Commodity Desks Feel the Ax in Move to Cut Risks
By Suzanne McGee

01/22/1996 The Wall Street Journal Page C1

Gold is flirting with the $400-an-ounce level, volatility in natural-gas prices is at historic highs, the grain markets are in their biggest rally in two decades and even the copper and coffee markets are percolating a bit.

So why have several big Wall Street securities firms picked this moment to scale back their commodity-trading operations?

At Merrill Lynch & Co., for example, 75 of the firm's 530 or so employees in its commodities division will be gone by the end of the month. Lehman Brothers -- a unit of Lehman Brothers Holdings Inc. with a rich commodities tradition -- has axed its veteran gold-market analyst, George Milling-Stanley, even after its precious-metals staff had already dwindled.

Meanwhile, Goldman, Sachs & Co. is scaling back its coffee-trading operations. And despite the company's denials, rumors stubbornly persist that it, like Morgan Stanley Group Inc., will get out of the business altogether before too long.

Simply put, the exciting rallies in many commodities have merely reinforced many Wall Street firms' dim view of a quirky business in which profits haven't always grown as fast as the risks.

"Commodities is a business that's been growing, but not as fast as foreign exchange or money management," says John Keefe, president of Keefe Worldwide Information Services Inc., a New York consultant to financial-services companies. It's a "volatile and risky" business, he adds, that has historically been dominated by firms that specialize in it.

Analysts who follow Wall Street agree that it isn't surprising to see a change in the way these big, full-service securities firms approach commodity trading. Few have top executives with a background in or knowledge of commodity markets, which still generate only a small part of most firms' revenues. Indeed, in some cases, managers with direct responsibility for these divisions may have come from outside the commodity business.

"With the new focus on risk-adjusted rates of return, many firms are demanding higher rates of return from businesses like commodities with higher risks," says Dean Eberling, an analyst at Prudential Securities Inc. in New York. "When those higher return thresholds aren't reached, the capital gets pulled and reallocated."

In 1995, even in the absence of inflation, many individual commodities rallied significantly, mostly in response to a combination of healthy demand and tightening supplies. But trading volumes and revenues at big securities firms didn't always follow suit. Lack of volatility hurt some big markets, such as crude oil. And in some once-hot markets, such as coffee, trading activity dwindled as some consumers and dealers got stuck with high-cost inventories after two frosts in Brazil's coffee-growing regions sent prices soaring.

In fact, coffee-trading operations have been the first to suffer in Wall Street's retreat from commodity markets. In December, Merrill quit the coffee-brokerage business, while Morgan Stanley is still in the process of winding up its own "physical" coffee-trading operations, which will include the dismantling of its coffee-tasting room. Goldman Sachs says it will close its London coffee- and cocoa-trading operations and centralize the business in New York "for greater operational and commercial efficiency."

The retrenchment in coffee doesn't come as a surprise to specialists in trading the so-called soft commodities, which include sugar, coffee and cocoa; these specialists watched badly burned speculators flee those markets in record numbers.

"The only way you can make money is not to have analysts, and all the support staff that goes along with that," says Howard Strauber, a broker at E, D & F Man, a commodity-brokerage firm in New York. "On a stand-alone basis, most of those trading operations seemed to be profitable."

But the recent cuts strike deeper. Merrill's new round of staff reductions included firing a third of its commodity-research staff, including one of its three grain-market analysts and the cocoa and livestock analyst. Their responsibilities have been doled out among the remaining staffers, Merrill officials say, while William O'Neill, chief futures strategist and now coordinator of commodity research, inherits the tasks of the departing manager of futures research, Chris Stewart. The firm is also restructuring the way it handles floor trading at the Chicago Board of Trade, Chicago Mercantile Exchange and New York Mercantile Exchange, which also will lead to staff cuts, and will cease floor-trading operations at the Kansas City Board of Trade and the Philadelphia Stock Exchange.

"We're going to take our [order] execution desk off the floor, and that will make the routing of orders more efficient," as well as allow the firm to cut back on floor staff, such as runners and clerks, says John Sievwright, managing director of financial futures at Merrill Lynch.

Mr. Sievwright says that over the years Merrill had committed itself to retail, or individual-investor, clients in commodities "to perhaps a greater extent than we really needed. We had too many resources devoted to a relatively small market, that wasn't growing as fast as others."

Now, Merrill plans to reorient its commodities operations to focus more on over-the-counter transactions with producers and other commercial customers, company officials say. Flavio Bartmann, London-based head of global commodities at the firm, says he plans more new hires in those areas, particularly in energy and base-metals trading.

A similar reorientation is under way at Lehman Brothers. Officials there confirmed the departure of Mr. Milling-Stanley, as well as other members of the precious-metals trading team, but added they hope to be back up to full strength shortly. Mr. Milling-Stanley had no comment.

The decision last year to cut the firm's energy floor-trading operations resulted in the departure of some 20 people, they note, but another five have been brought on board to beef up the over-the-counter dealings with energy producers and consumers.

Top management at Wall Street investment dealers appears to now be more demanding in evaluating their commodity profits. Once, a firm would have been content with only small profits from, say, coffee-trading operations, in the belief that this business was necessary to maintaining other investment-banking relationships with big food companies. Now, these dealers are more likely to insist that each niche market justify its existence.

Despite assertions that further staff cuts and rollbacks are unlikely, commodity-trading firms widely expect most Wall Street firms to further cut their involvement in grain markets, where giant specialist firms like Cargill Inc. still attract the majority of the sought-after institutional and commercial clientele.

"Many commodity markets are likely to become more and more dominated by the pure players in the business, the Cargills and their like," says Thomas Facciola, an analyst at Salomon Brothers in New York.

One contrarian is Travelers Group's Smith Barney Inc., which is expanding its commodities operations even as its peers retrench. The firm has hired at least one former Merrill coffee broker and plans to interview many more of those laid off in the more recent round of cutbacks. Its commodity-research division is now unusually large among Wall Street firms, boasting both a lumber analyst and an in-house meteorologist.

"Commodities and futures are an important asset class for many of our clients who are looking for a way to diversify," says Jack Lehman, director of the commodity-futures division at Smith Barney. But even he adds that the firm is still seeking ways to be more cost-efficient in dealing with these high-volume, low-margin clients; for example, by also steering them toward commodity funds offered by the firm, allowing Smith Barney to gather more assets.

Reasons David Vogel, executive vice president of Smith Barney: "Commodities are very cyclical and the last thing we want to do is get out of business at the bottom of cycle and then miss the upturn when inflation comes back."