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Is Goldman, Wall Street's Biggest Commodities Bull, Hanging Up the Horns?

Sri Jegarajah|Reporter, CNBC Asia Pacific
Tuesday, 12 Apr 2011 | 9:35 AM ET

Six years ago, Goldman Sachs said a commodity 'super-spike' could send crude to $105 a barrel. In 2008, they followed up that now infamous prediction with a call for $200. Goldman, which has made a name for itself as one of the loudest snorting commodity bulls on Wall Street, is now advising clients to cash out of oil.

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The markets were unsettled by Goldman's apparent change of heart, which contributed to U.S. crude futures slipping nearly 3 percent. But does the Goldman view herald a major trend reversal? Have they spotted the inflection point marking a change in price direction? Or do we take it at simple face value as a reminder to investors to book profits now since nothing goes up in a proverbial straight line?

Here's what they said: Goldman advised investors to close the 'CCCP basket' trade it recommended in December, which encompasses bets on rising oil, copper and other commodity prices, Reuters reported on Monday. The trade has returned clients 25 percent in four months.

"Although we believe that on a 12-month horizon the CCCP basket still has upside potential, in the near term risk-reward no longer favors being long the basket," Goldman's commodity team, led by Jeffrey Currie in London, said in a note.

The devil is in the details. What's important is Currie believes the long-term view is still intact. Rather, Goldman's caution is focused in the near-term and suggests the commodities bull market is running out of steam. Critically, Currie highlights the sheer level of speculative bullish bets in the oil market. Any number of bearish catalysts could lead to a disorderly unwinding of such record speculative length, and a sharp retreat in prices.

"As Goldman Sachs states they are positive long term prices," said Michael Langford, Proprietary Trader at StreamTrading.com. "This means if they can push prices down in the short term they can reset their positions to take advantage of where they believe commodity prices are headed. Strategically a smart and profitable move by the bank."

Langford added, "The catalyst for falling prices will come from the result of a strengthening U.S. dollar. The movement across commodities can be correlated to the movement in currencies. Goldman is adding to existing momentum to build profitable positions in the future."

Record Speculative Length

Critically, Goldman's Currie highlights the sheer level of speculative bullish bets in the oil market. Any number of bearish catalysts could lead to a disorderly unwinding of such record speculative length, and a sharp retreat in prices.

"Not only are there now nascent signs of oil demand destruction in the United States, but also record speculative length in the oil market, elections in Nigeria and a potential ceasefire in Libya that has begun to offset some of the upside risk owing to contagion," Currie noted.

Many in the financial markets — not to mention Main Street consumers — would welcome a pullback in the crude price, which would offer some much-needed relief at the gasoline pump. Prices for a gallon of regular unleaded gas are topping $4 at more service stations in the U.S., nearing the peak of $4.11 struck on July 17, 2008, The New York Times reported yesterday.

"What we don't want to see is a pickup in the velocity of the rate of inflation," said CNBC contributor Jack Bouroudjian, CEO of Index Futures Group. "That's really the key here. Can we see gold at $2,500 an ounce or oil at $250 a barrel and have the economy sustain what we're seeing? Yes, but it'll take time and that'll happen over the course of the next 5 or 7 years in my opinion. If that happens over the course of the next six months, we're in trouble and all bets are off."

Value-at-Risk

Jonathan Barratt, Managing Director of Commodity Broking Services, said a correction would help the market "get back to a proper sense of value and general economic theory" by removing the speculative noise. "The biggest issues are inflation in Germany, China and India and the interest rate cycle going from neutral to hawkish. This should see demand and therefore prices taper off."

Brent crude and U.S. oil futures in Asian trade are continuing to soften, helped by the Goldman call. Prices still remain stubbornly high in the triple digits suggesting that the bulls, for now at least, remain in the driving seat.

As for how Goldman's deploying its own cash in the commodities markets, we should get more visibility on April 19 when the firm releases first quarter earnings. Markets will be pay particularly close attention to Goldman's Value-at-Risk (VaR) indicator for commodities — an industry measure for how much of a bank's money is at risk on a day for trading an asset class.

The last VaR number suggested some caution in the final quarter of 2010 despite a 16 percent jump in the Reuters-Jefferies CRB index, the biggest quarterly rise in two years.

When Goldman posted its quarterly results on January 19, commodities trading risk hit a near seven-year low, suggesting the Wall Street giant had become less aggressive in taking advantage of surging oil, metals and grains prices.

Goldman's VaR for commodities stood at $23 million for the fourth quarter ended December 31. That was down 20 percent from the $29 million in the third quarter and almost 40 percent lower than the $38 million seen a year earlier.

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