Focus on the micro not the macro. For the past 9 months, commodities have been driven by strong macro trends, with significant cross-commodity correlations that pushed the entire complex higher through June. More recent macro trends –reflation unwind, Delta variant concerns and caution over China – have generated headwinds, driving all markets lower. Combined with low liquidity and fresh shorts from momentum investors the move has been swift and large. While liquidity will likely remain low and the trend is not our friend right now, we believe the micro -steadily tightening commodity fundamentals – will trump these macro trends as we move towards autumn, pushing many markets like oil and base metals to new highs for this cycle.
Shifting gears to a micro driven bull market. Indeed, we see these macro trends drawing attention away from increasingly constructive micro data across the complex. On the back of this data we maintain our bullish view. Even those markets like steel and iron ore where micro fundamentals have weakened, there are very specific idiosyncratic reasons for the weakness. While the demand for oil has clearly weakened in Asia, it has weakened less than we expected. Further, both base metal and agriculture demand remains strong. Although US shale output has surprised to the upside recently, it is in line with our expectations while supply elsewhere for oil and all other markets remains structurally weak. As a result, key markets remain in deficit with inventories in oil and base metals continuing to fall sharply. While peak growth is clearly behind us we once again emphasize that commodities are driven by demand levels not growth rates and once we pass through this Delta variant –China cases are already declining – even oil demand levels should recover into year-end. Accordingly, we maintain our 4Q price targets — $80/bbl oil and $10,620/t copper and now forecast 17.1% returns for the S&P GSCI into year-end.
Delta a transient event to oil demand, supply losses are persistent. Both oil prices and time spreads have sold off over the last three weeks as Delta concerns have darkened the outlook for demand; however, flat prices have overshot time spreads to the downside, suggesting an oversold market. So far the demand hit has remained within our conservative expectations in China (0.7 mb/d vs 1 mb/dbase case), and overall demand continues to track near 98 mb/d as regional mobility indicators remain robust ex-APAC. The c.1.5mb/d deficit over the last month has been focused in EM, where storage levels ex-China are now precariously low, and we expect DM stocks will have to take the brunt of future drawdowns. Cash markets have weakened substantially, partly due to the post-Covid biannual storage play unwinds, nevertheless refining margins have remained supported and, in fact, a simple average of Brent and Dubai prompt time spreads remain near post-Covid highs. In addition, supply data points continue to disappoint versus our below-consensus expectations; the IEA has now revised down non-OPEC+ ex US/Canada supply by almost 1 mb/d each of the last two quarters, with growth increasingly back-loaded. The latest leg of the sell-off has been more parallel in nature, with the market reflecting anxiety over medium-term growth, China stimulus, and the possibility that US shale maybe inflecting higher. Nevertheless, we expect Delta will prove to be a transient event,and that US producers will retain their newfound discipline, as the drivers of our bullish view shift from cyclical demand impulses to the structural binding constraints o funder-investment in supply that were only accelerated by Covid-19.
China steel weakness in Q3 is no canary in the coal mine. There is no doubt that China’s steel data has deteriorated since mid-year. After a strong H1 with apparent onshore steel demand rising nearly 6% y/y, the data since then has pointed to a 4% y/ydecline so far in Q3. Coupled with a softening trend in early cycle construction activity, investors are concerned over rising headwinds to onshore demand. We think such concerns are over emphasised. First, there have been transitory yet material distortions to steel apparent demand from mid-year. Flooding in several provinces alongside Deltalockdowns has exacerbated the seasonal slowdown in construction activity, which should reverse into Autumn. In addition, policy led steel supply cuts and resultant higher steel prices have contributed to downstream destocking which has, just as with copper in Q2 generated a negative adjustment to apparent demand. Second, it is also clear that Beijing is shifting to a more pro-growth policy setting which should generate a boost to infrastructure investment over the next 2-3 quarters, whilst also limiting further tightening measures on the property sector. In this context, we expect an improvement in China’s steel demand trends in Q4 (vs Q3) though the trend will be closer to flat y/yinto next year. In this context we also see iron ore as oversold after a near 30% fall. A combination of improving steel demand, policy developments and a stabilising physical market should act as upside catalysts for iron ore.
Sustained deficits across base metals supports higher prices. There is no evidence that the current weaker micro trends in China’s ferrous sector are feeding into base metals markets. Onshore inventories across all the base metals have drawn over Q3and for the majority are falling at the fastest pace seen year-to-date. In particular, we would note that onshore copper stocks (social and bonded) are now c.30% lower than their mid-Q2 peak, whilst high frequency indicators such as physical premiums and the import arb all point to a material tightening trend onshore. We think this reflects so far solid demand conditions through the summer period with evidence of y/y apparent demand growth rates inflecting higher after the negative downstream destocking distortions in Q2 (due to high prices). At the same time, supply side constraints via both scrap (Delta lockdowns impacting SE Asian processing flows) and power supply on smelting/refining (cutting refined output across a number of base metals) have supported the call on inventories. As demand improves seasonally from September, aided by reduced lockdown effects and some probable supportive policy adjustments, we expect continued tightness onshore into Q4 and support for higher import volumes of refined metal. This fundamental setup will offer support for a trend higher in both copper and aluminium prices in particular.
Goldman is also bullish gold and softs. In fact, there is no form of dirt that it does not like.
It is unusual for a merchant bank to be so pigheaded about a bad call. Usually, they let them slip away quietly. So, either GS is very long commods and seeking a patsy, or this is an irrationally held conviction call.
To be clear, the Goldman view that:
- China no longer matters to commodity prices;
- DM stimulus is the major driver of commodity prices;
- futures markets now play second fiddle to spot prices;
- micro trumps macro, and
- a rising USD won’t impact commodity prices…
is so diametrically wrong that red-faced is the least of it. As we have seen in the past two months:
- Chinese demand is all that matters to commodity prices.
- DM stimulus is largely irrelevant and is swamped by demand changes in China.
- Futures markets (especially in China) drive spot prices not the other way around.
- Macro always trumps micro, and
- If you add a rising USD to the above scenario then commodities will crash.
Fading Delta is negative for commods because it means no new stimulus in China and taper to go ahead…
