Goldman is excited about commodities. I mean, not so much on the revenues front, but rather on their Overweight call.
The bank is kicking of February with an enthusiastic reiteration of their upbeat commodity outlook and they’re basing that on the “the 3R’s”. Do you know what those are? Well, let Goldman tell you:
- reflation
- releveraging
- reconvergence
Boom. No one can argue with a thesis based on three themes that all start with the same letter – everyone knows that. It’s a fundamental axiom of sellside note writing.
No, but jokes aside, there’s clearly some merit to the reasoning here, and before anyone starts on the whole “contrarian Goldman indicator” meme, remember that just because a thesis isn’t borne out a year hence doesn’t mean the underlying logic wasn’t sound, it just means things change.
There’s a lot to the note, but the executive summary sums it up pretty nicely which makes sense because you know, that’s what executive summaries are for. To wit:
The 3R’s — reflation, releveraging and reconvergence — reinforce our bullish overweight commodity outlook. Strong demand growth against limited supply growth due to OPEC and Chinese supply curtailments created significant reflation in commodity prices last year. During 2H17, commodities were the best performing asset class, posting a solid 18% return.
Given the high level of debt held by commodity producers, not only do higher commodity prices reduce the number of bad loans and free up capacity on bank balance sheets, higher commodity prices also help strengthen EM currencies and weaken the dollar via the accumulation and recycling of rising excess savings. On net, this in turn lowers EM funding costs and leads to EM releveraging.
More EM leverage leads to more EM growth reconvergence, reinforcing even more synchronized global growth and, ultimately, reflation pressures – creating a feedback loop. Our global Current Activity Indicator (CAI) is tracking 5.1% annualized real GDP growth, and as of last Friday (January 26) financial conditions in the US were the best ever recorded in the history of our Financial Conditions Index.
For those of you wondering whether it’s possible to make that into a flow chart that shows the feedback loops and includes the maximum number of arrows, the answer is: “fuck yes it’s possible to make a flow chart with a dozen or more arrows”:
Of course the opposite of this would be the “3D’s” : deflation, divergence and deleveraging, another self-feeding loop key to which is a stronger dollar. So one imagines that should the greenback manage to sustain a rally (which admittedly seems far-fetched right now), this whole thing would probably need to be reassessed.
But for the time being, Goldman is raising their targets as follows:
- 12-month target on copper to $8000/mt (from $7050/mt, previously),
- 6-month target on Brent to $82.50/bbl (from $62/bbl, previously),
- 3-month targets on iron ore to $85/mt (from $55/mt) and met coal to $220/mt (from $165/mt).
- increasing our S&P GSCI returns forecast to +10% over the next 12 months
Ok, one other “note notable” (so to speak) is this from Hui Shan: “Commodities outperform all other asset classes during rate hiking cycles.” Here’s the chart on that:
You can take all of that for whatever it’s worth, but you can bet you’ll be hearing a thing or two about it today if you haven’t already. The bottom line from where Goldman is sitting is this: “the environment for investing in commodities is the best since 2004-2008.”
Now if only they could figure out when the environment was set to improve for trading commodities, they’d be all set.
