Nymex WTI futures on Friday were headed for their biggest weekly gain in two months, trading at around $57.49 per barrel in European afternoon trade.
This, as we’ve pointed out before, comes despite extremely weak fundamentals — nicely reflected in the following chart from Goldman Sachs showing current US inventories figures.
So what is causing this great disconnect? At FT Alphaville we have speculated that it must be the result of inflation expectations returning to the market place.
But as Goldman Sachs remind us in their latest energy research note:
Commodity prices cannot diverge for long from physical fundamentals as they are largely “spot” assets.
That said, they add there are varying degrees to which different commodities’ spot prices converge with physical fundamentals. Metals and agriculture, for example, are more ‘anticipatory’ than energy, meaning they are more prone to disconnecting from fundamentals by pricing in future inflationary expectations or other macro-economic conditions.
How anticipatory a commodity is, meanwhile, all comes down to the ease of its storage. As Goldman explain:
As storage bridges the gap between today and the future, commodities that are easier to store, such as metals and agriculture, are more anticipatory.
Thus, electricity followed by natural gas are the most spot or least anticipatory commodities given the difficulties in storing these commodities while base metals are generally the least spot or most anticipatory given their ease of storage, followed by agriculture and then oil.
And here’s the interesting point:
Nevertheless, the largely spot nature of commodities stands in sharp contrast to equities that are almost entirely anticipatory assets, which reflect the future. This distinction explains why our commodity-equity research team reiterated their positive view on the commodity-equity sector this week despite our near-term bearish bias.
So the fact that oil prices are increasingly correlating with equities (as reported here) and increasingly disconnected from bearish fundamentals, goes completely against historical precedent. As Goldman Sachs rationalise, this suggests the current oil rally simply can’t go on for much longer:
Oil will likely become more of spot asset as inventories near storage capacity. While the oil market has recently been pricing in the improving forward economic outlook, the market can only do this as long as there is room to store the oil and bridge the gap between the currently weak demand environment and the anticipated stronger forward fundamentals. With inventories already at record levels, the risk that oil inventories breach storage capacity and force spot prices lower to clear the current supply and demand balance rises substantially over the next two months, which is why we are maintaining our near-term target of $45/bbl, despite our year-end target of $65/bbl, mentioned above.
Of course, what we really want to know is what does it mean if oil prices don’t reconnect with the fundamentals? What does that auxiliary ‘anticipatory’ element in the price actually mean? Presumably either the collapse of efficient-markets theory, or the emergence of oil, just like gold, as a currency-type store of value in its own right.