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Nickel Nightmare

February 22, 2017

Chapter 89 in the exclusive series for Dynamic Commodities- becoming a commodities trader

The nickel business was a sideshow. The profits dribbled in while the real money was coming from precious metals trading. I watched over the business but it was not my main concern.

The nickel trader, under direct instructions from Marty Kaufman, was building up a relationship with the Russians. Norilsk Nickel located in Siberia is one of the biggest producers of the metal in the world. In the late 1980s, the Russians needed money. They barely had enough to run their commodities businesses. It was a sad state of affairs in the mineral rich nation. They had billions of dollars worth of commodities but not a wooden nickel to pull them out of the crust of the earth. Therefore, to transact with them, innovative financing was a necessary evil.

Buying nickel from the Russians in those days involved a pre-export finance arrangement. Since their credit was so poor, Philipp Brothers would pay the Russians a fixed price on one day for delivery of the metal in 90 days. Once it arrived at port and title transferred to Philipp Brothers, the transaction would repeat. Nickel was around $4000 per ton, so each 90 days there was approximately $4-8 million at risk. The credit facility was profitable. We would buy the metal at a significant discount to the market price. Each 1,000 tons made the desk around $400,000.

In November 1988, the nickel desk bought 2,000 tons for 90 day delivery and paid the Russians $8 million. The trader turned around the hedged the nickel by selling a 90 day forward contract on the London Metals Exchange (LME) to lock in the market price and profit. In the past, on the sixtieth day, the Russians would send documents and put the metal on a boat to an LME warehouse in Rotterdam in the Netherlands. The company’s agent would take the metal off the ship, cut it to LME specifications and deliver it against the short position. It was a clean and easy deal.

However, in early January 1989, there was no paper work from the Russians and not a peep. The nickel was due in late January and by the second week of the month, after many calls and telexes, no word. The price of nickel on the LME began to rise at the same time. Worried, the trader came to me. I suggested he buy some call options on nickel to hedge against an emergency. He spent the entire profit on the trade to cover the risk. If the price of nickel went higher and we did not receive the shipment, Philipp Brothers would not lose. At the same time, the trade would be a wash if the nickel did arrive on time. It was like throwing the $800,000 profit off the side of the ship.

Finally, during the third week of January, the Russians told our trader the nickel would not be coming because the Siberian ports were frozen and the ships could not leave port.

The price of nickel had not just rallied for the delivery date, by that time it had doubled. Had we not “wasted” the profit on the option hedge, the company would not have just lost the profit, it would have been in the hole $8,000,000. Whew, I count that as one of my best trades! Avoiding losses is often more gratifying than making money. Protecting the company takes a special skill.

The reason that nickel went into a monstrous backwardation was that Philipp Brothers was not the only merchant business doing these deals with the Russians. There were many other dealers and commodities traders in the same frozen boat. We didn’t lose a dime on the trade. Furthermore, Philipp Brothers was the only company that had a life boat in the form of an option. Thank God for Sidney Gold, had he not taught me the essence of the options business as “price insurance,” I would never have come up with that solution to a problem that cost many nickel traders their jobs during that cold Siberian winter in January of 1989.

Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities

Post Series: Origin Of A Commodities Trader

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