Quote from chief_editor on June 3, 2024, 10:12 pm

Trading physical commodities can be a lucrative but treacherous endeavor. With over a decade of experience in this field, I’ve encountered numerous pitfalls that have cost me time, money, and effort. This article outlines seven red flags that, if identified in a new counterparty, should prompt you to back out of the deal immediately. These insights, distilled from years of hard-earned experience, could save you from potential scams and ensure you engage only with credible and professional counterparts.

1. Request for Proof of Funds (POF)

A common red flag in physical commodity trading is a request for a Proof of Funds (POF). POF is a document or bank statement verifying that an individual or entity has the financial ability to complete a transaction. While this might seem like a reasonable request, it often signals inexperience or dishonesty.

In the dynamic world of trading, companies rarely have large sums of cash sitting idle. Funds are constantly in flux—receivables, prepayments, and ongoing transactions create a dynamic cash position. Demanding a POF disregards this reality and often indicates that the counterparty does not understand the business's fluid nature or is attempting to manipulate the situation. If a new counterparty insists on POF, it’s best to cut off communication and move on.

Case Study

A potential supplier once insisted on a POF, promising a lucrative deal with high volumes at below-market prices. My partner, eager to explore the opportunity, pushed forward despite my reservations. Predictably, the deal unraveled when the supplier demanded prepayment and proved incapable of fulfilling their promises. The entire ordeal was a costly lesson in recognizing and avoiding amateurish or fraudulent entities.

2. Defensive or Evasive Responses to Basic Questions

When starting a conversation with a new counterparty, it’s crucial to ask fundamental questions to understand their operations, suppliers, specifications, and payment terms. These questions help determine if the potential partnership is viable.

If the counterparty is defensive or evasive, providing vague or unclear answers, it’s a major red flag. Transparent communication is key in trading, and a reluctance to share basic information often signals dishonesty or a lack of professionalism. Legitimate businesses understand the importance of due diligence and will readily provide the necessary details.

Personal Experience

I once encountered a buyer in Italy who could only communicate via Google Translate due to language barriers. Despite initial attempts to move forward, it became evident that effective communication was impossible. Language and communication issues can lead to misunderstandings and complications, making it vital to ensure clear and open lines of communication from the start.

3. Demand for a Letter of Intent (LOI)

Another red flag is the demand for a Letter of Intent (LOI) at the onset of a transaction. An LOI signals a commitment to proceed under agreed terms and lays the groundwork for a more detailed contract. However, in commodity trading, especially for smaller deals, an LOI is often unnecessary and used improperly by brokers to establish claim over a potential client.

Reputable businesses with strong relationships do not need an LOI to prove their credibility. Brokers asking for an LOI are likely trying to secure a commission without adding real value to the transaction. Avoid deals where an LOI is demanded prematurely.

Example

On LinkedIn, it’s common to see brokers touting the LOI as a standard initial step. However, this practice mainly serves to protect the broker’s interests rather than facilitate a legitimate transaction. A genuine supplier with solid relationships will not rely on LOIs to validate their business dealings.

4. Lack of Detailed Information on Key Aspects

Professional trading requires thorough due diligence. If a supplier is unwilling to provide detailed information about the origin of their stock, production capabilities, or logistical details, it’s a significant red flag. Comprehensive details are essential for assessing the risk and feasibility of a transaction.

Skimping on due diligence can lead to significant losses. It’s better to walk away from a deal lacking transparency than to proceed with insufficient information and face potential fraud or operational failures.

Minimum Vetting List

In my training courses, I emphasize the importance of a minimum vetting list, including company history, financial health, production capacity, and legal compliance. Skipping these steps can expose you to undue risk. Ensure that every potential partner meets these minimum standards before engaging in any transaction.

5. Offers That Seem Too Good to Be True

In commodity trading, prices are generally aligned with market rates. If a deal seems too good to be true, it probably is. Unrealistically low prices or exceptionally favorable terms often indicate a scam or a trap set by an inexperienced trader.

The market operates on supply and demand principles, and there’s little reason for anyone to sell significantly below market price without a catch. Always approach such offers with extreme caution and a healthy dose of skepticism.

Real-Life Scenario

I’ve encountered numerous deals that promised below-market prices and high volumes. Without exception, these deals have proven to be scams or have collapsed under scrutiny. It’s crucial to remember that the allure of quick profits can blind you to obvious warning signs. Stay grounded and rational when evaluating deals.

6. Reluctance to Engage in Formal Agreements

Reputable companies are willing to formalize agreements with clear terms and conditions. If a counterparty is hesitant to engage in formal contracts or insists on vague, informal arrangements, it’s a red flag. Formal agreements protect both parties and ensure clarity and accountability.

Avoid any deals where the other party resists formalizing the terms. A lack of proper documentation and clear terms often leads to disputes and financial losses.

Personal Insight

In my experience, every successful long-term trading relationship is built on solid, formal agreements. They provide a framework for resolving disputes and ensure that both parties are committed to their obligations. Insisting on formal agreements from the start is non-negotiable.

7. Inability to Provide Credible References

Credible counterparts will have a track record of successful transactions and satisfied partners. If a new counterparty cannot provide credible references or verifiable history, it’s a major red flag. Past performance is a strong indicator of reliability and professionalism.

Always ask for and verify references before proceeding with a new partner. Contact previous clients or suppliers to confirm the counterparty’s credibility and performance.

Case in Point

I once considered a deal with a company that boasted impressive capabilities but could not provide any verifiable references. After some investigation, it became clear that their claims were exaggerated. Trust but verify is a crucial mantra in commodity trading.

Conclusion

The world of physical commodity trading is fraught with risks, primarily stemming from counterparty reliability. By recognizing and responding to these seven red flags, you can safeguard your investments and ensure you engage only with credible, professional partners. Always prioritize thorough due diligence and trust your instincts—if something feels off, it probably is. Stay vigilant and protect your business from potential scams and unprofessional entities.

For those looking to break into the commodity trading world, remember that experience is your best teacher. Use these insights to navigate the complexities of the market and build a successful, sustainable trading career. Stay sharp, stay informed, and never let the promise of quick profits cloud your judgment.

[REF] Damien Würsten Channel on YT