Goldmans Bullish On Commodity Prices
FN ARENA NEWS - 17/10/2008
No surprises - Goldman Sachs' global economics team has downgraded its global growth forecast for 2009 from 3.7% to 3.0% and the commodities team has thus been swung into action for downgrades of its own. The credit crisis is obviously the driver, and the analysts note ongoing uncertainty on the credit front means ongoing downside risk to commodity prices.
But this story has a bullish end.
There are two reasons why commodity prices have fallen as far as they have to date. The first reason is they were too high. If oil is the benchmark, the ridiculous speculative bubble experienced earlier this year is just another example of leverage gone mad and a classic tale of "upside panic". The bubble burst when it was obvious a point of demand destruction had been reached in the US, and thus there was nothing surprising about the fall back from US$147/bbl to the US$100 level as speculative positions retreated.
Buy today we are at US$70. The second reason oil has fallen is due to the sudden panic about a global recession, brought about by the last gasp throes of a dying credit market. All in the last month, more or less. While the two are obviously related, it has been rather unfortunate for oil investors that fears of economic weakness have intensified right in the middle of a deleveraging process of the grandest scale ever experienced. Other commodity prices have experienced a similar rout. At the beginning of 2008 commodity investment funds were the preferred alternative to investment to a volatile stock market, and now that money is leaving in droves as well and escaping into cash.
The stock market went first, the commodity market has followed. Selling begets more selling. But just as surely as the sun rises in the east and sets in the west, commodity prices will overshoot to the upside and then overshoot to the downside. So while the Goldmans analysts are forced to bow to current market volatility and thus the risk of more short term weakness, they suggest:
"Nonetheless, we believe that the point of maximum demand weakness for many commodities and especially for oil is likely occurring right now while the credit markets are frozen. These credit conditions have generated severe dislocations in the commodity markets, in some cases substantially depressing demand far below where weak economic conditions would suggest."
And thus Goldmans suggests that once credit market tightness and general fear abates, so too will the intense selling pressure on commodities.
The analysts have been forced to significantly rein in their 12-month price forecasts, conceding that they had underestimated the potential severity of the economic slowdown that will be derived from the freezing of credit markets. However, they also note that even after making such downward revisions, prices remain historically high.
This could be put down simply for the "stronger for longer" theme, otherwise known as the China Story. Chinese demand is now expected to pull back, but there was always two sides to "stronger for longer". The other is global under-supply. There are supply constraints across the globe from China to South Africa, from South America to Russia. And in Australia. These constraints will remain in place even as demand weakens.
"As a result," says Goldmans, "it is likely that the supply constraints that have propelled commodity prices to record-high levels in recent years will likely be even more binding as the credit crisis resolves and as economic growth regains positive momentum. This suggests the potential for substantial upside from commodity investments in the medium-to-longer term."
A combination of fear, destocking and supply disruptions has sent oil demand crashing, the analysts note. Oil demand has likely fallen 10% in only the last week but underlying GDP weakness would imply only a 3-4% reduction in demand, they suggest. This provides the capacity for a market rebound "much stronger than it has been historically". There will not be the usual inventory overhang because tight credit is a disincentive to store oil.
Having said that, Goldmans has reduced its 2008 year-end price forecast from US$115 to US$70, and its year-end 2009 price from US$125 to US$107. This sends it 2009 average price forecast down from US$123 to US$86.
The analysts reiterate, however, an earlier warning that while credit markets remain in turmoil oil could trade as low as US$50 in the near term.
On the base metals front, Goldmans notes that nickel, zinc and lead prices had already come down a long way ahead of the latest financial cataclysm as demand from OECD nations, particularly the US, had subsided. This is what they expected, and they also expected copper and aluminium to hold up given supply constraints. But now copper and aluminium have been hit too.
Goldman's economists believe that the recent moderation in Chinese economic growth will now continue into 2009. They have downgraded expectations for domestic demand, construction, industry, exports and fixed asset investment. All of these have an impact on metals prices. Copper remains the most vulnerable, as it remains the only metal still trading substantially above its marginal cost of production, the analysts note.
It is Chinese demand that to date has held metals prices above historical levels. Demand for copper, for example, has been driven by a strong Chinese real estate market. But growth in real estate, and also manufacturing, has begun to abate.
The good news is that Goldmans nevertheless believes a bit of a fall in what were strong real estate prices is not a bad thing. With softer prices but generally rising incomes in China, the analysts expect demand for real estate to recover in 2009, which will in turn lead to increased demand for base metals towards late 2009. Assistance was also be provided by lower Chinese interest rates in response to the easing of the inflation threat.
Goldman's new 12-month base metals price forecasts are US$2600/t for aluminium, US$6625/t for copper, US$1525/t for lead, US$14375/t for nickel, and US$1640/t for zinc.
But the Goldman Sachs analysts remain long term base metal bulls.
They are looking for long run infrastructure growth in China, with the focus now moving to the underdeveloped central and western parts of the country. These areas will provide the next phase of real estate and general infrastructure growth, the analysts suggest.
On a more general note, ongoing urbanisation, demand from the vast population for manufactured goods that were not part of the "comsumption basket" as little as a few years ago, and subsequent industrial production of manufactured goods will underpin a robust pace of growth and support base metals demand.
While all the above is going on, China will continue to suffer from mature and overstretched production infrastructure, ongoing supply disruptions and marginally high costs of production. This is the supply-side factor that will also be supportive of commodities prices.
Despite dropping forecast prices, Goldmans is still expecting a net 10% return from metals investment in the next 12 months.
All is not lost. It's just a rocky road.
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