Goldman’s commodity bubble-blowers are capitulating:
Macro markets today are facing a navigational challenge worthy of Odysseus. In the Greek myth, Odysseus chose to risk his ship by sailing close to the rocks of Scylla rather than risk being pulled under by the whirlpool Charybdis. In our view, policymakers are trying to navigate between the Scylla of high physical inflation today, and the Charybdis of supply constraints that could slow future growth. While it appears that much higher rates are needed today to lower demand and inflation, they may also drive a fall in capex and investment that will prolong the structural undercapacity in physical commodities and hence this environment of high headline inflation and lower growth throughout the 2020s.
We believe that promoting higher investment in capacity – and bearing Scylla’s cost of higher physical inflation today – can policymakers avoid the Charybdis of stagflation.
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As in the myth, staying close to Scylla’s cave is mild as Odysseus would suffer minimal damage (ie keeping rates lower, leaving prices higher to drive investment); however, if his ship is sucked down by Charybdis (a decade of stagflation after high rates kill off the capex cycle), he would lose his entire ship. It is important to emphasise that policymakers can solve the core inflation problem without entirely fixing the headline inflation problem given the importance of persistent wage inflation in driving core inflation.
…Investors should remember that Fed-induced slowdowns are simply a short-term abatement of the symptom – inflation – and not a cure for the problem – under-investment. More broadly, when macro imbalances are physical and supply-driven, financial-based macro policies surrounding demand cannot resolve them, only co-ordinated investment policy can. With central bankers now focused on the costs of high inflation, there is a risk that the long-run cost of too deep of a recession is the end of the capex cycle and a failure to grow sufficient capacity to debottleneck the system. When Volcker took the Fed Funds Rate to 20 per cent in 1980, it was after a decade of rising capex, allowing the subsequent fall in demand in the space to debottleneck global supply chains.
In the current environment, the ‘capital-heavy’ capex cycle has barely begun and is at risk from a recession or resumed only through a return of physical inflation after growth resumes. Crucially, because the Fed looks to lower inflation at the lowest cost to the economy, most Fed-induced recessions are mild, and allow the capex cycle to continue, as was the case pre-Volcker in the 1970s.
Readers will know that I have never subscribed to the structural shortage argument.
- There is no great surge of supply needed for ESG metals. The climate transition is quite manageable even at aggressive speeds thanks to recycling.
- Where there are shortages, such as lithium, they can be solved swiftly with one of two mega-mines.
- Bulk commodities are in a structural glut as China slows.
- Buying commodities as an inflation hedge for short-term commodity inflation is ridiculous.
There was little in the pre-Ukraine argument that made sense.
However, the Russian invasion of Ukraine bailed a lot of this wooly thinking out.
- It has completely absorbed the immense global gas glut and thus forced up fertiliser and softs prices.
- It has lifted thermal coal premiums in sympathy with gas.
- It has made short-to-medium term oil shortages real.
- It has caused supply-side frictions that have widened the crack spread.
In short, the energy bull market story is real thanks to Vladimir Putin.
Once the Fed has crushed energy prices, as it must, the odds, therefore, favour a swift rebound. Indeed, this cycle may have to repeat several times over the next five years as the supply side of energy adjusts.
Over a few years, I’d expect the huge impetus towards renewables to work things out for coal and gas.
But oil is an interesting one now. As Russian shipments decline, it may need the EV transition to really kick it lower again.
It is also probably fair to say that higher oil will keep the overall commodities complex higher than it would have been given it is a key cost input into it and the Goldman’s of this world just love to sell such stories.
So, I expect a goodly commodity crash as the global recession takes hold. But, post-Ukraine there is some basis for thinking about energy as a supply-side supercycle.