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Commodities Seen as Worst Pick Before Year-End Rally

13:51PM Jan 28, 2015

Commodities will lag behind equities, bonds and credit markets over the next three months before a rebound in oil sparks a recovery, according to Goldman Sachs Group Inc.


The bank cut its near-term outlook for raw materials to “underweight”, predicting losses of 10 percent, compared with a 0.4 percent return for stocks, its top pick. Commodities will leapfrog equities as the best performing asset class over 12 months, returning 10 percent, according to a Jan. 27 report.

The Bloomberg Commodity Index slid to a 12-year low this week, with crude, hogs and copper leading losses in 2015. Inventories are rising after a decade-long bull market spurred farmers, miners and drillers to increase production. A strengthening dollar and falling energy prices are threatening to prolong the rout as they make it cheaper to produce more.

“Despite the large declines in commodity prices, we see risks as still skewed to the downside over the near term,” Goldman strategists and analysts including Jeffrey Currie, Christian Mueller-Glissmann and Peter Oppenheimer wrote in the research report. “Lower oil prices are also driving cost deflation across the broader commodity complex.”

There’s a risk that oil, gold and copper may drop further, according to the bank, which predicts West Texas Intermediate oil will remain near $40 a barrel for most of the first half of 2015. The U.S. benchmark crude slid almost 60 percent since a peak in June last year and was at $45.55 a barrel on the New York Mercantile Exchange today.


Roll Yield


As oil’s drop and a stronger dollar leads to shrinking costs for producers, inventories are also weighing on immediate commodity prices relative to longer-dated contracts, creating a market structure known as contango. When near-term futures expire, investors who want to keep their oil holdings need to sell the cheaper contracts and buy the more expensive, later- dated ones. That creates what’s called as a negative roll yield and further erodes returns, according to Goldman.


Slowing supply growth and more normal levels of inventories by 2016 means oil prices will move toward the marginal cost of production by the end of the year, or about $65 a barrel for WTI and $70 for London’s Brent crude, according to the bank. The European benchmark was at $49.05 today.

Goldman’s prediction that oil prices will remain depressed this year before a rebound in 2016 is echoed by other banks including UBS Group AG and Barclays Plc, which both cut price estimates on Wednesday. WTI will average $49 a barrel in 2015, down from a previous projection of $64.75, according to UBS. It will recover to $62.50 in 2016 as demand improves and supply growth slows, the bank forecasts. Barclays see prices averaging $42 in 2015 and $57 next year.


China Growth


“For our constructive 12-month view, we would need to see roll yields improving (in particular, a slowdown in oil inventory builds), over the coming months,” the analysts wrote. They recommend buying palladium, nickel and zinc while selling copper, amid slowing Chinese growth, and gold.


China’s economy expanded 7.4 percent last year, the slowest pace since 1990, data from the statistics bureau show. The country is the world’s biggest metals and energy consumer.

Cost deflation already prompted Goldman to cut its estimates for metals and mined raw materials including copper and iron ore over the next three years by about 10 to 20 percent. Copper will average $5,542 a metric ton this year, down from a previous projection of $6,400, according to an e-mailed report on Friday. Iron ore will be $66 a ton, compared with $80 previously, the bank predicted.

The Bloomberg Commodity Index tracking 22 raw materials was at 100.95 on Wednesday, down 3.2 percent this month. The gauge touched 99.91 on Monday, the lowest level since 2002.

The bank sees five-year corporate bonds returning 0.5 percent over the next three months, dropping to a 0.4 percent loss in a year. Cash investments will return 0.1 percent in the near-term and 0.2 percent in 12 months. The loss on 10-year government bonds will increase from 3.4 percent over three months to 7.9 percent in a year, according to the bank.

After the supply re-balancing, commodities will offer better diversification benefits while protecting against a potential pick-up in inflation, the analysts said.