Traders – Secrets in the Commodity Game Part XI- Armajaro, the Trade who Blown up a $3B Sales Merchant Business.
What’s the point about trading, Glory ?
Through this episode of 2010, a firm has revealed the speculative character of its operation in commodity trading; they have cut the corners, waging a merciless war for the supply control. They have overpaid to trade a commodity and at the end, they have lost.
The financial management of the firm can be an expansive discussion to have, egowise, when its management is comprised of ex-traders.1.
“I left in 1992 and joined Phibros. Andy Hall was my boss there but the way he traded was to just double up the size of the position every cent down on the market,and then to double up on the way up. For cocoa that meant being pretty big time, too big for the market, especially in the 1990s. It was really crazy but it was a great finishing school. I had marvellous training!”
“Four years later Citibank bought Phibro. The Glass–Steagall Act still existed at that time, which meant that Citibank could trade oil but they couldn’t trade food. The act was quite specific about what a bank could and couldn’t do. But it suited me any way; after four years I was fed up with them. I started Armajaro on 1st October 1998. I took over Phibros’ staff from cocoa and I also took over their contracts. So I really took over the cocoa part of their business”.
Where did you get the financing to start up the business?
“Phibro didn’t give me any financing but they had a very big contract with the Ivory Coast to repay the debt left over the cocoa debacle in the 1980s – it was about $200 million, a lot in those days.”
“The original contract was to pre-finance the Ivory Coast but the cocoa price went down. In the end I negotiated to get back about $0.35 or $0.38 on the dollar, to be paid in cocoa. That was 80,000 tonnes a year of cocoa, which was significant at that time and gave us a big part of the market. This was still going when I left Phibro so I took those contracts over, agreeing to pay Phibro back when we got the money. I went with the contracts to two banks, Credit Agricole and Natixis, and they agreed to finance it. My partner [Andrew Gower] and I put up $3.5 million in capitalization to start Armajaro”.
So you took over the Ivory Coast contracts, which give you access to the finance. I understand you first concentrated on Ghana rather than Ivory Coast? I read somewhere that you had 450 employees in Ghana, 3,000 suppliers and 150,000 small farmers.
“That was all true over time. Our focus from the beginning was both Ivory Coast and Ghana. I have always had very long relationships with both countries but the Ivory Coast privatised in 1999 /2000. It was a different risk model and we weren’t sure we fancied that risk model”…
What more can be done to help smallholders in countries like Ivory Coast and Ghana?
It’s not my job to restructure African politics. I think that we in the West are really arrogant about pretty much every country in the world. We think that we’re democratic and right, and that everyone else is wrong. It took us about eight hundred years to go from being feudal to the pretty second rate democracy we have in the UK today. I think we Westerners should understand that, and be much less arrogant. Africa does have elected leaders and had elected tribal leaders before. Don’t expect the system to change in one day, or even in fifty years. It’s going to take time.
I am not at all keen on telling other people what I think is best for them. I believe that this is the big mistake that the US has made for the last forty years
You sold your physical trading business a couple of years back and are now a pure commodity speculator. What benefit do you bring to the market – or to the world in general?
“Speculators are essential to any market. In fact I think you should call them investors and not speculators. There are a lot of investors in commodities who can be both long and short. I think we might get more respect for the commodity business if we try to change the word speculator to investor, and explain that definition.”
“Ninety percent of the investors in my fund are actually pension funds. It would be good to try to get that message across. It is a profession – and we are professional investors. In the stock market, people aren’t called speculators, they’re called investors, even if they’re buying put options. In the old days we had jobbers, who were the market makers in the stock market: that still sounds rather better than speculator. I think we would do a really great service to the world if we could get people to think differently about this…”
In the Cocoa Market, the July and September contracts can be vulnerable to shortages of fresh cocoa supplies due to the crop season in the world’s largest cocoa-producing region, West Africa, with the main harvest due to start in September/October…
Such a situation usually reflects concerns over availability of stocks for short-term supplies are mirrored by the low-level of certified warehouse stocks in Europe, partly as a result of a decline in production in Africa.
However in July 2010, Armajaro took a one billion dollar long position in the July Liffe cocoa futures market. That’s more than 40% of the open interest on the NYSE LIFFE Cocoa July Futures (London).
As the delivery time of the July 2010 cocoa futures contract (i.e. 15 July) approached, shorts who previously sold this contract could fulfil their contractual obligations positions held on Futures by either;
– Trading out of position before delivery required, or
– Delivery of certified cocoa to the London terminal market or by buying.
You can check these maths, oversimplified, sort of, but with revealing results..
At the end of June, the make out of the certified warehouse stocks in Europe were to 259,000 tonnes.
The trading house/hedge fund took physical delivery of 240,100 mt, $998M worth of the soft commodity.
That’s more than 8% of the world supply while at the time, Armajaro is a 150M net equity company, figure.
As a result, shorts were forced to settle their contracts in cash with the longs at a loss.
At this moment, LIFFE July cocoa futures is trading at a hefty premium of £270 a tonne ($415) to the September contract. USD/GBP= 1.54
If the position coincided with the rising open interest that in July 2010, the long position was built at average weighted price of £2350 a tonne.
On July 15 the theoretical paper profit is $129M but to realize it, Armajaro would had had to quasi-simultaneously dispose the $998M stocks.
–Selling them all at once was an impossibility as cocoa prices would have later plunged and profits would be lost…
–This had an impact on how they would eventually complete the transaction.
When a merchant buys inventory he takes risks that it knows it will have to sell later. This is the curve.
Figure 1. Arbitrage Spread between NYSE LIFFE (London) and ICE Futures (New York) for the December Contract warehouses stocks (ICCO) .
This price premium over the nearest positions is a major factor in attracting additional physical stocks.
At that time, the London/New York arbitrage spread has risen to more than $1100, $600 and $400 per tonne for the July, September and December 2010 contracts.
The cocoas from Ghana and Cote d’Ivoire deliverable to New York receive a $160 per tonne quality premium. Consequently, under normal market conditions, London futures prices would be expected to be higher than New York prices, but not by more than $160 per tonne..1a
Conversely, Traders have delivered beans against the London markets.
The Emperor with no clothes
The favorable outlook for weather (and paradoxically high prices) with these developments after mid-July have sent the London flat prices south by more than £390 per tonne ($600/mt).
The September cocoa is trading at a premium of £71 a tonne to the December contract, the December contract is traded at – £15 below the March Contract and so on.
The curve has flattened.
ARMAJARO’S BALANCE SHEET TIMELINE
1-15 July Long at £2350
15 July The Trader took delivery. Paper Gains: £354 per tonne.
Mark-market at £2700 and entered the position at LIFFE +71 hedged under the september, december and march contracts.
14 August Mark-market at £2058/mt & hedged evenly between the sep, dec and mch contracts.
Hedging losses: –£59 per tonne
-Warehousing Carrying cost of –£27 per tonne
One of Armajaro’s numerous problem was the premium they paid to convert their long futures into physicals.
No Free-Lunch in the Commodity Market
The £85 million paper market gains it was not a free-lunch; to maintain a £648 million position on cocoa at LIFFE + 71, Armajaro had to hedge the delta and disbursed all the associated carrying costs (financial and warehousing) until december/march (more than £140 million).
Any conservative estimate would put this manoeuvre break-even at LIFFE +145 per tonne…
The extent of this position imposed on its promoters an obligation of results.
“It’s not my job to restructure African politics”.-Tony Ward
“I think that we in the West are really arrogant about pretty much every country in the world. We think that we’re democratic and right, and that everyone else is wrong. It took us about eight hundred years to go from being feudal to the pretty second-rate democracy we have in the UK today. I think we Westerners should understand that, and be much less arrogant. Africa does have elected leaders and had elected tribal leaders before. Don’t expect the system to change in one day, or even in fifty years. It’s going to take time.”
“I am not at all keen on telling other people what I think is best for them. I believe that this is the big mistake that the US has made for the last forty years” -Tony Ward
Guy-André Kieffer, the assassinated journalist, had highlighted the special contribution of Armajaro in the sociopolitical life of countries where relations are marked by violent antagonisms.
According to the French investigation journalist whose list of alleged executors and assassination sponsors does not cease to lengthen wrote that the company had actively participated in the rebellion financing.3
A bit cynical, all those traders, aren’t they ?
The strategy devised by Armajaro rested on the decay of the political situation in Côte d’Ivoire.
The various destabilization underway in the country and the military standoff resulting from the elections would “logically” lead to an increase in prices on the international market like in 2002.
Unfortunately, the chocofinger had totally misjudged the cocoa market. (but yes indeed, the crisis did materialized with mass graves and more than 3000 deaths).4
Ivorian cocoa in the physical market had traded at a premium to the London delivered price making the exchange a relatively cheaper way to acquire cocoa during the crisis but just not enough for Armajaro to break-even.
When they exited the position, the £85 million paper gains would unfold into an £55 million loss estimate.
Instant Karma ?
“You “sold” your physical trading business a couple of years back and are now a pure commodity speculator”. 🙂
With the losses of $7.5 million in fiscal year 2012 Armajaro was forced to liquidate all its assets, a merchant business with more than 500 employees and $3 billion in revenues.5
After back-to-back losses, after the redemptions, bruised egos the firm’s position was irreparably compromised.
Armajaro now described itself as “a firm that specialised in the management of commodity investments“. The firm is no longer active in the physical trading of commodities. It rather sounds like they are now a Macro Hedge Fund with “commodity-knowledge foundations”.
Perhaps they are smart guys with financial and the physical knowledge who dreamed to build the next Phibro but realized that to prove out their theories, their leverage futures-physical trading model needed too much overheads and patient capital to break-even.
A logo strangely Phibro…
Not a risk model, but rather a risky model
Armajaro’s original business model built an overnight sensation in cocoa and coffee.
Its founder ambition and actions led to it rise & fall despite the fact that the Willie-Wonka made (and probably preserved) 1 or 2 millions at Phibro plus lately a couple of millions in “management CHOCO-fees”.
Armajaro (2010) eloquently sums up the problems in futures cash convergence.
It also reveals the speculative character of (1) operator in commodity trading.
They went sometimes right to the edges, cutting the corners, waging a merciless war for the supply control ending up overpaying to acquire the commodity.
In our view, it has to do a lot with the personality of the trader.6
Jacques, S (2017) “Traders-Secrets in the Commodity Game Part XI: Armajaro, the Trade who Blown up a $3B Sales Merchant Business. , Navigating the commodities markets with Freight and Spreads , August 5, 2017.
Manager of commercial relationships and mastering the art of commodity merchandising, Simon Jacques is advisor to leading energy marketers and producers on defining and imparting the knowledge and skill sets necessary for their professional staff to function effectively.