Having been proven right about their prediction of a rather substantial correction in commodities earlier this month, Goldman Sachs is now out with a new view.
A bullish view.
As Jeffrey Currie and team wrote on Tuesday:
We remain structurally bullish commodities
Although we remain structurally bullish and have long argued the structural case for being long, timing does remain critical. This was evident in the recent market correction, which brought commodities down roughly 10% from their April highs. With prices now more in line with near-term fundamentals and price targets, we believe that the risk/reward once again favours being long commodities. Although the economy has likely shifted into a slower, but sustained, growth environment, we continue to expect that economic growth will likely be sufficient to tighten key supplyconstrained markets in 2H2011, leading to higher prices from current levelsRaising oil price targets on persistent impacts from MENA events
We expect that the ongoing loss of Libyan crude oil production and disappointing Non-OPEC production will continue to tighten the oil market to critical levels in early 2012, with rising industry cost pressures likely to be felt this year. We are now embedding in our forecasts that Libyan production losses will lead to the effective exhaustion of OPEC spare capacity by early 2012. This raises our year-end Brent crude oil price forecast to $120/bbl from $105/bbl, our 12-month forecast to $130/bbl from $107/bbl and our end-2012 forecast to $140/bbl from $120/bbl.Mid-cycle pause nearing a trough, creating upside to metal prices
While a sharp decline in world economic growth remains a downside risk to commodity prices, we see the current slowdown in economic growth as part of a normal mid-cycle pause, partially driven by higher commodity prices, and therefore not a reason to expect commodity prices to decline substantially. Further, we believe that the recent evidence of economic weakness represents signs of a slowdown and not a downturn, which is reinforced by signs that Chinese metal demand has already returned with the SHFE-LME copper arb opening again, exchange inventories declining and the Shanghai copper forward curve moving into backwardation.
The copper point, though, is particularly interesting. It seems — above all — that Goldman Sachs is not
buying the Chinese faux financialised demand story. China is set for a slowdown, they say, but it won’t be anything as bad as a long-term downturn.
They cite the proof of that in the Shanghai-LME arbitrage re-opening to attract copper back into China once again. That and the fact that Shanghai exchange copper inventories are dropping sharply with the forward curve going into backwardation, as indication that there is substantial spot demand for the commodity.
Though, of course, that does come on the back of extremely plump LME inventories. Which makes us wonder if there’s something of a hot potato game being played.
Nevertheless, here’s what Goldman say about the Chinese copper conundrum:
We recognize that China may experience some further economic weakness before comfortably resuming a growth trend; however, for the commodity markets we view copper as the best barometer of these events. After dropping as low as $8,700/mt last week from a high of $10,160/mt before the Libyan supply shock, LME copper has rebounded somewhat, which reinforces recent developments in Shanghai. Accordingly, we are recommending a long June 2012 position, currently trading at $8,804/mt, with a 12-month target of $11,000/mt. We also see significant upside in zinc. Although we do not see the zinc market balance getting as tight as copper next year (see Metals Watch, May 13, 2011), given how low current prices are relative to industry economics we are also recommending getting long December 2012 with a 12-month target of $2,700/mt against a current price level of $2,189/mt.
Updated 1308 BST: Confused about the bullish copper/bearish China position? Here’s the view of veteran copper market analyst Simon Hunt, of Simon Hunt Strategic Services, on the points Goldman raises.
1. There is a political cycle at work on China’s economy. The incoming leadership does not want to be burdened by all of the mess they will inherit from the outgoing leadership – and the latter wants to leave on a high note. Inflation and real estate prices is their primary focus and the latter continued rising in April and the former using CPI remains too high for their comfort since they know that actual inflation being experienced by households is noticeably higher. At least one more hike in interest rates is likely quite soon – June 5th holiday? Monetary policy will remain tight into the 3rd quarter thereafter relaxation will be slow and gradual.
2. Meanwhile, the usual longs and pointing to declining SHFE stocks and some 100kt which has come in from bonded warehouses.
3. What is now being seen is that fabricators who have been operating on a hand to mouth basis, now seeing prices having fallen by $1000+ , are replenishing those inventories. It is not a signal that actual production of semis, i.e material going into furnaces has improved. On the contrary, I expect to be told that business is pretty weak.
4. Price wise, on a technical basis we are looking for a counter trend rally in the Euro and in global stock markets which could last for the next couple of weeks or so. Copper prices will be helped by the game being played and thus we could see prices rise to around 9500 and then begin falling to at least 7500 by October. Hope this helps – don’t forget that prices and “demand” are being driven by the financial community and not by real consumption that is material going into furnaces.
For more on Hunt’s views check out the speech he recently gave to the Sixth China Copper & Aluminium Summit on May 19-20, available in the usual place.
Related links:
Michael Pettis on China’s very own zaiteku – FT Alphaville
China’s bonded-warehouse copper mystery – FT Alphaville
China’s copper as collateral addiction - FT Alphaville