Another note from Goldman on the endless appeal of commodities:
- With the vaccine-shaped recovery well underway, markets have been pricing in expectations that US – and global – growth will peak this quarter. Alongside the surprise hawkish tilt in the Fed’s reaction function, this shift in growth outlook helped to partially unwind the reflation trade in June, with the yield curve flattening at the front, long-dated rates repricing secular stagnation and the return of duration and a stronger dollar. This has created a macro headwind for commodities, with BCOM returns flat since the start of June.
- Yet our rates strategists see US Treasuries overbought, our FX strategists see longer term dollar downside and our economists remain constructive on global growth, suggesting a reflation hibernation rather than reversal. With rate hikes still two years away and financial conditions easing significantly, the outlook for the real economy – and hence commodity demand – remains robust. Remember, commodities price the relative level of demand and supply, and hence peak economic growth does not imply peak commodity prices, as reflected in our 12m BCOM (S&P GSCI) forecasts of 7.1% (9.9%).
- Unlike forward-looking financial assets, commodities are not anticipatory and so cannot sustainably price future changes in supply and demand over current levels of physical inventories. That means growing tightness in oil justifies higher prices today even though production is set to increase next year. For copper or aluminium where the where inventories are already low, that raises the prospect of demand rationing swings to prices as stocks draw in 2H21, similar to grains or timber recently. Therefore despite other markets pricing a reflation hibernation, we expect outsized total commodity returns on the back of industrial metals, grains and precious metals alongside heightened sector volatility.
- On top of falling inventories raising prices, commodities across energy and metals and agriculture are trading in backwardation. With the BCOM (S&P GSCI) roll yield sitting at 5% (7.5%) pa, structurally tight markets offer additional returns potential to investors above and beyond spot price returns.
Let’s take each of these points one at a time.
- Partly right. The other headwind is slowing Chinese growth and credit tightening which continues despite the RRR cut.
- “Reflation hibernation rather than reversal”. Well, sure. We all know that as growth slides away, at some point we’ll get more stimulus. But in the meantime, growth is sliding away. Being wrong about the timing is the same as being wrong. Commodities do not only price supply and demand. They also price the future via hoarding. If that future dims then the hoarding can unwind and prices fall a lot. This is why peak growth in China often equates to peak commodity prices and a prices bust.
- Rubbish. Has Goldman never heard of futures markets? Many physical commodities price directly off these paper markets. Iron ore and oil are both cases in point. Futures can by (mis)used to either hoard and inflate spot prices. Or, to short, and crash spot markets.
- Backwardation is precisely what we see at the top of bull markets. It is indicating that the current tightness of some spot markets is going to ease. Incipient bull markets illustrate contango, an upwards sloping curve. This is like pointing at an oncoming train and telling your companion not to worry because it is only the caboose.
Don’t get me wrong. I could just as easily be mistaken. If the Fed and Chinese authorities get spooked quickly enough to inject MOAR stimulus in a hurry, before any growth scare can take hold, then I will be. The commodity futures market will erupt and drive spot prices higher.
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But that’s the point, right? Commodities are not some kind of Platonic super-asset never impacted by growth and financialisation.
On the contrary, they are cyclical as fuck!