Goldman Commodities Mea Culpa: ‘We Didn’t Understand The Fundamental Rules Of Investing’

Right, so Goldman was stopped out of their long commodities trade reco (initiated last November).

YTD, the GSCI is down 10% which is, well, worse than pretty much everything on the board:


This was, of course, the product of lower crude prices, a development that pretty much anyone could have seen coming.

After all, it’s not like you had to be some kind of commodities savant to know that US production was going to spike following the OPEC cuts. Put differently, you needn’t have consulted Nostradamus to predict that the cuts would, in the short- to medium-term anyway, be self-defeating thanks to the US shale response.

But while that was predictable, Goldman swears that rising production in Libya and Nigeria was not, and besides that, the bank admits it made another mistake when it comes to commodities: namely not understanding “the fundamental rules of commodity investing.” To wit:

… more importantly, the fundamental rules of commodity investing have been underappreciated both by us and by market participants.

The important thing about mistakes though, is that you learn from them and below find Goldman’s “lessons learned”..

Via Goldman

Lessons Learned Part 1: It is the Supply, Not Demand

Unlike other markets, commodities are physical assets rather than anticipatory assets: you cannot consume a barrel of oil that is not produced or in storage. This physical nature implies that the shape of the futures curve is a reliable barometer of demand and supply fundamentals. If spot prices were to rise too high on expectations of a deficit market in the future, oil would flow out of storage, crushing spot prices. Year-to-date, the movements in the curve shape for near-dated oil contracts have pointed to strengthening fundamentals. In other words, demand growth has been catching up to the excess supply.

Lessons Learned Part 2: Trading Beyond the Current Supply Cycle is Self-defeating

Because of the physical nature of commodities, speculative trading beyond the current supply cycle is often self-defeating. This is most clearly seen in agriculture as the supply and demand balances are reset with every growing season. When investors bid up prices beyond the current supply cycle, higher prices incentivize farmers to plant more. The result is higher supply and lower prices. While shale has not altered this fundamental rule of commodity investing per se, it has reduced the oil supply cycle significantly. What this means is that, when oil prices rallied in late 2016 on the back of growth optimism and OPEC cutting, shale producers were incentivized to increase production, sowing the seeds for the 2017 sell-off.

We see the same dynamics in metals too. In each year over the past few years, market participants expected copper to move from surplus into deficits over the coming years, which in turn encouraged producers to ramp up production, incentivized scrap supply, and capped subsequent price gains.




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