Goldman Sachs warns that investors are starting to cool on commodities and could miss out on further gains for the year's best-performing asset class.
Earlier this week, the bank raised its outlook for its commodities index, which tracks assets like crude oil and copper. It now thinks the Goldman Sachs Commodities Index will return 8 percent over the next 12 months, up from its previous forecast for a 5-percent gain.
Commodities are now posting their best year-to-date gains in a decade, according to Goldman. The fuel for that performance is crude oil. International benchmark prices have risen more than 51 percent over the last year, while the cost of U.S. crude is up nearly 45 percent.
"The rally likely has room to run, particularly from a returns perspective. Oil fundamentals are now more bullish as robust demand faces supply disappointments," wrote Jeffrey Currie, Goldman's global head of commodities.
But Goldman says the market's mounting concern over a slowdown in global growth and rising U.S. interest rates are weighing on sentiment around commodities. Goldman notes that record-setting long positions in oil — or bets that crude prices will keep rising — have moderated since the commodity crossed $73 a barrel.
Goldman thinks the market's fears are largely unfounded, saying "Growth concerns will likely prove temporary" and "realized demand remains robust."
Brent crude briefly topped $80 a barrel on Thursday, approaching Goldman's target of $82.50. Falling output in Venezuela and Angola, the return of U.S. sanctions on Iran and bottlenecks in America's premier shale oil region threaten to leave a finely balanced market undersupplied by about 1 million barrels a day, Goldman says.
It also stresses that physical markets — the buyers who actually take delivery of commodities to meet real-world demand — tend to ignore growth concerns and rising rates. They also tend to shrug off a strengthening U.S. dollar, which makes commodities priced in the greenback more expensive to holders of other currencies.
In other words, the world doesn't stop consuming things like corn, copper and crude just because of headwinds that might sideline financial traders, who swap derivatives to take advantage of rising or falling prices.
The bank also notes that the 14-member oil producer group OPEC is currently limiting its output — and it has historically failed to restore production fast enough to meet demand. That means OPEC's current deal with Russia and other producers to keep 1.8 million barrels a day off the market is likely to cause at least a short-term undersupply of oil.
"OPEC has never been able to catch late-cycle demand growth to replenish inventories before a recession occurs," Currie says.
Currie compares the current environment to 2000. Then, OPEC upped production by 3 million barrels a day in the first nine months of the year, after cutting supply to contend with the fallout of the late-90s Asian financial crisis.
Then as now, growth in developed markets was coming to an end while emerging market growth was ramping up. Rising rates were creating inflationary pressure, a technology boom was underway and the U.S. dollar was strengthening. In the oil market, U.S. sanctions were limiting output from a major OPEC member, crude stockpiles were moderate and oil prices were lower for delivery in the future.
Despite OPEC's exit from production cuts, demand for oil outstripped supply, and the United States had to tap strategic oil reserves to tamp down high gasoline prices. Consequently, Goldman's Petroleum Index rose 51 percent that year.
Today, Goldman sees several other factors boosting oil prices.
Growth in dollar credit will help emerging market oil importers contend with higher crude prices. Those prices will probably remain at least in the $60-$70 per barrel range, creating demand for crude futures among financial traders looking for easy gains through the so-called carry trade. Lower stockpiles will only enforce the oil market's backwardation — where today's prices are higher than future prices — which in turn encourages the carry trade.
Investments in long-lasting oil wells are also too low to meet future demand because U.S. drillers are focusing on quickly depleting shale fields, Goldman says. That's another callback to 2000, when the tech boom sucked capital away from the old industrial economy, creating shortages in key areas.
"While the similarities are striking, we are still hesitant to expect similar returns in 2018, but they do serve to show why being long commodities into a growth slowdown makes a lot of sense," Currie said.