Earlier this year, it emerged that the London Metals Exchange had been holding a bunch of bags filled with stones instead of the nickel needed to back trades for major commodities players, including Trafigura. Before that, commodities trader Mercuria was given painted rocks instead of the copper it was supposed to take delivery of. In short, the commodities world is no stranger to fraud. But what is it about the business of trading, moving and storing commodities that makes it so susceptible to scandal? In this episode, we speak to repeat Odd Lots guests and commodities collateral specialists Mercury Group CEO Anton Posner and President Margo Brock, about some recent episodes of counterfeiting in commodities world, why they seem to keep happening, and what could be done to prevent further instances from occurring. This transcript has been lightly edited for clarity.
Key insights from the pod:
What is collateral management? — 4:23
How is collateral normally managed in commodities trades? — 6:24
Why are there so many commodities frauds occurring? — 8:59
Complacency with counterparties — 10:30
Different types of commodities fraud — 13:24
Paperwork in commodities trading — 14:44
Overpledging of collateral — 16:14
Keeping collateral at a customer’s facility — 17:39
Banks getting out of the commodities business — 24:00
Liquids versus dry bulk sampliong — 35:36
Using new technology like drones — 37:19
Commodities most vulnerable to fraud — 41:07
Too much water in the Mississippi and the barge business — 42:57
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Tracy: (00:09)
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe: (00:14)
And I'm Joe Weisenthal.
Tracy: (00:15)
Joe, have you ever heard of something called The Tablet of Ea-Nasir? I'm going to mispronounce that because my ancient Mesopotamian isn't up to scratch, but the tablet of Ea-Nasir.
Joe: (00:27)
No, never.
Tracy: (00:28)
This became a big internet meme. There were lots of jokes about it, but it was basically this tablet, this old Mesopotamian tablet, I think it was like 4,000 years old, with cuneiform written on it. People sometimes talk about it as the world's oldest business complaint.
Joe: (00:45)
You know, not only have I never heard of this tablet, I'm actually struggling to figure out what the next thing you're going to say is that connects it to this episode that's coming up.
Tracy: (00:54)
This is the most random intro to one of our episodes ever.
Joe: (00:56)
I like this one. I like where you're going.
Tracy: (00:58)
I'm trying to bring the historic context, but, okay. So written on this tablet was a business complaint against this guy, Ea-Nasir, who was a copper trader in ancient Mesopotamia. And his customer had written a complaint basically saying, you promised me a certain amount and type of copper. You gave me lesser quality copper, and I'm upset and you have to do something about it.
Joe: (01:21)
I get this is, okay. Now I get how this makes sense. And I guess this is like a phenomenon throughout history that if you're buying actual physical stuff, there is a question of you enter into a contract, did you actually get the stuff? Is the stuff that the person said they were going to give you, is it actually what it is? Is it real?
Tracy: (01:38)
That's exactly it. And how do you check beforehand to see whether or not the stuff that you're going to be getting is the stuff that was promised to you? These are ancient, ancient problems. And the weird thing is it seems like the commodities world hasn't actually progressed that much from cuneiform tablets written on stone to what we use today, which is mostly paperwork.
Joe: (01:57)
I remember an episode we did with Dan Davies several years ago, and we talked about the salad oil scandal, right? The famous one where the guy filled up those tanks filled with water and then put a thin layer of oil and they came and they checked and they're like, “oh, these tanks are oil.” And he was able to borrow against them, right? It was Warren Buffet made a bunch in the crash of all the entities that were associated with it. But this stuff always fascinates me because I think these are the stories where there's something different between just the lines we see on the chart, which are these abstracted version of commodities versus like the actual handling of the real things.
Tracy: (02:30)
Right. There's the financialized commodity -- the line that you see on an electronic screen and then the actual commodity, and the two are supposed to match or relate in one way or another, but they're definitely not the same thing. And recently, one of the reasons we wanted to do this episode, is there have been a series of scandals in commodities land that have to do with collateral management. So the big one that springs to mind is LME discovering that it had a bunch of rocks instead of nickel backing some of its contracts. And this kind of was a major talking point in commodities world.
Joe: (03:04)
Yeah, we recently did that interview with CME Chief Terry Duffy, and he seemed to acknowledge that there's something about nickel specifically that makes it susceptible to this sort of deception. But we didn't really get into the details, but this is just so fascinating, that involves heists and scams and deceptions and fraud. And it’s, as you say, it's throughout history. So I'd love to learn more about how this business works.
Tracy: (03:26)
Yeah, why does the commodities world seem so sort of ripe for these types of scandals? I'm very pleased to say that we have truly the perfect guests. We are going to be speaking with multi-time Odd Lots guests at the moment. Mercury Group CEO, Anton Posner, and Mercury Group COO Margo Brock, thank you so much for coming back on Odd Lots.
Margo Brock: (3:43)
Thanks for having us.
Anton Posner: (03:46)
Yeah, thank you. Great to be here again.
Tracy: (03:49)
So the last time we talked, I think we were talking about the barge business and what was going on in the Mississippi River. But walk us through your approach to collateral management, because this is a space that you play in, I think you do some business for major players such as the big banks. But what exactly do you guys do in the field of collateral management?
Anton: (04:09)
Sure. Yeah. I'll take the lead on that one, Tracy. And first I'd just like to say also that cuneiform reference you made, they're still fighting it out in court in Athens, their errors still have not been resolved. So it's still going on.
Tracy: (04:22)
We can litigate it right now.
Anton: (04:23)
Exactly. It's continuing. So yeah, that's why I have a cuneiform keyboard on my iPhone. So what we do, as you mentioned, we work several major banks that are involved in physical commodity finance and trade, in addition to trading companies and producers in commodities. Certainly a strong focus on metals and steel and raw materials that go along with it.
On the collateral management front, we perform audits and inspections at facilities for banks and financers that are financing physical commodities to do some initial vetting work finding out the procedures, diving into everything from the ownership and the procedures and the personnel that are involved in issuance of documentation, to who's going to be the primary point of communication, how are they keeping track of who owns what and so forth.
That is the work that's done preliminary ahead of a finance deal. And then once there are physical commodities in place, we're doing jobs like having auditors go out and count physical metal, counting bundles of aluminum ingots in warehouse for banks to verify what's there. And even to the point where we have, through our subcontractor partners, [been] flying drones to measure the height an angle of repose of stockpiles of coal, for example, to verify approximately how many tons are in stockpile for banks that are financing dry bulk commodities like that.
Joe: (05:59)
I have a question before we get into the various frauds and deceptions. Why don't we take a very sort of simple, sort of vanilla instance of how a trade would work? Like suppose Tracy has a bunch of oil and she wants to pledge it, borrow some money from me, and I would need to make sure that she actually has the oil…
Tracy: (06:18)
Can we do coal instead? I actually have some coal.
Joe: (06:21)
Or coal, yeah. So Tracy has coal
Anton: (06:22)
The oil is the old story, right? Tracy's story.
Joe: (06:24)
Yeah. Tracy has coal. She wants to borrow against it, get some liquidity for it. I say, “yeah, I want to, I'm happy to lend against your coal Tracy, but I need some proof that it's there.” She goes to you. What's like the basic steps of the process? What do you produce for me?
Anton: (06:39)
Sure. You know, initially, and we work with our clients, with our bank and trading clients to determine what level they want to go down, how far they want to go down the rabbit hole in terms of analyzing. I mean, it could be to the point of sending a surveyor out taking samples, sending it to a pre-agreed laboratory that has expertise in that particular commodity to verify the quality that’s there.
Of course, the quantity inspection is important, right? Verifying that the quantity matches what Tracy's declaring, right? To the bank or the financer. So verifying the quality, the volume, and then also verifying and working to ensure that the facility that it's being stored at, Tracy's house in Connecticut, may not pass muster in terms of a secure collateral.
Tracy: (07:31)
I will say there are a lot of squirrels that have made nests within the coal pile.
Anton: (07:31)
Exactly, the biomass that's mixed in, exactly right. So ensuring that. And we have clients that sometimes don't want us to go that deep. Sometimes it's just volume, but we're not taking samples for qualities and so forth. So our initial approach with one of our clients at high risk for collateral management services is determining how far down they want to go.
Tracy: (07:58)
I was going to ask, how much of this depends on the sample size? Because it seems like an easy thing for me to do, if I was worried about the quality of my coal is, I don't know, I would get a really nice piece of anthracite from somewhere else and say “here's a sample of my coal.”
Anton: (08:13)
Sure. Yeah.
Margo: (08:14)
Well, most importantly, if you're going to draw samples, it's going to be randomized. And you're going to have a certain percentage of the cargo that has to be sampled. If it's quite a large stockpile of coal, you know, you're going to want a lot of representative samples from different sides, different angles, top, bottom, so people can't pick the most attractive piece of anthracite to put out there. Right. So it really does depend on the parcel size that you're talking about.
Tracy: (08:40)
I mean, you've just laid out how it's supposed to go, in theory, and yet what we've seen recently is numerous examples of people fooling the auditors, people fooling the inspectors sometimes in kind of amusing ways with painted rocks and things like that. So what's going on there?
Anton: (08:59)
Yeah. I mean, there's a lot of opportunity for fraud at all levels, at all the facets, right, of this process, as you said, going back you know to the Phoenicians and their complaints. Nothing's much has changed except the methods of communication. But, you know, the things that could go wrong where you had the recent Trafigura mess there with their thousand containers of what appears to be steel discs or fake, you know, nickel. And then there was other, other examples that Hin Leong scandal in Singapore, for example, where you had the warehouseman that was storing the petroleum, oil in this case, was issuing documentation to multiple financiers for the same exact stocks. That’s a situation where it wasn't the supplier that was the problem, but rather the facility that was doing the storage, which has been a problem.
Joe: (09:59)
Well, so I was going to ask, and it’s sort of perfect -- your answer -- because I was going to add on to Tracy's [question], do entities become vulnerable when they work with the same counterparties over and over again and just sort of drop their guard essentially? It's like, “oh, this is the way we've always done it, this is the way we've always done it.” And then someone figures out how to enter into that relationship that's existed for a long time, like maybe the first time Tracy pledges her coal to me I do a big inspection, but by the 10th time, yeah, I know you're good for it, but is that when fraud starts?
Margo: (10:30)
Absolutely. Because you get complacent and you let your guard down like anything else in life. So these longstanding relationships that have always just run on autopilot and someday some guy has a great idea of how he's going to fool the system and make money. I think you have to keep the guard up. You have to have your checks and balances in place from the beginning of that relationship straight through to the end. That's why they exist. Once you drop your checks and balances, that's when you stop being accountable, you stop, you know, looking at what you have.
Tracy: (11:19)
So here's a really basic question because, you know, we all read a little bit about the Traifgura and LME scandal but everyone was focused on those very big names for obvious reasons. But what happened to the alleged fraudster? Do they just disappear with the money? I imagine their business of commodity shipping and producing is pretty moot at that point.
Anton: (11:42)
Yeah. The producer in India on the nickel situation, I'm sure is untouchable at this point in terms of ability to transact with anyone else really, at this point.
Margo: (11:56)
Right, but he also got half a billion dollars, so he's fine.
Joe: (12:00)
There's no real obvious recourse against it?
Anton: (12:04)
Trafigura’s pursuing, you know, we certainly don't know the ins and outs of Trafigura -- we're not involved in that, to be clear on that, right? So we're reading what transpired, you know, from news reports. But it looks like they're pursuing legal avenues to, you know, to go after them, but that's going to be long and drawn out.
Joe: (12:24)
Just to be clear on nickel, and I think this is something Terry Duffy, when we talked to him, he was like, “there's something about nickel.” It's that it's in bags, right? Some metal is stacked. You see it. What would be an ideal form of auditing? I can't imagine you open every bag, but…
Margo: (12:40)
But opening some bags?
Joe: (12:42)
Yeah.
Margo: (12:42)
Again, it becomes that randomized audit, that randomized sampling and you do have to look and you have to go in and say, “let's, you know, it's all stacked in the warehouse, right? Let's break some down, let's pull it out and let's just -- at a minimum -- open the top of the bags and look in.”
Anton: (13:00)
And also, I was going to say too, nickel is a much more higher value metal versus aluminum, let's say, or zinc. So it's like counterfeiting, if you're going to counterfeit bills, you're going to probably counterfeit, if you’re taking the time to do it, you're going to be doing a hundred dollars bills, right? Rather than focusing on counterfeiting a dollar bills?
Joe: (13:20)
Oh, so in bags, high value, big honey pot.
Margo: (13:24)
And there's really been two different types of fraud on it. And one is the Indian one that Trafigura is involved in -- is during shipment. So by the time it lands where it's headed, the last containers are already afloat and everything, all the documents are presented and everyone's been paid. So they haven't had the opportunity to open doors on that very first container that's shipped to even look and find their fraud. So that fraud, you have to really concentrate on combating at load.
And then there's the fraud of the rocks that were in the nickel bags and that was in warehouse for years and years. But again, nobody opened up the bags there. So there's, you know, like Anton said, it's a system as old as time, and there's so many points within that system where fraud can happen and theft happens and the opportunities present themselves.
Tracy: (14:17)
So, just on this note, my impression is that one of the issues here, and one of the reasons why the commodities world is susceptible to this type of fraud is not just that you can fake nickel by using some rocks put in a bag, but also so much of it relies on paperwork and invoices and trade receivables and things like that. Can you talk a little bit about why that is, and how endemic it is in your line of business?
Anton: (14:44)
Sure. Paperwork, the documents that go along with the shipment are fairly easy to forge, right? So the quality certificates that went along with that nickel coming out of India, or the paperwork, let's take the Hin Leong situation in Singapore, right? The documentation, the warehouse receipts, the holding certificates that went to the banks to show that that there was ownership are just printed off a computer, signed and stamped.
It's fairly easy to make these documents and send them along. So the paperwork is only as good as the counterparty that's drawing it up. So it's the old trust but verify premise as Margo said, right? You’re taking representative samples, not just, you know, the paperwork really is to go along with it, but it has to be part of a part of the bigger process, right?
Joe: (15:45)
So obviously one way of fighting fraud is, as you say, go in the bags, rip open a bunch, do samples. The other way to engage in fraud that you've sort of hinted at, but haven't talked about as much is Tracy comes to me, asks for money against her call, but also does it for like six or seven entities right? Overpledges it. So what are some of the checks that you do, or that a party should do to avoid or prevent multiple pledged collateral?
Anton: (16:14)
Yeah. And this is a tougher one because, let's go back to the to the Qingdao scandal in China 10+ years ago, I believe, where the western warehousing companies – LME warehousing companies -- and China doesn't have London Metal Rxchange warehouses. So these are the same companies that had subcontracted warehouses in Qingdao storing copper and other metals.
And the warehouse there, there was a couple of warehouses in Qingdao that were subcontracted by the LME warehousing companies, and they were in cahoots with some of the local traders there to double, triple, quadruple pledge the stocks of copper to multiple banks. So they'd say, “right. You’ve got 10,000 tons of copper cathodes sitting in there.” And the local warehouseman was issuing warehouse receipt to multiple banks and financing entities for that same stack of copper, unbeknownst to the warehousing company that was contracting with them.
So they thought -- the western warehousing companies, or the large LME warehousing companies -- thought that their Chinese subcontractor was doing the right thing and being honorable, but was really handing out paper left and right for the same stack of metal.
Margo: (17:39)
And I would say, if Joe is looking to finance Tracy's coal, you don't wanna do it on Tracy's property. Because Tracy retains control of it. And that's going to be step number one. I want your coal somewhere where I have a trusted third party controlling it and hopefully issuing only one warehouse receipt on it.
Joe: (17:59)
Oh. So it would be the warehouse, o in the process of getting that confirmation, it would be the warehouse sort of vouching for it, and then it would be on them, it would be on the warehouse, would be the one breaking the law or being complicit and breaking the law if they were sending it out to multiple [parties].
Margo: (18:14)
Right. Which is what happened in Qingdao.
Anton: (18:16)
And Margo brings up a really good point. And often we've had multiple conversations over the years about providing collateral management services for stock retained at a customer's or at a facility that's controlled by the entity that's benefiting from the financing, right? So, as Margo said, that's always a more complicated collateral management approach, then you have to have regular inspections verify that when the inspector's not there, is that material being taken out, right?
We did a similar project for an inbound steel slab going into a rolling mill in Ohio. The bank that we were working for on that one was financing the steel slab, but it was on the property of the rolling mill. And then the bank would have possession of the slab, but also the steel coils that were rolled from that slab afterward. That meant we had to send in – Mercury, our predecessor company, we had to send in inspectors regularly to verify what was there. Did the mill take more slabs than they were supposed to from the stock that was dedicated to that particular bank? And in one case, Margo uncovered an interesting situation.
Margo: (19:37)
I found fraud. It was only detected simply because we were working on behalf of both banks that were financing the slab and the ultimate hot rolled coil that were coming out of the slab. So at the end of each day, there was a pledge list of, you know, we've removed this much slab from your inventory by specific piece number. And to balance out the value, you now have this stack of coils and these are the numbers of your coils. And this happened on a daily basis. And all those reports came to us. And basically it was a simple overlay of reports. And we started identifying coils that were double pledged.
Joe: (20:14)
Sorry, explain that? An overlay of reports, what does that mean?
Margo: (20:17)
Just taking both inventory reports, both daily declarations to each of each of the banks. And doing them side by side to look and start realizing that we had a handful of coils that were pledged to both banks.
Tracy: (20:30)
So out of curiosity, how much was that slab and the coils worth? And the reason I ask is because this seems like a lot of work and very granular, high risk. And I kind of wonder about the incentive structure here if there are commodities dealers out there who basically say, “this is a risk we're willing to take, we're going to find someone, you know, a warehouse or whoever with the least amount of paperwork, the least bureaucratic process to go through, because this all seems like quite a lot.
Anton: (21:02)
Yeah, the value of the slabs is a few hundred bucks a ton. And then when they were rolled into coils, they were adding value at that point. So, you know, add on another a hundred bucks a ton. I'm certainly not a steel pricing expert, right? But that was just to give you approximate value.
But, you know, Tracy, just to your question, we're seeing banks that bailed out of commodity trade finance because of these problems. ABN Amro and BNP Paribas a couple of years ago announced that they were getting out of a pretty significant portion of their physical commodity trade. It's left a smaller group of banks that are willing to get involved in this at this point, which has opened up the door to some of the less scrupulous ones. Take the Greensill disaster, right?
Joe: (21:54)
Explain there, because I don't think of that in the same category. So how does Greensill fit into this story?
Anton: (22:01)
Greensill -- it boils down for the most part to an entity, Greensill Capital, that, that was too close with one of the steel producers. They were financing trades that involved the steel producer, the bank that the steel producer owned was heavily involved.
Tracy: (22:25)
It was trade receivables, right?
Margo: (22:27)
But also future sales.
Tracy:
So inflating their future sales and borrowing against them?
Anton: (22:37)
And fake invoices that were presented to Greensill to finance and Greensill was backed by Credit Suisse. And we know where Credit Suisse is at these days. So none of this worked out well for Credit Suisse.
Joe: (22:48)
The number of rakes Credit Suisse stepped on over the years.
Anton: (22:51)
Yeah, exactly. I mean, this was one of a massive strike against the bank. And of course, now look where they are? Merged into UBS. But, you know, this was a situation as Margo mentioned, the future receivables, which was never made clear to Credit Suisse and their investors in the funds that were backing Greensill, that they weren't financing physical sales, they were financing theoretical sales, right? I mean, when you read what transpired there, you know, I think our teenage kids could have figured out that this was a bad deal.
Joe: (23:29)
So it’s one thing to be a future receivable and a future sale may one day become a receivable, but it's clearly not the same thing by any stretch.
Anton: (23:37)
Exactly.
Joe: (23:38)
You mentioned the banks have gotten out of this business, that's interesting to me because that implies it's not just the occasional idiosyncratic thing that pops up on the news and becomes a scandal that we talk about once every two years. That it must be a big enough challenge for the industry that some banks [are] like “this is not worth it.” Can you talk about how big are we talking about here?
Anton: (24:00)
Yeah. We've seen, you know, with ABN Amro and BNP Paribas getting out, they were two major banks that had a major presence in the physical commodity trade. So the banks that are left in it – ING, Rabobank, Brown Brothers Harriman here in New York, of course, JP Morgan Chase and so forth.
But it's left a dwindling number of banks that have the appetite for getting involved in physical commodity trade finance in this way. Look at what happened with Trafigura, part of the story, and certainly again, I’m not an expert in exactly what happened, but Citibank bailed out of financing those nickel trades with that particular supplier, I think it was about a year before maybe before the problem became evident. So there was must have been some red flags that were, that were coming up.
And Citi was keen enough to be able to extract themselves from that prior. That left Trafigura in a situation where we saw they went to some non-traditional, secondary finance entities to mitigate their risk. They weren't using their own money for purchasing that nickel. They were using trade finance company money that ended up getting caught up in the in the mess at this point too. So it leads to the question of, if a major company like Trafigura can't get bank level interest rates to finance this, and they're going to the secondary lenders that are much higher cost, well, why, right?
Tracy: (25:39)
Well, I've seen some people draw a not very subtle connection between, okay, the regulators put in additional rules around trade financing because it's a risky business for the banks. So a bunch of banks pulled out. Now you have a smaller body of players, some of varying qualities, and this might be one reason why we're seeing more scandals, because you don't have as much credit, you don't have as big an ecosystem as you did previously. Is there any truth to that claim?
Anton: (26:11)
Yeah, certainly with less lenders and less participants in the field, it's concentrated that risk into a smaller group of entities that are willing, the banks, the financiers, that are that are doing this type of this type of business. So yeah, I think that there's some credence to that.
But it ultimately goes back still to the quality, right? If we're talking about financing aluminum coming out of an Alcoa smelter, it's not quite the same as what Trafigura got hooked into or the problems with, you know, the fake copper painted bricks and so forth. This metal was not coming out of an Alcoa or Rio Tinto level of producer and counterpart.
So the minute you're getting involved in entities that may not have quite the level of reputation as these major producers have, you need to start ramping up your level of collateral management and oversight and risk management. And I think that's really where the problem is. Where we see regularly not that desire to go as far as they need to.
Joe: (27:46)
Can we talk about gold. The internet loves the occasional story about gold theories. It’s like “all the gold that's in Fort Knox is actually brick and it's painted. No one has inspected it in 50 years.” You know, you just see this constantly, constantly. What kind of regular inspections are [there], is there A) is there a gold fraud? Is that a thing that exists in terms of this is not gold or something painted that someone moved it out and no one's checked the warehouse. And how is gold inspected?
Anton: (28:18)
Yeah. Gold is not something that we get involved with. We don't get involved in precious metals. So caveat with that. That being said one of the inspection companies that we work closely with, they fly somebody down to the Cayman Islands every once in a while to go into the bank vaults and check out the gold stockpiles.
Tracy:
That sounds like a nice job, I’m just putting that out there.
Anton: (28:38)
Doesn't it? I thought that was fantastic.
Margo: (28:41)
Anton's applying. Yeah. Yes. He likes the Caymans.
Anton: (28:42)
I love Cayman Island.
Joe: (28:44)
I just want to say, I've never admitted this before, I did this field trip.
Tracy: (28:49)
I thought you were going to say you're a gold bug.
Joe: (28:50)
No, I did this field trip to the New York Fed when I was in high school, and they brought us down to the gold vault. And it was pretty cool. And they showed us how often when one entity, like the IMF, sells gold to another entity, the gold is put on a
Anton: (29:08)
All those pallets there.
Joe: (29:10)
Yeah pallets. Someone else's locker. But anyway, I was standing next to the gold and I sort of scratched a little bit of it myself and a couple pieces of dust fell. And I sort of freaked out
Margo: (29:21)
And then he put it in his pocket?
Joe: (29:22)
No, I didn’t! It went on the floor.
Tracy: (25:25)
that must be a federal crime that was just admitted here.
Margo: (29:29)
Statute of limitations has expired.
Joe: (29:31)
A few little pieces of dust fell through and I sort of got freaked out that that was even possible. So somewhere there is a golden ingot with just like a little [missing], I don't know. Anyway. Statute of limitations. I was freaked out. I didn't take anything.
Anton: (29:44)
Fantastic. Yeah. We see them pulling, right, [in] the movies. Pulling the gold around in these big pallets with these pulleys. And not to dive too deep into gold because it's not our area of expertise, but same principles, right?
If you're flying down to the Cayman Islands and you're going to inspect gold, in this story, in this particular case, one of the major global banks that was financing the gold there in a vault in the Caymans. I'm not sure what level --how far they took [it], they went as far as taking samples and sending it into a lab for analysis and so forth, or if it was just a simple counting. But when you get into a simple counting of gold bars, then you're just counting them. You're not verifying that they're actually gold. And you might end up with something, you know, that like is on that table over there.
Tracy: (30:31)
Oh, what is on the table? You brought props.
Joe: (30:34)
[Holds up plastic gold bar] So what is our takeaway from this prop?
Anton: (30:41)
The takeaway is that I can count that as one, but it doesn't mean that it's one bar of gold, one brick of gold, right? So just doing a count is only one step in a process, right?
Joe: (30:54)
Well actually, you brought a couple more. And so I guess part of the story could be you sampled this one and this one, but not that one, but not that one. How common is stuff like that, because that actually is not that different from even conceptually the salad oil scandal, right? Which is like, you have this layer of something legitimate. So talk to us a little bit about just sort of the way some of this can get concealed if, you know, the top layer or something like that is legit and the inside isn’t.
Margo: (31:19)
Well, it's kind of exactly what you said. You make those outer layers look to be the right material. And then the onus is on someone to be responsible and look inside, right? Look inside that stack and see is it what you think it is all the way through? And again, that's just, like I said, you know, early on you talked about the nickel, and maybe you do have to get into the warehouse and occasionally say, I want that lot there broken down and pull out all of them. And I want to look inside the bags in the middle. Don't forget about the middle. That's where we all, you know, it's like the middle of the mashed potatoes where you hid your vegetables as a kid.
Joe: (31:53)
I’m envisioning it like a movie in which someone is convinced there's a fraud and just goes through just tearing up bag after bag and still..
Tracy: (32:02)
While they slowly go insane.
Joe: (32:03)
And then they slowly go insane. They know there's fraud and they finally get carted out.
Anton: (32:06)
And the warehouse has the right to charge for the labor and time where you can move all that stuff. So, and warehouses doesn't care, but certainly whoever is perpetrating that potential fraud…. I think this goes too to what Margo said earlier too about the repetition, the comfort, right?
If the inspector that flies down to the Cayman Islands to go inspect for the bank shows up once a month and he does the same thing and doesn't dive too deep, you know, a potential thief at that point, someone that has ulterior motives could say, “we know that he's never going to go beyond just the first layer,” right?
Tracy: (32:47)
So one thing I wanted to ask is how often -- maybe two questions -- how often does commodities fraud go hand in hand with insurance fraud? Because I imagine a lot of these dealers must have some insurance in place, although I did read about Mercuria, I think, which thought it had insurance, and then it turned out that that insurance was also fraudulent. And then secondly, just going back to your example of the steel slabs, what happened after you discovered that? Do you start talking to the counterparties? Do you make a claim for loss? How does it all work?
Margo: (33:21)
Settling that became easy in that we went back to the facility, we went back to the steel mill and said, you know, we found a problem and you are double pledged, and how are we going to rectify this? And they looked at it and they said, “okay, we're going to rescind that report and republish it.” And they said, you know, citing it was just a clerical error, which it could have been. And they definitely focused on what was the more high-profile important bank that you would all know.
Tracy: (33:52)
The favored counterparty.
Margo: (33:52)
Yes. Who they really needed to make sure they stayed in their good graces. They said, “don't touch that report and don't tell them anything.”
Anton: (33:57)
Yeah, some bank favoritism at play there.
Margo: (33:59)
Yeah. So the bigger one with the bigger line is who got to keep the double-pledged coils and the secondary bank got a new list. But we did have, in that instance, someone on site so we could dispatch them at any point to go out with the list and say, “I need you to verify these coils.”
And that's what you do. You go out and you say to the warehouse owner or the facility where it's being stored, “this is the cargo I want to spot check, tell me on your report where it is, and now let's go find it.” And that's what, you know, that's a bit of the corrective action for the checks and balances. Let's make sure it's where they say it is. And it truly exists.
Anton: (34:37)
After Margo had identified, I think it might have been the second time that it happened, because it wasn't just once. The larger bank – [it was] the first time I ever heard the phrase, “the de-risking team got involved” and they withdrew themselves.
Tracy: (34:51)
De-risking, that's when you know you're in trouble when the de-risking team is involved!
Anton: (34:53)
Right? Yeah, exactly. I thought the same thing. The de-risking team is extracting.
Tracy: (35:00)
I’m imagining like a SWAT team that just like comes in through the window.
Margo: (35:02)
Yeah. It's definitely, it's a military action, right? And they come in, it never ends well for you.
Anton: (35:06)
But yeah, that bank wound down their involvement in that trade after Margo's discovery, which was the right thing to do, was just getting sloppy, you know, at that point.
Joe: (35:16)
Can you talk a little bit about liquids? And I started talking about the salad oil scandal. Did anything change fundamentally after that in terms of how inspections are done? Because that was pretty clever. The oil floats to the top, [but there’s] water underneath, but did anything fundamentally change? And are liquids still tricky to verify in some cases?
Anton: (35:36)
Liquids is not an area that we're involved. So take it with a grain of salt in this case, or a dash of olive oil. But, yeah, liquid sampling and so forth. Something that we, Margo and I were both ships officers, Merchant Marine officers. So we had our time learning in school about taking samples in a tanker and so forth. But I don't think that there's anything like, it's still the same basic principles of representative samples, not just going to the top layer, right? But doing a thorough inspection and also vetting of the facility that's storing it, ensuring that that facility is vetted, vetted properly, and that the ownership and the management and the procedures are tight and intact and the counterparty risk.
But the sampling, physical sampling of when it comes to liquid commodities, I think is something that hasn't changed in the past few thousand years. And it's just a matter of how thoroughly it's done and if it's done in the right way.
Tracy: (36:44)
So speaking of change, I mean, we started this conversation talking about that Mesopotamian tablet and the complaint about copper quality. It does seem like a lot of this hasn't technologically advanced, but talk to us about what is happening on that front, because you mentioned drones surveying coal.
I imagine ancient Mesopotamia did not have the benefit of drones. I'm certain there have been dozens if not hundreds of people on LinkedIn pitching blockchain for trade receivables, . That must be a thing. But what kind of advancements are people talking about?
Anton: (37:19)
As you said, certainly the drone ability to use drones to measure physical dry bulk stockpiles is an advancement that gives a far more accurate picture of what's there versus an eyeballing, an estimation, which would be another form of doing that. Or verifying – very complicated -- verifying of the weight of everything that's gone into that stockpile. But that can change any day as materials [are] withdrawn.
The blockchain and electronic bills of lading and so forth -- it all helps, but still it goes back to Trafigura, right? All of the paperwork was perfect, right? So the paperwork, whether it it moved via blockchain or went via FedEx, it was still perfect. The metal wasn't? Right? So blockchain's not going to prevent that. It might catch some other problems.
Joe: (38:17)
Garbage in, garbage out, right?
Tracy: (38:20)
You can just track it better.
Joe: (38:22)
You can track the garbage better
Anton: (38:23)
Track the rocks better.
Tracy: (38:24)
What about even more basic solutions? And I'm sure there's a really obvious and simple reason why you couldn't do this, but for instance, the nickel in the bags, could you like put it in plastic bags or glass jars so you could see it?
Anton: (38:38)
Hmm. Something more visible, yeah.
Margo: (38:40)
So, well, I'm assuming the bags that are used are for longevity. Glass is going to add weight, harder to handle, so that's not really too feasible. But yeah. Different bags, I don't know.
Tracy: (38:52)
But what are the warehouses saying about this? Are they, you know, making noises about “we're going to start doing things maybe slightly differently in order to avoid all these things that have happened?”
Anton: (39:00)
We were talking about this earlier.
Margo: (39:01)
Right. I mean where is the liability and who's authenticating what that material is? If the warehouseman is merely storing it, their receipts will say “said to contain.” They don't make a guarantee. I'm warehousing this as copper, but I'm not a metallurgist. I have not been part of the buy and sell on this. I'm merely the guy whose building you put this in. So I'm just saying those 24 stacks are there.
And they're purported to be this, maybe we've weighed them and we can authenticate the weight of the units, but I can't guarantee that it's copper or at a different level. You are saying it's, you know, a certain quality and it's truly a different quality. I certainly can't authenticate that.
But there are, you know, you can certainly hire people to come in and do whatever is the right level of scrutiny for the commodity. Obviously all commodities have different approaches on that -- liquid versus hards versus soft commodities and so forth. And the warehouse can play a role in that for a hired service for whatever liability they're willing to take on.
Joe: (40:11)
Yeah, I was going to say, because you mentioned that earlier. So on some level, I imagine there are some commodities in which there's not much fraud probably because it's just cheap and bulky and there's not much, I don't know, there's probably not much point in putting something fake [for] like soybeans or corn or something like that, would be my guess.
But I guess for the ones that are more susceptible to fraud, that take more time for someone to go in and do representative samples, etc. Is there a de facto, you know, higher risk premium that traders in these markets pay, they're paying for the warehouse’s time, the warehouse has this, and you as a participant on one side of the trade rents time, I guess from the warehouse for that inspection.
Is that basically how it works? And so to transact in some of these commodities, whether it's like nickel that for reasons because of the bags or whatever, they're valuable and not visible, you ultimately like have to pay more to transact in these commodities?
Anton: (41:07)
Certainly, you know, from an insurance standpoint, when you're getting an all-risk cargo insurance, which is typical policy when you're moving and storing goods and commodities like this, that the insurance premiums are going to be significantly higher for higher value goods like that.
The facilities themselves will often look at -- the warehousing companies facilities -- will often look at higher costs for storing higher value. The risk is higher, the incidence of theft are higher, you know, with those type of commodities. So yes. there is going to be more costs in dealing with higher value commodities for sure.
Tracy: (41:50)
One thing I wanted to ask before I forget, is there a commodity that is particularly well suited to fraud?
Margo: (41:57)
Oh, I think, I think nickel apparently.
Anton: (42:00)
Copper also has been a big one?
Margo: (42:03)
Something that's higher value. So that's what piques interest because it's a great thing to steal and resell. Copper can go on the secondary market quite fast. Aluminum, nobody steals aluminum, nobody cares. It's not worth enough. And it's really big and heavy so people don't move it.
Anton: (42:21)
Unwieldy, right?
Joe: (42:24)
Small and expensive is where you want to go.
Anton: (42:26)
Exactly.
Margo: (42:27)
Gold bricks, precious
Tracy: (42:28)
Gold bricks, precious jewels. They’re a classic for a reason. Okay, that makes sense. So we would be remiss if we didn't also ask you while we have you here what's going on with the Mississippi River and the barges, because the last time we spoke, I think it was back in August, September. There was a drought. There wasn't enough water in the river and so people were having difficulty getting the barges where they needed to be. Now we've heard some stories that there's too much water. What's going on there?
Margo: (42:57)
I think the last time we spoke, we weren't even into the belly of the beast yet. It got worse before it got better. It was pretty epic last year what we saw, and it was what most people haven't seen in a lifetime of doing river business, it's just been that long. The river is always cyclical and we do see drier periods and we do see periods where we get a lot of the, you know, this time of year we get a lot of runoff from the mountains -- from snow -- and makes its way all the way down to Mississippi. And so that is a classic feast or famine. And both of them present similar challenges where we have to reduce the tow size. Navigation is harder and as an overall, the river just slows down and trade slows down.
Joe: (43:44)
So can you walk through the mechanics of why does too much water, you know, reduce tow size?
Margo: (43:49)
We end up with the water is moving too fast in a lot of instances. And they will take down the tow sizes just to keep better controls. That's when you start seeing tows break apart. Whereas in the fall we were on smaller tow sizes because we had to, the towboats had to navigate little water in so many places. They couldn't take the big tows.
Joe: (44:12)
And they couldn't be filled up as much, right?
Margo: (44:13)
Yeah, we had to have them really, really light.
Anton: (44:16)
A typical tow, like on the main line tow on the river would be tugboat pushing as many as like 30 barges. So, to give you a perspective. So reducing that from a 30 barge.
Margo: (44:28)
Yeah. So we're over that hump now. We're getting back into normal flows and more normal water size, water depths. So that puts the river at a better speed and we get back to some normal traffic for a bit.
Anton: (44:43)
And you mentioned, Tracy, but the high water situation, it was in the upper Mississippi River, so north of St. Louis, like up through, up to Minneapolis. You know, that'll get back to normal. But yeah, it's low water, high water. Low water, high water.
Tracy: (44:59)
Is it ever perfect? What's the perfect level of water in the Mississippi for the barge business?
Margo: (45:04)
Oh my goodness. I don't know, it seems to happens like twice a year. I don't know a moment that's going to happen this year.
Tracy: (45:10)
Fair enough. Alright, well Anton and Margo, we really appreciate you coming back on Odd Lots. Thank you so much. We appreciate your props too.
Anton: (45:17)
Always fun.
Tracy: (45:19)
Yeah, thanks so much.
Joe: (45:20)
Thanks so much, that was really great.
Tracy: (45:34)
So Joe, I really enjoyed that conversation. I’ve got to say, I feel like we need to do an Odd Lots on location where we follow the guy who's flying down to the Cayman Islands to check on the gold.
Joe: (45:44)
I love that idea. Yeah, actually do an inspection. You know what I was thinking about? And I guess it even goes back to some of our conversations that we had with Javier Blas last year. Commodities seems very uncorporate, compared to the rest of the finance industry. And this is like another reminder of that.
Tracy: (46:02)
Totally. And it's kind of weird when you think that it's the basic building blocks or so much of our world. And yet it still seems to be this sort of -- I'm going to mix my metaphors here -- but swashbuckling wild west.
Joe: (46:14)
Yeah. Piracy, gray areas. All of these things in which you just sort of assumed that large corporations would've like squeezed all that out. Crime is kind of hard in many digital realms at this point, but it feels like when there's physical stuff, crime finds a way.
Tracy: (46:30)
But the other thing I was thinking is it does feel like there's a sort of clash of incentives here where you want to encourage people to use the best counterparties, use warehouses with very stringent risk control measures. And yet that also seems extremely time consuming and expensive and bureaucratic. So you could see why people might want to switch to others.
Joe: (46:51)
And I guess that also, to the original point, a warehouse like the LMe, you just don't expect it to have any issues. And then that is ultimately the mental bias, I suppose, that the fraudsters take advantage of. If you can get in somehow into the most reputable entities where people feel like nothing bad is going to happen here. So you can see how it's sort of like this, I don't know, cat and mouse game.
Tracy: (47:15)
Speaking of mental bias, you need to shift your take on the gold in Fort Knox and you scratching it, and say you you didn't accidentally touch it, you were checking. Checking on the quality.
Joe: (47:26)
I was checking. It was the New York Fed. I have confirmed for everyone, that at least one gold bar that was in the basement of the New York Fed in 1998 when I took a field trip there was real gold.
Tracy: (47:39)
Public service, not crime.
Joe: (47:40)
I've done my part. I have done my part. Thank you. Excellent. Thank you for the reframe.
Tracy: (47:44)
All right. On that note, shall we leave it there?
Joe: (47:46)
Let's leave it there.