Blast from the past: US banks enjoy commodity trading boom

IFR 2360 - 21 Nov 2020 - 27 Nov 2020
4 min read
Christopher Whittall

Banks' commodities desks are enjoying their best spell in nearly a decade, as a surge of client activity in precious metals and energy trading have led to a steep rise in revenues.

The gains come amid a bumper year for trading divisions and further pad the top lines of US investment banks' in particular, as US institutions have come to dominate this space after numerous rivals exited in recent years.

Commodity trading revenues across the top 12 investment banks have increased by about 80% in the first nine months of the year to more than US$5.5bn, according to analytics firm Coalition, with Citigroup, Goldman Sachs and JP Morgan among the banks to have reported strong performances.

"Commodities businesses don't get talked about for several years and then suddenly there's a massive spike in activity," said Michael Turner, head of competitor analytics at Coalition.

"There are not many banks left in commodities – almost everyone cut back apart from the US banks. Those left have been well positioned to benefit from the huge growth in trading revenues this year.”

Low profile

Commodities desks have tended to keep a low profile in banks’ trading divisions, typically accounting for about 5% of their revenues in fixed income, currencies and commodities, according to Coalition. When JP Morgan highlighted its strong performance in commodities as part of its third-quarter earnings report, it was the first time in more than five years that the world’s largest investment bank had mentioned how this business was faring in a results presentation.

Regulations put in place after the 2008 financial crisis hit banks' commodities businesses hard. Higher capital requirements and a ban on proprietary trading forced executives to rethink their presence in the market. Many, including Barclays, Deutsche Bank and Societe Generale, cut back substantially or exited commodities trading altogether.

Even those that stayed around, including Citigroup, Goldman Sachs and JP Morgan, had to shutter prop desks and narrow the focus of their activities, such as by selling or exiting some or all physical trading businesses. Trading revenues slumped, reaching a low ebb of US$2.4bn across the top 10 banks in global markets in 2017, according to McKinsey.

"Commodities is a highly cyclical business that has been in recovery for the last couple of years since hitting all-time lows,” said George Kuznetsov, a partner at McKinsey. “Strategically speaking, most of the banks that still maintain a presence in commodities have done it for reasons outside of global markets, such as servicing corporate clients’ hedging and financing requirements.”

Those lenders that stayed around have enjoyed a significant payday this year during what was already a fruitful period for banks’ FICC divisions. Commodities accounted for about US$1bn of the US$4.5bn growth in FICC revenues in the third quarter, according to Coalition. Fourteen of the 15 banks analytics firm Tricumen tracks reported growth in commodities revenues during the quarter.

Oil and gold

Energy trading dominated the first half of the year – a tumultuous period that saw the price of some oil futures contracts fall sharply into negative territory at one point. Revenues in this space had topped US$2bn by the end of the third quarter, Coalition said.

Precious metals trading has been another bright spot, as greater uncertainty over the economic outlook pushed gold prices to an all-time high in August, above US$2,000 an ounce. Banks had made US$1.2bn to US$1.3bn in precious metals trading by the end of the third quarter, Coalition said, already about 50% higher than their total haul from 2019.

Strategists at Goldman predicted in their 2021 outlook that the recovery in commodity prices will be the start of a “structural bull market”.

At the very least, this year’s trading upswing will exacerbate any lingering doubts in the minds of those management teams that made swingeing cuts to these activities. Even so, analysts are doubtful that will be enough for banks to invest meaningfully and reverse years of cuts in this corner of financial markets.

"Some of the US banks may be thinking about filling small gaps in their product set,” said Coalition’s Turner. “The European banks made their decisions around strategy and it's hard to see them re-investing in this business right now."

Commodities trading revenues jump