Some deep thoughts from Goldman Sachs, by way of Jeffrey Currie and team, on the drivers of the current commodity sell-off (and no, their short gold advice from last week isn’t listed as one of them):
The sharp sell-off in gold was triggered by growing fears that the central bank of Cyprus would sell its gold reserves, potentially reflecting a larger monetization of gold reserves across other European central banks. The decline in prices was exacerbated by the breach of key technical price support level at $1,530/toz and then at the $1,434/toz 200-week moving average, creating the largest one day decline. Spillover from gold and renewed European and EM macroeconomic concerns also created sharp sell-offs in crude oil and base metals, that were mostly front-end driven, crushing spreads (the carry), as longer-dated prices remained remarkably stable. This stopped us out of our CCB (Commodity Carry Basket) recommendation with the potential loss reaching our 6.0% stop.
Although gold has now traded below the $1,450/toz target embedded in our short recommendation, we are maintaining our short as we argued last week that prices could decline more than we initially thought as positioning is stretched and the momentum is to the downside. The most recent ETF holdings showed acceleration in the liquidation of length, which points to a broad-based sell-off extending beyond the futures markets with potentially more room to go. As a result, we are now lowering the stop to $1,400/toz (which locks in a potential gain of 12%) while we wait for evidence of a bottom, though we are not changing our price forecasts now.
We believe base metals are closer to a bottom than oil. Although we maintain our bullish 3-month targets on oil and copper, the base metals complex is likely closer to a bottom than oil, which is why we exited our long oil recommendation yesterday but maintain our long copper view with conviction. Metal prices have fallen to the point that they (price declines) are beginning to generate significant micro adjustments in fundamentals to support higher prices. Unlike in oil where nearly all the markets are in contango, in copper the Shanghai market is backwardated, the Shanghai-LME arbitrage window is open and Shanghai exchange and bonded warehouse inventories are declining. In oil we believe that the market will need to see evidence that the recent product weakness is created by an exaggerated seasonal swing and not a deeper underlying economic weakness before it can rally again.
Here’s the ETF dump in graph form:
Also it’s interesting that Goldman sees backwardation as a good re-entry point into the metal markets. We’re not so sure about that ourselves.
As we have pointed out previously, curve signals are not what they used to be. What they are indicating is being warped by a negative interest monetary world, in which backwardation has to be a lot deeper to imply real market tightness. In short, even with a slight backwardation the incentive to hoard and carry forward may still be there because a small loss on a hedged collateral deal is still better than monetising that commodity and having it earn negative interest at the bank. You also can’t really invest it in more production.
More so, any episodes of contango are likely to be briefer as they provide too much of an opportunity to lock-in synthetic yield. You can be sure any contango interest will be gobbled up quickly.
Related links:
*Something* is happening in Brent… - FT Alphaville
Is the end of the oil era nigh? – FT Alphaville
Capping the gold price – FT Alphaville
Are we entering the peak “end of an era” research era? - FT Alphaville