We’re Witnessing Commodities’ ‘TINA-Moment,’ Goldman Says

When it comes to hedging macro risks, there is no alternative. To commodities.

That’s one message from Goldman’s Jeff Currie who, in a new note, explained why raw materials prices generally held up recently despite fundamentals briefly turning recessionary amid China’s COVID lockdowns.

“To square this pricing paradox, investors must understand how commodity market behavior shifts when they enter into periods of prolonged scarcity,” Currie wrote. “As we saw in gasoline markets in 2006, when inventories appear after a period of scarcity and volatile prices, market participants — from refiners to manufacturers — begin to hoard the spare stocks as a hedge against future scarcity.”

Conceptually, that’s just another manifestation of the shift from just-in-time (which became a religion in the globalization era) to just-in-case (which is gathering adherents in the post-pandemic world). Currie emphasized as much, writing that,

Participants are looking to build thicker and more resilient supply chains after two years of COVID and now the geopolitical fracturing of sanctions. Moreover, this behavior is government mandated — from European natural gas storage requirements to food export bans, policymakers are trying to retain domestic stockpiles to avoid further inflationary shocks.

This, Currie suggested, is an epochal behavioral shift, and it’s now migrated upstream such that “the entire physical economy” is engaged in an effort to build precautionary inventories.

Although fundamentals softened recently and market participants are now engaged in a frantic effort to assign odds to a potential recession, “conditions of acute scarcity” will likely remain in place, Goldman said. In other words: Demand destruction sufficient to offset the largest negative supply shock in modern history isn’t on the horizon. Especially not as China reopens, and seasonals favor higher demand for crude and metals. And that’s to say nothing of extreme weather and the knock-on effects for crops.

Currie noted egregious YTD performance for traditional 60/40 portfolios, which are currently mired in one of their worst drawdowns on record. Commodities are the only asset that’s performed in 2022, leading Goldman to suggest raw material are “beginning to have their TINA moment.”

Crucially, current stressed conditions are conducive to explosive commodity rallies at the first sign of incremental problems. India’s decision to ban wheat exports drove a massive weekly surge, for example.

“It is precisely because commodities react so intensely to unexpected physical inflation shocks that they make the best hedge for this in the portfolio,” Currie said, calling commodities “the only consistent hedge for unexpected inflation, usually as the source of it in the economy.”

I talked at length recently about the significance of stocks’ newly negative correlation to breakevens. In the beginning, COVID was a deflationary supernova, hence the initial collapse in market-based inflation expectations. Breakevens thus became a real-time referendum on the Fed’s success in averting a depression. As such, breakevens and risk assets tracked each other pretty much in lockstep. In addition to signaling reflation success, rising breakevens mechanically pushed real yields lower, paving the way for higher equity valuations. More recently, the positive correlation between stocks and breakevens has dissipated, and even turned negative (figure on the left, below).

As the chart header suggests, that’s a sign the market now views rising inflation expectations as evidence of overheating, not growth optimism. Commodities, on the other hand, have insulated investors from the impact of surging prices, precisely because they (commodities) are the proximate cause of the surge.

Currie emphasized that while equities, being a forward-looking asset, respond to peak growth, commodities are “driven by levels of demand, not growth rates.” They’ll benefit from the long-awaited goods-to-services switching (assuming it ever pans out) and because commodity-induced recessions compel central banks to hike rates, bonds aren’t as likely to outperform during downturns linked to soaring raw materials costs.

Finally, Currie wrote that, “when the slowdown in overall activity is itself driven by commodities [they] tend to perform strongly… driven by the fact that, in these recessions, commodities are themselves the binding constraint on the economy, with price falls stimulating further real activity.”

Goldman’s portfolio strategy team has OW recommendations in just two asset classes over the next three months: Commodities and cash.