A:

A sense of mystery still surrounds Yasuo Hamanaka, a.k.a. Mr. Copper, and the magnitude of his losses. From his perch at the head of Sumitomo's metal trading division, Hamanaka controlled 5% of the world's copper supply. This may sound like a small percentage, given that 95% of the world's copper supply remained in other hands. However, copper is an illiquid commodity, which means it cannot easily be transferred around the world to meet shortages. For example, a rise in copper prices due to a shortage in the U.S. will not immediately be canceled out by shipments from countries with an excess of copper. Moving copper from storage to delivery to storage again costs enough to cancel out any price differences. The challenges in shuffling copper around the world and the fact that even the biggest players hold only a small percentage of the market made Hamanaka's 5% quite significant.

Sumitomo owned large amounts of copper that was warehoused and stored at factories as well as numerous futures contracts. Hamanaka used Sumitomo's size and large cash reserves to both corner and squeeze the market via the London Metal Exchange (LME). As the world's biggest metal exchange, the LME sets the world copper price. Hamanaka kept this price artificially high for nearly the entire decade leading up to 1995 and, as a result, garnished premium profits on the sale of Sumitomo's physical assets.

Beyond the sale of its copper, Sumitomo benefited from commissions on other copper transactions that were handled by the company. Commissions are calculated as a percentage of the value of the commodity being sold and delivered. In this case, Hamanaka's artificial prices inflated values, which allowed Sumitomo to pocket greater sums.

Hamanaka's manipulation did not go unnoticed. Many speculators and hedge funds knew of Hamanaka and the fact that he was long in both copper physical holdings and futures. Whenever anyone attempted to short Hamanaka, however, he would pour more cash into his positions, thereby sustaining the price and outlasting the shorts, simply by having deeper pockets. Hamanaka held long cash positions that forced anyone shorting copper to deliver the goods or close out their position at a premium. Hamanaka was helped greatly by the fact that, unlike the U.S., the LME had no mandatory position reporting and no statistics showing open interest. Basically, traders knew the price was too high, but they did not have exact figures on how much Hamanaka controlled and how much money he had in reserve. In the end, most cut their losses and let Hamanaka have his way.

Nothing lasts forever, and that includes Hamanaka's corner on the copper market. The market conditions changed in 1995 thanks to the resurgence of mining in China. With the price already floating away from the fundamentals, the price of copper was significantly higher than it should have been. Sumitomo had made good money on its price manipulation, but it was left in a bind because the company was still long on copper at a time when the market was heading for a big drop. Worse yet, shortening its position - that is, hedging it with shorts - would make Sumitomo's significant long positions lose money faster because the company essentially had been playing against itself.

While Hamanaka struggled to get out with most of the ill-gotten gains intact, the LME and the Commodity Futures Trading Commission (CFTC) began investigating the manipulation of the copper market worldwide. Sumitomo responded by "transferring" Hamanaka out of his trading post. The removal of Mr. Copper was enough to bring the shorts on in earnest. Copper plunged and Sumitomo announced that it had lost over $1.8 billion and that the losses could go as high as $5 billion, as the long positions were settled in a poor market. Sumitomo also claimed that Hamanaka was a rogue trader and that his actions were completely unknown to management. Hamanaka was charged with forging one of his supervisor's signatures on a form and convicted. Sumitomo's reputation was tarnished as many people believed that the company could not have been ignorant of Hamanaka's hold on the copper market, especially because it profited for years from it.

Traders argued that Sumitomo must have known of Hamanaka's wrongdoing because the company threw more money at Hamanaka every time speculators tried to shake his price. Sumitomo responded by implicating JPMorgan Chase and Merrill Lynch as funders of the scheme, revealing that the banks had granted loans structured as futures derivatives. Sumitomo, JPMorgan Chase and Merrill Lynch all were found guilty to some extent. As a result, JPMorgan Chase's case on a similar charge, related to the Enron scandal and Mahonia Energy, was hurt. Meanwhile, Hamanaka served his sentence without comment. Since the copper market manipulation, new protocols have been added to the LME to make a repeat less likely.

(For more on this topic, read The Biggest Stock Scams of All Time, and Trading's 6 Biggest Losers.)

This question was answered by Andrew Beattie.

RELATED FAQS
  1. What are the main reasons an investor would look at the metals and mining sector?

    Learn about long-term growth prospects for the metals and mining sector. Find out how these natural resources can help balance ... Read Answer >>
  2. What does it mean to invest in base metals?

    Learn what is means to invest in the base metals sector and how investors can take advantage of various investment strategies ... Read Answer >>
  3. Are there high capital gains when there's low income?

    My father sold a piece of property that he inherited in order to pay for assisted living expenses. He ... Read Answer >>
  4. What commodities are the main inputs for the electronics sector?

    Explore the use of commodities in the electronics sector. Discover potential risks and opportunities presented by raw materials ... Read Answer >>
  5. What part of the economic cycle is best for investing in the metals and mining sector?

    Consider the pattern of growth and loss in the metals and mining sector, and find out why it can be challenging to correlate ... Read Answer >>
  6. What kind of risk exposure does an investor face when investing in the metals and ...

    Examine risks related to companies involved in the exploration and extraction of precious and base metals. These include ... Read Answer >>
Related Articles
  1. Markets

    The Top 5 Copper Stocks for 2016 (TSX, FCX)

    Discover five copper miners most likely to see positive results in 2016 and beyond even as low prices spread challenges throughout the industry.
  2. Markets

    How Copper Investors Can Strike Gold (FCX, FM.TO)

    Copper is an overlooked metal with important worldwide applications in industry and electronics. Considering the current marketplace and oversupply, now may be the best time to invest, especially ...
  3. ETFs & Mutual Funds

    The Top 5 Copper ETFs for 2016 (JJM, JJC)

    Discover information about the copper and copper mining industries, and learn more about the top five copper exchange-traded funds for 2016.
  4. ETFs & Mutual Funds

    Copper Is Still King

    With improvements in global infrastructure increasing at a rapid pace, investors should consider adding some copper exposure to their portfolios.
  5. Trading

    Active Traders Continue to Bet Against Copper (FCX, JJC)

    The charts of these copper-related assets suggest that prices are headed lower. How are you trading the move?
  6. Markets

    Copper Price Hits 11-day Low on China Worries

    Copper prices at the London Metal Exchange tumbled Thursday as the U.S. dollar appreciated in the past few sessions.
  7. Investing

    Profit From This Multi-Billionaire's Bet On An Unloved Commodity

    The super-rich are not like the rest of us. People like Warren Buffett and Bill Gates take on mythic status. As they build fortunes that exceed the Gross Domestic Product of many countries, every ...
  8. Markets

    Watch Out For Falling Copper Prices

    Commodity traders have been turning their attention toward copper prices over the past several weeks.
  9. Markets

    Falling Copper Prices Will Drag These 2 Stocks Lower

    With copper trading near six year lows, many traders are starting to wonder whether the bottom and whether a reversal could be in the cards over the coming months.
  10. ETFs & Mutual Funds

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
RELATED TERMS
  1. Mr. Copper

    Otherwise known as Yasuo Hamanaka, Mr. Copper was a trader in ...
  2. Doctor Copper

    Market lingo for the base metal that is reputed to have a Ph.D. ...
  3. Long Hedge

    A situation where an investor has to take a long position in ...
  4. Base Metals

    Metals that oxidize, tarnish or corrode relatively easily when ...
  5. New York Mercantile Exchange - NYMEX

    The world's largest physical commodity futures exchange. Trading ...
  6. Semiconductor

    A materials product - usually comprised of silicon - which conducts ...
Hot Definitions
  1. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  2. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  3. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  4. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  5. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  6. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
Trading Center