders were siphoning much of the profit. They were industry veter- ans who, like Pierre Andurand, used a combination of strategy and heft to play the markets to their benefit. Along the way, their bets that commodity prices would rise had the ability to move markets upward, and their bets that prices would fall, the opposite. For the most part, they weren’t manipulating prices by hook- ing up with fellow traders to orchestrate group decisions, nor were they buying physical commodities to constrict supplies while collecting money by betting that the futures prices would go up, a classic commodity swindle known as cornering. But their intimate knowledge of nuanced industries, their access to closely held in- formation, and their enormous resources gave them tremendous advantages that few others had. And even when they bet wrong, they were still so rich and well connected that they could usually return the next day and begin to make their money back.
It was an industry of optimism, peopled by wealthy, focused traders who were not afraid of an occasional setback. Some had absentee fathers whose gaps they longed to fill with power and money, some were simply more comfortable with risk than their counterparts. After all, commodities were an area in which the market swings in a given day could be exponentially greater in size than the typical moves in stock or bond markets.
“When you trade commodities, you realize really quickly that markets can do anything,” explained Gary Cohn during an inter- view in Goldman’s sleek New York corporate offices one day in 2012. “So I love when I sit there with guys who say, ‘that would be a three-standard-deviation move,’ ” that is, a shift in market prices that was three times as great as the typical one would be—as if that notion should come as a shock to the listener, he added: “In commodities, we have three standard-deviation moves in a day.”
Commodity players can appear pampered, even lazy. Maybe they spend half the summer in Provence or Nantucket, working remotely from a Bloomberg terminal in their home office while their kids are minded by a live-in nanny. They might piddle away a serious investor meeting talking martial arts, move a long- scheduled international appointment just days in advance, refuse to take a view on the markets, or be too busy grouse-hunting in Norway to answer a couple of questions about the crude-oil business. All of the above happened with people interviewed for this book. But when it comes to trading raw materials, they are a shrewd and indomitable lot, and, at least for the moment, the contracts they trade are still so loosely regulated that the correct combination of money and skill creates irresistible opportunity. That’s why I am only half-joking when I call them the secret club that runs the world.
In BlueGold’s prime, it had several hundred competitors in the hedge-fund business, each of varying size. Commodity hedge funds, typically based in London, Greenwich, or Houston, picked one or more raw materials they understood well, then made a business of trading in the related contract markets. Their inves- tors, usually a combination of larger money-management firms and wealthy individuals, presented them with billions of dollars to trade. There were many winners, but John Arnold, a onetime Enron trader who went into business for himself after it folded, did the best of all; his natural-gas-focused hedge fund, Centaurus Energy, generated 317 percent returns in 2006. Several years later, Arnold retired, a billionaire at the age of thirty-eight. He became a philanthropist.
Prodigies like Arnold were the superstars of the industry, com- manding respect as a result of the enormous sums of money they’d made. Andurand, who generated 209 percent returns in 2008, was in there too. But few hedge-fund traders were quite that accomplished. The rest of the commodity-trading hierarchy was topped by the large, multinational brokers involved in every single aspect of commodity harvesting and trading, from extract- ing the coal out of Colombian mines to hiring massive cargo ships to move them to Singapore while hedging the future price of coal as it was transported. Those companies, based largely outside of the U.S., had a long and sordid history of doing backroom deals with shady politicians, flouting international trade and human- rights laws, and engaging in tax dodges, pollution, even, allegedly, child labor. The big players in the industry were companies like Glencore and Trafigura, and their founding father was the Amer- ican fugitive Marc Rich. Other parts of the commodity business feared their aggressive approach to business, given that they transacted with parties with whom the majority of the business world feared to work.
But their scope and sheer manpower helped them understand tiny regional discrepancies in the price of oil and other goods, allowing them to source commodities more cheaply and sell them at a premium. That process generated tens of billions in profits. “This is off the record,” or at least it has to be anonymous, one industry analyst told me, before describing one of the companies, because he didn’t want the subject of his comments “to be blowing up my car.” Many investors and even other traders had reservations about the international trading houses. But the comprehensive approach taken by Glencore and others, helped by a creative use of corporate regulatory havens, had given them elite status in certain commodity markets and made their execu- tives exceedingly wealthy.
Most hedge-fund traders sat somewhere in the middle of the totem pole. In the larger scheme of commodity trading, they were essentially money changers, pooling other people’s cash to try to outmaneuver the markets, placing bets on where prices would go, and skimming profits off the top of whatever they made when they were right—generally 20 percent of a year’s earnings and about 2 percent of the money investors gave them. A Frenchman who had socialist influences growing up, Andurand considered the physical oil business to be dirty and distasteful, and told me at one point he would never consider taking delivery of an actual barrel of crude. He was just a trader, and although he had an £11 million house near Harrods in London, a customized Bugatti sports car, and a gorgeous Russian wife, he would never attain the sort of riches and power that his counterparts in the corporate commodity logistics business would. He was a mere millionaire, not a billionaire.
Still, Andurand had something others lacked: fearlessness. He traded billions of dollars’ worth of oil contracts in the markets daily, exposing himself to potential losses that many traders couldn’t stomach. Commodity hedge-fund traders talked often about their daddy issues and other insecurities and how they had learned to compartmentalize their financial woes without bringing them home at night. “My wife couldn’t tell you if I had a good day or a bad day—ever,” one Greenwich-based oil trader told me late in 2011. Andurand shared that thinking; he preferred to spend tens of thousands of euros on a bespoke wedding gown for his fiancée than to acknowledge his setbacks to her directly.
The international banks that dabbled in commodities were lower in the pecking order. In better days, Goldman Sachs and Morgan Stanley took in more than $3 billion apiece in revenue from buying and selling oil, gasoline, copper, and other commodities. They arranged elaborate hedging strategies for airlines de- pendent on cheap jet fuel, charging fees for their advice along the way, and they lent capital to hedge-fund traders, pocketing inter- est and fees in return. Sometimes they profited from trading directly with those clients, buying a commodity the client was selling, for instance, and making money unexpectedly when markets moved against that client. But the real money was made in trading for the house—turning their commodity traders into mini-Andurands with purses provided by the bank’s shareholders. In 2008, for instance, two of the best-paid employees at the Swiss firm Credit Suisse were a pair of commodity traders who took home a combined $35 million after betting correctly on the crude markets. Their role was effectively eradicated in 2010 when a new law in the U.S. barred bank employees from trading for the house, prompting them and many of their counterparts to flee to less regulated parts of the industry. But the banks continued nos- ing around the regulatory margin, looking for ways to optimize their commodity-trading chops, and the Credit Suisse traders simply quit the bank and started their own oil-focused hedge fund.
Lying miserably at the bottom of the commodity-trading power structure were the individuals and corporations that depended on physical commodities—the Coca-Colas, Starbucks, Delta Air Lines, and small farmers of the world. Those actors were paralyz- ingly dependent on aluminum, sugar, coffee, and jet fuel for sur- vival, but were, almost without exception, unable to keep up with the commodity traders at banks and hedge funds. Conservative- minded by nature, and loath to use the exotic financial products or fast-moving trading strategies that professional commodity traders employed, they lacked the expertise to game the markets and felt it wasn’t their job to try, anyway. After all, they were sell- ing lattes and airline seats, not risky commodity contracts that required multithousand-dollar down payments. Still, with the prices of many commodities climbing, the companies couldn’t ac- commodate price shocks, so they often wound up hiring banks to hedge their vulnerability to volatile product markets. The result could include added fees, bad quarters—even potential bank- ruptcy, if large demands from banks or other trading counter- parts for extra cash or collateral became too much to bear.
And if their limited knowledge and power were not enough of an obstacle, these companies and people were also damaged by sleaze in the brokerage business. Twice in the aftermath of 2008, middleman firms that lent money to commodity-contract buyers and sellers to make trades and then finalized them on exchanges failed due to the mishandling of funds, wiping out customer money in the process. One of them, MF Global, was run by Jon Corzine, a former head of Goldman Sachs in the 1990s and later the governor of New Jersey, who at MF used small investor money to pay debts from a side bet on European bonds that had gone bad. The case against him is still cycling through the courts, and it took more than two years for MF Global’s customers to be made whole.
The astonishing wealth of commodity trading’s inner circle was created in near-total obscurity. Because it operated within either closely held companies that didn’t trade on public exchanges or deep within large banks and corporations, where commodity prof- its and losses weren’t disclosed separately, the commodity-trading power elite has enjoyed utter anonymity. But if the individual par- ticipants in the boom went unnoticed, their impact did not. The commodity market’s sudden growth in volume, and the parallel surge in commodity prices, along with the entrance of public in- vestors such as the California Public Employees’ Retirement Sys- tem, raised serious questions about whether traders were jacking up the prices paid for commodities by average citizens.
In the United States, where so many people depend on car travel, fuel was an especially charged issue. During the commodity price spikes of 2008, the resultant $4-per-gallon price of gasoline sparked an outcry in the U.S., where members of Congress held forty hearings on the topic in the first half of that year alone. Motorists, trucking companies, and other fuel buyers blamed commodity speculators for driving up prices, and they wanted the government to rein things in. Under intense public pressure, Congress and the Commodity Futures Trading Commission vowed to scrutinize the speculators, who their own records showed were accounting for a much larger portion of the markets. But the brewing financial crisis and an ongoing political struggle between those in Washington who believed speculators affected commodity prices and those who didn’t made the CFTC slow to act.
Overseas and in the States, the cost of food was another red flag. Food prices had risen during the market boom of the mid-2000s, but the concurrent inflation of home prices and the availability of cheap credit had blunted the impact on consumer spending. In the years after 2008, the price of staple grains like corn, wheat, and soybeans hit all-time highs, making food products costlier, even unaffordable. Some analysts believed that grain prices were caus- ing revolution in already-stressed places such as Egypt, which played a pivotal role in the 2011 uprising known as the Arab Spring. And while unpredictable weather, poor crop yields, and a rise in demand were certainly influences, some academics also argued that commodity indexes like the GSCI were to blame, saying that the structure of those investments, which was to bet over and over again that prices would rise, actually caused such rises to happen in the physical and futures market.
They had a point, as an academic paper published in 2010 later proved. But the clear evidence of causation was still hard to find; even when a connection appeared obvious, the support for the theory tended to be largely anecdotal. Andurand estimates that during that fateful day in May 2011, BlueGold moved the Brent futures market down an additional $2 or $3—exacerbating by up to 33 per- cent what was already a huge, $10 down spiral in the crude market. Negative headlines about a lawsuit implicating the hedge-fund manager John Paulson, a large holder of the physically backed gold security known as the GLD, appeared to force gold futures down nearly 2 percent on a single day in 2010—a considerable move in a very large market that is difficult for any single party to affect. The idea that there is a connection in both cases is powerful, and likely accurate. But because the impact of market sentiment is impossible to document, we’ll never completely know.
What is clear is that the last decade in commodity trading had a unique impact, both on the market itself and the public’s perception of commodities as a compelling investment. The abundance of new speculators, the meteoric growth of the GSCI and other, similar investment vehicles, and the general ebullience about the supercycle and its implicit effect on raw materials all made the market’s shifts more dramatic. That volatility created kings in the trading world’s empowered class, and drove other people and companies into financial ruin. The commodities bubble of the 2000s is a snapshot of one of the most extraordinary periods in American finance, providing an object lesson on the role of markets, regulators, and how the money world can sometimes lose its connection to the real one.