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.

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