If you want to know how up against it the Fed is in its fight to bring commodity prices under control today then look no further than the latest from Goldman:
Hoarding tees up the next leg higher. In the past two months, hoarding by consumers has concealed just how weak commodity demand has been. From early April to mid May, commodity fundamentals were effectively pushed into recession as China imposed the broadest COVID lockdowns since 2020. By our estimates, global oil demand fell 2.5% while onshore copper demand fell 10% as Chinese PMIs saw their worst print since February 2020. In a similar vein, Russian supply came in above our expectations (0.7mn/b vs 1.7mn/d), driving inventory builds across the complex. Despite this fundamental softening, commodity prices – and time spreads – have held up, with oil at $120/bbl, copper at $9,550/t and corn at $7.75/bu. To square this pricing paradox, investors must understand how commodity market behavior shifts when they enter into periods of prolonged scarcity. As we saw in gasoline markets in 2006, when inventories appear after a period of scarcity and volatile prices, market participants – from refiners to manufacturers – begin to hoard the spare stocks as a hedge against future scarcity. This creates backwardated markets despite building inventories and signals a strong set up for the next leg higher, as Chinese stimulus pressures continue to build and consumers continue their rotation toward higher travel and leisure spending. Today, we are seeing this across commodities – energy consumers in Europe and China are building precautionary inventories, Chinese manufacturers continue to buy metal to catch up on lost production this summer, while governments look to restrict agricultural exports in the hope of taming domestic inflation.
In many of the commodities that I follow we have already seen this pulse. It was the cause of the scarcity, not the other way around.
The Ukraine war changed that for energy medium-term, and grains short-term, but nothing else.
Then Goldman really gets its wriggle on:
Slowing growth hits equities, not commodities. One concern of macro investors in allocating to commodities remains the near-term headwinds to overall demand from higher prices and rising rates. Yet it is important to remember such headwinds take time to emerge, while continued growth above capacity – as we are seeing today – keeps commodity markets in deficit and commodities outperforming as an asset class. It is important to remember that slowing growth hits equities, not commodities. Crucially, for growth-based, forward-looking equities, the topping of US growth rate and household savings’ accumulation has driven a clear repricing in stocks, yet does not signal the end of price appreciation in commodities. Driven by levels of demand and not growth rates, commodities – crude and cracks in particular – are set to benefit from the rotation away from goods toward services. Moreover, when the slowdown in overall activity is itself driven by commodities, the price behaviour of commodities across the business cycle shifts. As Exhibit 14 shows, commodities rally more aggressively into commodity-induced recessions, with a shallower retracement and more rapid rebound than traditional recessions. This is driven by the fact that, in these recessions, commodities are themselves the binding constraint on the economy, with price falls stimulating further real activity. Moreover, with rates having to rise during such recessions, bonds’ usual outperformance of commodities is weaker until central bankers begin to cut rates and re-inject liquidity into the system. Accordingly, while there are clear macro risks on a longer-term horizon, they remain broadly minimal to commodity returns, in our view.
If we use the archetypal energy shocks of the 1970s as the template, which I suspect Goldman has done, then there is some truth to its argument.
However, if you chart it on a broader canvas, the notion that you should buy commodities on the verge of a commodities demand-destruction recession is pretty short-term thinking. The yellow areas are US recessions:
Yes, the mania persisted partway into the recession but prices still crashed roughly 40% when the penny dropped, as the mania unwound for many months afterward.
It is also true that if the shortages are structural, such as during the rise of Japan and OPEC, then you can ride out what is pretty serious volatility.
If they are structural.
My conclusion is that with the Fed on the warpath, and unable to stop because commodities rocket whenever it does, now is a much better time to be short than long commodities.
This includes energy, though I acknowledge that it has a better chance than most of enjoying another robust cycle when the Fed does relent, given the supply side will take time to resolve post-Ukraine frictions.