Clearly, Goldman Sachs is still too long commodities:
Growing scarcity across physical markets. Since last October, policymaker and investor focus has remained on the vaccine-driven demand recovery from the deepest recession on record. Yet today, physical goods demand has reached such high levels — above pre-pandemic trends in all but oil — that the system is becoming increasingly constrained in its ability to supply these goods. Now with the pandemic inventory glut run down, these markets are becoming increasingly exposed to any type of supply disruption or unexpected demand increase. The lower the inventory cover, the bigger the risk and the larger the scarcity premium in prices when one of these events materializes – just as we are seeing in European gas and power today.
The consumer-led recovery accelerated the revenge of the old economy. It is important to emphasize that most of these shortages, outside of labour issues, have very little to do with covid. In fact, the seeds were sown following the financial crisis in 2008 when long-cycle ‘old economy’ capex collapsed in favor of short-cycle ‘new-economy’ capex – a fact we highlighted in 2019. To incentivize long-cycle capex, physical goods prices will need to significantly overshoot to the upside to compensate for the growing risks involved in long-cycle capex projects. As commodity markets are unable to react to the first leg higher in prices through greater supply, once inventories are exhausted, like in European gas today, demand destruction is the only option to rebalance markets which requires sharply higher prices to curtail demand in line with supply.
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Despite tighter markets, commodities remain under-invested. Deep-rooted bottlenecks and widespread supply shortfalls have fueled a historic rally in global gas, while continued drawdowns in visible inventories offer obvious signs of deficit trends across oil and base metal markets. Despite this, commodity markets remain broadly under-invested. Markets like TIPS that are pure investor products are far off their highs while the CRB Raw Industrials Index, which has no investor involvement, is near all-time highs. Investors have abandoned the reflation trade based upon sentiment and not fundamentals. In our view, European energy pricing dynamics offer a glimpse of what is in store for other commodity markets, with widening deficits and depleting inventories leading to elevated price volatility as markets struggle to balance strong demand with sticky supply. We see S&P GSCI and BCOM12m index returns of 10.9% and 6.3%, respectively – with these returns facing growing upside risk, we reiterate our long commodity call.
So, then, if that’s the case, with iron ore leading the global drawdown in inventories, it must be through the roof!
In the last couple of notes, Goldman upgraded iron ore to an average price of $195. When iron ore missed to the downside spectacularly, Goldman argued it was massively oversold and you should buy in the $160s. It has since kept plunging yet, strangely, it gets no mention in this note.
On that chart, outside of cars, inventories for goods are pretty much fine. Also, the commodity inventory draws are tiny. The levels are not examined. And when it comes to base metals, they are really just shifting pallets in warehouses anyway and are easy to manipulate.
There are any number of short-term supply disruptions in gas and coal (most COVID-related). Energy will probably stay well bid on this basis.
Outside of that, this is bubble-blowing par excellence, which is not to say it won’t succeed for a while.
As China slows much more than Goldman expects, led by the bust underway in property development and infrastructure, the clear risk is that many commodities and especially base metals will follow the unmentionable iron ore price lower.