Why Commodity Brokers Fail to Get Rich?

Introduction

Commodity brokers and traders operate within distinct business models, each with its own set of challenges and potential for success. Understanding the differences and key points can provide valuable insights for individuals considering a career in this field or looking to invest in commodities.

The Risk and Business Model of Commodity Brokers and Traders

• Commodity brokers act as intermediaries connecting buyers and sellers of commodities, earning income through commissions on facilitated transactions without taking any ownership or risk.

• Traders, on the other hand, buy and sell commodities, taking on the risk of ownership and making money by selling raw materials at specific terms required by clients, earning a margin for the risks they undertake.

• It’s crucial to differentiate between the business models of brokers and traders as they involve distinct levels of risk and income generation.

• The video does not focus on financial brokers or brokerage firms that deal with crude oil swaps, OTC products, forward contracts, and the like, despite their connection to commodities.

• Understanding the fundamental differences between commodity brokers and traders is essential for anyone considering a career in this field or looking to invest in commodities.

The Flawed Business Model of Commodity Brokerage

• In highly competitive markets dominated by only a few players, firms often resort to obfuscation and deception to protect their positions.

• Large firms use brokers to test the market and hide their trading activities from competitors by sending orders to multiple brokers.

• The fundamental flaw in the commodity brokerage business model lies in the misalignment of incentives. When a deal is successfully brokered, the broker’s value to the counterparties becomes negative, as they no longer need the broker and may even be better off without them.

• Unlike commodity traders, where successful deals build trust and ease future transactions, for brokers, each successful deal with a counterparty makes it harder to continue working with them.

• This flawed model prevents the creation of long-lasting value and leads to a constant struggle for brokers to maintain their relevance and usefulness to their clients.

Challenges of Building a Business as a Broker

• Starting a business as a broker may hinder the ability to build a successful and lucrative company due to the focus on closing big deals for commissions.

• While closing large deals may bring in substantial commissions, it doesn’t provide the capital needed to grow a business in the long run.

• For instance, in the case of brokering a 50,000 metric ton shipment, the commission may be significant, but it wouldn’t be sufficient for scaling the business.

• Securing financing for large deals becomes a major challenge for brokers, limiting their capability to expand and grow the business.

• This highlights a fundamental conflict for brokers, as their focus on big deals contradicts the need for gradual growth and capital accumulation essential for building a sustainable business.

Key Points on Building a Trading Business

• When transitioning into trading to build a bigger and more sustainable business, it’s important to consider the financial aspects.

• Starting with small deals can be a viable approach, but securing the necessary financing is crucial.

• For those without access to large capital, pursuing deals that are financially out of reach should be avoided.

• As a commodity trader, it’s essential to borrow money strategically and use leverage to maximize returns on equity.

• Strengthening the company’s balance sheet over time can enable access to better borrowing opportunities.

• Building a trading business creates an asset with potential for unlimited upside, while brokering may not yield long-term profits or residual value.

The Key to Success in Commodity Trading Business

• The key recommendation is to switch to running a part of the supply chain that you could finance yourself. For example, if dealing with coal, consider getting involved at the sourcing stage, where you can finance the transportation of trucks to fill a vessel.

• By financing the truckloads, you can make a return on your investment by depositing the trucks at the port and then using the money to pay for more trucks at the mine. This process can help in rolling your money and creating a small balance sheet, paving the way to bigger opportunities in the future.

• The speaker shares their personal example of starting a biomass trading business when they didn’t have enough money to start an energy or gas trading company. They emphasize the importance of finding something that you can finance yourself and taking the leap to do it, even if there’s fear of potential losses.

• The speaker also addresses the fear of losing money and highlights that if someone is too afraid to put their money on the line, they may not be suited to own a commodity trading business. This suggests that taking risks and being comfortable with potential losses are integral to this field.

Conclusion

Transitioning from commodity brokering to trading can provide opportunities for building a more sustainable and lucrative business. By understanding the flaws in the brokerage model and the key aspects of successful trading, individuals in the commodities industry can make strategic decisions to enhance their long-term financial outcomes.

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