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What is Cornering the Market?
In the financial context, cornering the market refers to the acquisition of shares or particular security in large quantum. The quantum remains so large that the acquiring company or the cornerer gets a hold over the price movements of that security in the market. Here the security can be a share, bond, commodity, foreign exchange, or any other asset.
The cornerer gains control over the supply of security and thereby creates an artificial shortage of that security. It will enable the cornerer to sell that security at a higher profit by consistently raising the prices of the security without the risk of losing considerable business.
Since the cornerer influences the market price of the securities, they must hold a big chunk or substantially large quantum of that security to able to control and direct the prices. But, the cornerer or such cartel does not have a monopoly in this market. The cornerer or such cartel puts the market in such a tight situation that supply is limited and the purchaser or market has no escape. And it all happens without the risk of losing considerable business by raising prices. It creates a temporary monopoly or duopoly like situation. As a result, the market finds it difficult to find security with any other seller or with few sellers only. And thus the buyers have to pay the price and the market turns out to be a sellers’ market.
In a monopoly market, a single seller dominates the market through its unique product/offering. Being a sole provider of products with no near substitute, it enjoys no or minimal competition.
Applicability of Cornering Concept
The concept of cornering is appliable in all sorts of businesses and markets. And not limited to the financial securities market. The intent and process for cornering the market remain the same across the businesses. In an industry or commodity market the company using this technique either buy and hoard the large quantity of that product. Or there remains a cartel which does the same job or controls the production resources and thereby creates shortage. In another way the person, company or cartel gets a major chunk of the market share of that particular product.
This way they can dictate prices and supplies of the products. Buyers and market remains and behave in a tight spot and price rise happens, premiums are being charged, or advance payments are insisted and so on. Ultimately in the bargain the cornering party gains handsomely.
The main aim of cornering the market is to maximize profits. And for that the parties or persons involved can adopt legal as well as illegal means.
Legal Means to Cornering the Market
Big and established institutions are better positioned than their peers to corner the market, if they chose to, through legal means. Not only do they have a competitive edge but also significant capital to acquire the majority of the security or economic activity or commodity in the market.
Let’s say that one’s aim is to corner the market price of a chemical company A. The cornerer starts to stock up the company’s shares, creating a buying frenzy, thereby pushing the price of the shares way up. As is usually the case in the stock market, rising prices draw more buyers and investors, resulting in increased demand for the company’s shares.
This inflated price and demand enable the corner to then offload the accumulated shares to book handsome profit. The Cornerer now short sells his position as once the shares start to sell, making their way back into the market, the normalcy will resume, causing the prices to drop.
Prevalence in Future Contracts
This scenario is quite common in the futures contracts of a commodity market. Futures contracts provide trading opportunities in commodities that are vulnerable to factors (e.g. weather) affecting supply or demand. Also, another thing that makes futures contracts lucrative is its usage of leverage.
In simpler terms, while entering a futures contract, the trader doesn’t need to put the full amount of the contract’s value but only an initial margin. The initial margin is usually 20-30% of the total contract’s value. Also, it is dependent on factors like creditworthiness of trader/investor and size of the contract, etc. Though leverage draws traders into the futures market, it is also risky as they can lose more than the initial margin amount. Few examples are:
Hunt Brother’s Market Manipulation
In the 1970s and 1980s era, Hunt Brothers -Bunker and Herbert Hunt- tried a similar approach to corner the market by hoarding silver. In 1974, they started accumulating futures contracts. These contracts gave them the right to buy silver at pre-decided prices on a pre-decided date in the future. The general practice prevailing in the commodity market is that the traders do not keep the contracts alive till the expiry, rather sell their contracts beforehand. They don’t prefer to take the physical delivery of the commodity as they have to incur huge logistical expenses by accepting the delivery.
Hunt brothers were of a different opinion. Rather than selling the contracts, they took delivery of the silver. As Americans were not allowed to hold gold, Hunt Brothers chose its less precious cousin- silver- whom they considered a tangible and inflation resistant asset. Their bullishness on Silver also influenced affluent Saudi oil sheiks. Together, they formed a partnership -IMIC (International Metals Investment Company)- focused on buying silver futures.
Their increased activity in the silver market didn’t go unnoticed. In 1976, CFTC (Commodity Futures Trading Commission) questioned the Hunt brothers of their total possession of the silver. Their hoarding and manipulation had skyrocketed the silver prices from US$6 an ounce in the year 1979 to ~US$50 an ounce in the year 1980. It was silver’s highest price ever recorded at that time.
SILVER RULE 7 – NEW RULE ENACTED
Towards the end of 1979, together they had acquired ~60% percent of the silver in the COMEX (Commodity exchange) warehouse. What a precarious situation to be in for Comex? COMEX retaliated by enacting a new rule-Silver Rule 7, in January 1980. This new rule restricted purchases of any further silver, though selling was allowed. Moreover, stricter restrictions were put in place on the buying of commodities on margin, causing a steep decline in the price of silver.
The Hunt Brothers were caught in an extremely tight spot as their purchases had been financed through heavy borrowings. Now they couldn’t buy any more silver but if they sold theirs, they have to incur major losses. The fall in the price of silver triggered a margin call of $100 million. The Hunts couldn’t meet the margin call and had to take a paper loss of ~$2 billion.
Illegal and Unethical
The above-mentioned example indicates that cornering the market is not only illegal but also unethical. The cornerer’s influence on security or commodity price gives him an unfair advantage over his peers. Tables turn soon when the corner’s identity is not unknown anymore.
This inefficiency is soon observed and the market starts taking opposing positions, lowering the value of the cornerer’s holdings. The cornerer finds it difficult to exit his position without further participating in falling prices. Hunt Brothers met with a similar fate.
The case of Hunt Brothers highlights the importance and intervention of regulatory authorities. Whenever a company accumulates large quantities of security, it attracts the attention of the Securities and Exchange Commission (SEC), CFTC, and other regulatory authorities.
Therefore, if an individual or company tries to corner the market by controlling and limiting the number of willing sellers and buyers, it can not hold so for a long. Ultimately, it becomes visible and the process starts to break down sooner or later as a regulatory intervention comes into play to restore it. Also, Markets exist to boost competition enabling competitive price discovery and thus have always a way to restore its balance.
The strategy of cornering the market is illegal and unethical. It creates an artificial shortage of the commodity or security and price hike to the advantage of few. This disturbs the equilibrium of the market and healthy competition amongst the buyers and sellers.
There are regulatory authorities with every country which keeps a close watch on such market manipulative activity. They take stricter actions with the defaulters and tries to restore back the normalcy in the market by punishing such individuals, companies, or cartels.