Goldman Sachs continues to ratchet up predictions for commodities, laying out a bullish case for commodities of all stripes in 2018.
The investment bank said that its forecast a year ago for higher commodity prices “played out much better than expected.” The bank pointed to industrial metal prices, which are up 24 percent this year, plus the 13 percent increase in oil prices.
But looking forward, Goldman sees plenty of room to run. “The demand backdrop today is now even stronger than a year ago, with robust and synchronous global growth clearly evident,” Goldman analysts, led by Jeffrey Currie, wrote in a December 11 research note. The extension of the OPEC deal also led the bank to revise up its forecast for oil prices, as inventories should continue to fall throughout 2018.
There are other reasons to be bullish on commodities. The investment bank argues that commodities tend to outperform other asset classes when central banks move to tighten rates. That is because rate hikes typically occur when demand is exceeding supply – the higher prices resulting from that mismatch are why central banks are trying to raise rates, but it is those higher prices that support the investment case into commodities.
The report concluded that "a positive carry in key commodity markets and already strong global demand growth across the commodity complex reinforces the case for owning commodities. And hence we maintain our 12-month overweight recommendation, now with a forecasted return of almost 10 percent."
On top of that, Goldman argues that it “pays to be late and enter commodity markets as the business cycle matures.” The logic is that in the oil market, for instance, futures are in a state of backwardation, which makes investing highly attractive. “The reason for this is that once the returns are based upon carrying and less on price appreciation, the persistence of the carry delivers more stable and dependable returns,” Goldman wrote.
And because the oil futures market is not heading back into a state of contango next year, the “persistent level of backwardation [will be] the primary driver of returns next year,” the investment bank predicts. “More specifically, we see 15% returns next year from the role yield in oil and 10% yield from the roll yield across all commodities”
With all of that said, Goldman says the returns are probably much higher in markets where the supply response is much less elastic. For example, in sectors like copper, zinc, iron ore and met coal, it can take years to bring new capacity online. Oil tends to have a much quicker response time – i.e., U.S. shale can ramp up production in a matter of months if prices are attractive enough. Those short lead times reduce volatility and also limit the upside potential. “Accordingly, the markets where technology hasn’t substantially shortened the supply cycle, and where cost is rising, (i.e. copper) have the greatest long-term upside in prices,” Goldman analysts wrote.
Investment in upstream copper capacity cratered in response to lower prices following the bust in 2014, and that should translate into tight supply conditions for quite a while. “The lack of investment over the past few years implies that copper mine production is likely to decelerate notably after 2019, given its long-cycle nature,” the investment bank said.
The notion that commodities appear to be one of the hottest investment strategies is shared elsewhere. Jeffrey Gundlach, CEO of DoubleLine, echoed Goldman Sachs in comments to CNBC, arguing that commodities are the best investment strategy for 2018.
Meanwhile, in the oil market, all signs point to an ongoing tightening process well into next year. OPEC is even looking at a “continuity strategy,” jargon for cooperation beyond the expiration of the current deal to limit production. "We are designing a framework for a continuity strategy for supply management to help ensure a stable and sustainable oil market," OPEC Secretary General Mohammad Barkindo said in a speech in China, according to CNBC.
Barkindo also said that the surplus in global oil inventories above the five-year average has dropped to 130 million barrels as of November. To put that in context, the surplus has fallen by more than half since the start of 2017.
“The fundamentals of the oil market have not been this strong in the past several years,” Barkindo told Bloomberg. “Both the global economic rebound, as well as strong oil market fundamentals, for the first time in so many years are all pointing to the right direction.”
By Nick Cunningham of Oilprice.com