Can You Corner a Market?

Having established the Standard Oil Company of Ohio in 1870, John D. Rockefeller had pretty much cornered the oil industry in Ohio by March 1872. By 1878, he controlled 90% of all oil refined in the U.S. and, soon thereafter, most of its marketing facilities. In the end, though, the Sherman Antitrust Act bit and the Standard Oil Trust was broken up.

There's a great little game you can play on the PBS website titled "Play Corner the Market" that'll give you some useful lessons if you're interested in building monopolies.

We've come a long way since the great trusts/monopolies of the late 19th century, and the sophistication of our various markets-financial, soft commodity and metals, to name but three-would be a source of wonder to the likes of Rockefeller and his contemporaries. However, the temptation to try to corner markets, whether by individuals or institutions, appears as strong as ever. Only now, people are less prepared to wait to reap the rewards of their efforts.

A very brief review of just some of the more audacious (or dumb) attempts to corner various markets over the past 30 years or so leaves you scratching your head and asking: "Why?"

Treasury bonds (yes, Treasury bonds), silver, propane, energy ... you choose! It's been tried.

What can we learn from studying these attempts, and what markets may be vulnerable in the future?

Treasury Bonds

Perhaps some of the most audacious attempts at corners (in terms of the market used) were those of Salomon Brothers Inc. in the U.S. government bond market back in late-1990 and -1991.

Even with rules in place to prevent any one dealer holding more than 35% of each issue, in at least two instances, using the names of other people who had authorized no such bids, Salomon bid at government auction for, and got, more bonds than it was allowed. In both these cases it was then able successfully to put on a squeeze.

As one participant in the market at the time told the International Herald Tribune: "This would never have happened if the Treasury would modernize the bidding process for government bonds and install a computer."

So, while the Salomon's traders may have thought they could get one over on the Treasury because it lacked a computer, it seems surprising that they thought they might also get one over on the Securities and Exchange Commission (SEC) who, quite naturally (and with computers), had been tracking bond sales following their squeezes.

In the end, the fallout for Salomon Brothers was severe. The scandal took the heads of John H. Gutfreund, chairman and CEO; John W. Meriwether, vice chairman; and Thomas W. Strauss, president, and the firm had to pay a fine of $290 million. Warren Buffett took over as chairman and CEO to clear up the mess.

Paul W. Mozer, the main Salomon trader involved in the scandal, paid a hefty fine and went to jail. His top aide, Thomas Murphy, was also the subject of various lawsuits.

Two particular aspects of the affair continue to make you gasp: Mr. Murphy was, at the time, chairman of the Public Securities Association's committee on government trading practices (the government bond dealers' trade group). And, early in the investigation, Salomon had insouciantly explained that it was only because of a "practical joke" that it had, by mistake, bought $1 billion of bonds.

Silver

Who else but Bunker and the brothers Hunt?

In 1979-80, just over 10 years prior to Salomon's efforts, Nelson Bunker Hunt, together with his brothers Herbert and Lamar and, amongst others, a group of fiercely rich Saudis, tried to corner the world's silver market. They succeeded, but their success was a passing one. By 1990, Bunker and Herbert, anyway, were bankrupt.

Essentially, in a little over a year, the team contrived to take control of both the futures and cash markets in silver. On the one hand, it held vast quantities, off the market, of physical silver (at one time it controlled silver worth in excess of $14 billion); on the other, it held massive futures positions for which, on maturity, it demanded physical delivery. It was a classic squeeze.

In January 1979, silver was worth around $6 an ounce. On one day in January 1980, it traded briefly at over $50. By March 1980, however, the price had crashed to around $12. In 1993 it was back down to around $5.

How did the team get its comeuppance? When the price of silver approached $50 an ounce, the U.S. Commodity Futures Trading Commission [CFTC] and markets took action by imposing liquidation-only trading. That is, traders were prevented from either rolling forward or establishing any new positions and had to trade only to close out existing positions. The day following the imposition of such trading, the price of silver dropped some $12.

Through late March, the team sought vainly to support the metal's price. To compound the team's woes, the exchanges increased their margin requirements. On March 19, the Hunts failed to meet their margin calls. On March 26, in one last desperate fling, they proposed to issue bonds backed by their silver holdings. The market would have none of it. On Silver Thursday, March 28, 1980, the market crashed and that was the end of it. The rest is history. (When asked later what he thought about it all, particularly losing his fortune, Bunker's simple reply was: "A billion dollars isn't worth what it used to be.")

The Hunts' attempt was certainly audacious, in its scale if nothing else. What they hadn't taken into account, though, was that with their ability both to impose liquidation-only trading and increase margin levels, the exchanges actually had quite effective tools to curtail such activities.

Propane And Energy

More recently, BP tried to corner the market in propane gas, while (it would appear) Amaranth (a hedge fund) tried the same in energy. The result for both? Disaster and expense.

On October 25, 2007, BP in the U.S. agreed to pay nearly $303 million to settle civil and criminal proceedings brought against it by the CFTC and the U.S. Department of Justice. The CFTC alleged that, back in February 2004, BP's natural gas trading team in Houston, Texas, sought to corner the TET propane market. BP, of course, denied any market manipulation.

At the end of the day, BP not only had to pay a huge settlement, but, ironically, it also made a trading loss on the original scheme. (At the end of February 2004, possibly realizing the nature of the squeeze, a large seller of propane entered the market and the price of the gas plummeted!)

A little more than a year earlier, in September 2006, the hedge fund Amaranth lost over $6 billion on its natural gas investments and saw its fund value drop 65%. Immediately after taking these huge losses on its energy bets, rumors swirled in the markets that the fund, mainly using the less strictly regulated OTC market, had actually been trying to corner the natural gas futures' long contract. (McCullough Research produced quite a compelling report on September 26 of that year analyzing Amaranth's activities.) And, indeed, in July 2007, both the CFTC and the Federal Energy Regulatory Commission charged Amaranth with trying to manipulate the physical natural gas markets, seeking some $291 million in penalties.

History has yet to relate any outcome to the two regulatory bodies' attempts to go after Amaranth, not least because of the bizarre turf war being fought between them as to who actually has the right to go after the fund in the first place! It's probably not wise to hold your breath whilst waiting for any sort of resolution.

Why Try A Corner?

A good question! Trying to corner a market will be expensive, inherently risky, certainly not guaranteed to make money (burying the corpse following a market manipulation can wipe out any gains from the manipulation itself) and, probably, illegal. (And, unfortunately, as happens following a supernova, a manipulation will inevitably leave behind traces of itself.)

In addition, there will always be contingencies in the market which are either unknown or for which no plans can be made. For the Hunts, it was liquidation-only trading; for BP, it was a seller entering the market at the end of the month; for Amaranth, it was market volatility; and for Salomon Brothers, it was, perhaps, hubris.

And then there's always the issue of diversification: Why try to make money by trying to put all your eggs in one basket?

A Corner Despite Itself

One final observation may be in order. Although corners have been effected in both deep and very liquid markets (for example, Mr. Yasuo Hamanaka of Sumitomo in the copper market back in the mid-'90s), shallow and illiquid ("thin") markets are particularly vulnerable.

With the recent establishment of exchange-traded funds [ETFs] in various precious metals, might not one of these funds eventually find itself to have established a corner despite itself? For example, with the world's two largest producers (South Africa's Anglo Platinum and Impala Platinum) facing long-term power supply problems, and with continuing strong industrial demand, platinum is now trading at a level in excess of $2,000 a troy ounce. In addition, as noted by the Financial Times on February 16, Impala Platinum's forecast is that this year's global supply deficit could be as high as 620,000 ounces, a level not breached since 1999.

What with a rising price and the pressure on supplies, industrial buyers (auto companies in particular) are finding themselves forced to secure physical supplies of platinum. At the same time, however, it has been estimated that, of the 1-2 million ounces of platinum stocks physically available worldwide, platinum ETFs are "indirectly tying up" some 311,000 ounces-between 16% and 31% of such global stocks-with the metal still (and, perhaps, increasingly) an attractive investment proposition.

Currently such a corner may still be but a hypothesis, but in certain market circumstances (increasingly imaginable), it could become a reality.

Links For More Information

* The Silver Institute
* U.S. Commodity Futures Trading Commission
* Federal Energy Regulatory Commission
* London Metal Exchange