You Will Have to Pry Goldman’s Bullish Commodities Thesis From Their Cold, Dead Hands

By Heisenberg

Let’s just get one thing straight on Wednesday: you are going to have to pry Goldman’s Overweight commodities outlook from their cold, dead hands.

Yes, the global reflation narrative has fallen on hard times recently, and yes, things were looking decidedly tenuous in early to mid-March what with the bottom falling out from crude and correlations between copper/oil and HY spiking commensurate with the pain.

But generally speaking “patience is working [and] reflation requires time.” Or at least that’s what Goldman is out saying this morning.

Here’s a bullet point summary of the bank’s note followed by a few short excerpts and visuals.

  • Besides agriculture, commodities are back to the same levels they were in February, bank says.
  • Bank says markets likely to be supported by hard macroeconomic data, real physical demand for metals in China and U.S. oil inventory draws caused by OPEC production cuts
  • Markets “need more patience”
  • Goldman says its 2017 top trading recommendation to go long on the enhanced GSCI is up 7% “due to patience”
  • “The strategic case for commodities remains as solid with cross-commodity and cross-asset correlations collapsing. We believe this is a direct result of the reduced uncertainty around long-term oil prices due to confidence in shale as the marginal source of supply”

Via Goldman

1) Oil prices have rebounded back to their pre-March sell off levels. Take out the weather driven sell-off in agriculture, commodity markets are back to the same place they were in late February and are seemingly facing the same questions as they were then. Will the survey macroeconomic data turn into strong hard macroeconomic data; will the Chinese credit data turn into real physical demand for metals; and will the OPEC production cuts turn into solid US oil inventory draws? We believe the answer to all of these questions is yes and that the base case logic remains intact. We still believe that the market needs more patience. The macroeconomic data has been partially distorted by weather events in the US. In China, we still have no hard data yet for March to know whether the post-Chinese New Year rebound in activity has occurred, and the oil draws were not anticipated until second quarter. As a result, we maintain our overweight recommendation on commodities and our 3- and 12-month ahead forecasts of +5% and +4% respectively. Due to patience, our 2017 top trading recommendation, long the enhanced GSCI, is back to being up 7%

2) In addition, the strategic case for commodities remains as solid with cross-commodity and cross-asset correlations collapsing (see Exhibit 1). We believe this is a direct result of the reduced uncertainty around long-term oil prices due to confidence in shale as the marginal source of supply. With shale now the dominant new resource base, the only uncertainty on the supply side is how much will shale cost to extract, not what technology the marginal barrel of oil will come from.


3) We have long argued that demand drives commodity markets on a 1-to-2 year horizon while supply drives these markets on a 2-to-10 year horizon. With supply uncertainty mostly resolved across most markets, this reinforces confidence in long-term pricing, leaving demand as the primary focus for the market.

4) On the macroeconomic front there are three variables we are focused on to pace the transmission of survey data into hard data: industrial production, retail sales and labor participation. The global manufacturing data, which is the most important for commodities, has been very strong through March (see Exhibit 5).


5) In addition to ‘peak’ sentiment, the market also appears to have lost confidence in the Trump administration’s ability to implement policy. Currently, the only part of the Trump trade that the market still remains confident in is the impact from deregulation, as that can be implemented without congressional approval. Although the equity market has lost confidence in ‘good’ policy such as an infrastructure spending program, we are far more optimistic on potential infrastructure spending, though not our base case, as infrastructure can be self-funding through potential user fees that can back bond issuance.

6) Adding to the political uncertainty around the Trump administration – French elections, US missile strike on Syria and increased military tensions in North Korea – we believe the elevated gold price reflects a market that is caught in a tug-of-war between heightened geopolitical risks and a strong underlying global economy (despite a weak US payroll number last Friday). This tug-of-war has been reflected in the recent disconnect between real interest rates, that have been pricing an improving global economy, and gold that is reflecting the increased political uncertainty. Barring a US government debt ceiling crisis, which ultimately would affect the government’s ability to carry out tax reform later this year, we believe that the upside in gold from here is limited.

7) Unlike gold, copper remains in the same holding pattern as it did at the end of last year, waiting for evidence of stronger demand and physical tightness. Concerns over demand weakness have been supported, but not conclusively so, by 10-20% declines in steel and iron ore prices over the past month. But we believe this ferrous weakness can be explained by ferrous de-stocking after prices rallied to extremely high levels earlier this year, particularly as steel demand growth remains healthy (see Exhibits 8 and 9). Substantial upside risk to our current 3-month price target of $6200/t comes from the Chinese property market. Should property sales volumes in the cities not subject to a crackdown on speculative activity more than offset the slowdown in sales volumes in the 40 odd cities subject to restrictions, our 1H17 tactical bullish copper view could stretch through 2H17. With capital controls increasingly successful, the probability of this occurring is rising in our view, though not our base case. We await the March nationwide sales data.


A return to the pre-2003 environment goes to the core of our outlook for strong commodity returns this year, which is based upon backwardation and not price appreciation. In the 1990s, commodity returns were generated from carry not price appreciation. For example, in 1996, investing in oil generated 100% returns despite only a 30% rise in prices (see Exhibit 12). While we see prices almost unchanged from here, we expect 4% – 5% total returns, driven primarily by the positive carry. In addition, the stability in long-term oil prices is also what helps create the lack of correlation between oil and the dollar, which from 2003 to 2016 acted as a buffer to higher commodity prices to the rest of the world, as higher oil prices reinforced a weaker dollar. With that correlation substantially reduced the inflationary impact of higher commodity prices is also increased. In other words, it doesn’t take nearly as much of a move in commodity prices in the current environment to create commodity returns and much welcomed inflationary pressures outside of the US. Finally, the decline in correlation across commodity sectors is also driving the volatility of the broader basket of commodities in the S&P GSCI lower, which further increases, from a sharpe ratio perspective, the appeal of investing in commodities. This was particularly visible last month with further declines in 1-mo realized volatility despite the sharp sell-off in oil prices, and has brought commodity volatility closer to the current low equity volatility levels (see Exhibit 13).


Global Asset Allocation Update

By Joseph Calhoun of Alhambra

There is no change to the risk budget this month. For the moderate risk investor, the allocation between risk assets and bonds is unchanged at 50/50.

The Fed spent the last month forward guiding the market to the rate hike they implemented today. Interest rates, real and nominal, moved up in anticipation of a more aggressive Fed rate hiking cycle. Post meeting, a lot of the rise came out of the market. Nominal and real 10 year Treasury rates dropped by an identical 11 basis points on the day. Rates fell at the short end too as the yield curve shifted lower but didn’t flatten significantly. The market was looking for a big change in the Fed’s growth and inflation expectations and the dots basically didn’t move. Long term growth expectations are still 1.8-2.0% and inflation expectations were unchanged at 2.0% on the PCE deflator.

Just as or maybe more important was the emphasis in the statement on its “symmetric” inflation target. Rather than say, as they did in the last statement, that inflation was expected to “rise to 2% over the medium term”, the Fed now says “inflation will stabilize around 2%”. I know it seems like a minor change but what it means is that the Fed isn’t going to get too excited if the inflation rate goes above 2% for a period of time. They further emphasized the point by saying:

The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

What all the language changes mean is the Fed isn’t really shifting to a more hawkish stance and that rate hikes will not be coming fast and furious this year. The dot plot indicates the Fed still expects two more hikes this year. The market was starting to price in four (today’s plus two more) and that had to come out of the market after the meeting. This was the most dovish rate hike in the history of rate hikes. Greenspan’s old conundrum was that long term rates weren’t rising as the Fed hiked. The conundrum today is that even short term rates aren’t rising as the Fed hikes. Two year note yields are right back to where they were after the December rate hike.

The post-FOMC moves today were very beneficial for our allocation. Obviously, the move in bonds was beneficial as we are overweight bonds in our moderate risk portfolio. We also have more duration in our bond allocation than most firms; we are much more wary of credit risk than duration risk. The indirect consequence of today’s meeting was felt in currency and commodity markets which was also beneficial. The dollar index fell hard after the announcement as the difference in growth expectations between the US and Europe continue to narrow. That pushed gold and other commodities higher along with commodity sector stocks, all of which are represented in our portfolio.

Overall, our indicators haven’t changed enough to warrant any changes to the allocation. The yield curve sits in the middle of its historic range, providing us with little guidance. Credit spreads narrowed, then started widening again and finished up a bit wider than the last update. But it wasn’t enough to trigger any action. Earnings were up in Q4 and may even be able to get a third consecutive quarter of improvement in Q1 but stock prices have once again outpaced actual earnings growth. In other words, valuations in the US are still sky high. As I’ve stated many times over the last couple of years, ex-US stocks are much cheaper and that is still true. Momentum isn’t telling us a lot either, certainly nothing that warrants a change in allocation.

Continue reading Global Asset Allocation Update

Trader Warns: Fed Meeting Will be “Death Knell” for Reflation Trades

By Heisenberg

Dammit Mark, didn’t you learn anything from Goldman’s overnight note on commodities?

When reality doesn’t reflect what you think it should, you just cast that reality aside and posit your own reality.

That’s how this works.

It’s just like Goldman said, “the lack of hard evidence” should never get in the way of a good trade reco. Which is why instead of admitting that maybe the plunge in commodities is exactly what it looks like – a deflationary bombshell – it’s actually something different because “there are two reflation themes at work.” Only the one that doesn’t matter got hit. From Goldman:

We reiterate our constructive outlook as activity levels drive the reflation themes, not growth rates. The 5% sell off in commodities (-3% metals, -7% energy) this past week would suggest that the global reflation trade has taken a step back. However, we believe that this sell off revealed that there are two reflation themes at work – a manufacturing reflation theme and a service reflation theme. Until this week’s commodity rout these two themes were very hard to identify separately. The manufacturing reflation theme is China- and OPEC-centered and is reflected in tradable goods prices, of which commodities are at the core. In contrast, the service reflation theme is US- and European-centered in the non-tradable sector. Despite the commodity rout, the service reflation theme was un-phased this past week with Friday’s US labor report reinforcing the trend as well as comments out of the ECB about reflation in Europe (see Exhibits 1 & 2).


See? Again: there were actually two reflation(s) at play here. We just didn’t know that until last week.

That folks, is your full retard analyst excerpt of the day right there. And former FX trader Mark Cudmore isn’t buying it anymore than I am.

Below, find some excellent color from Cudmore on everything said above.

Via Bloomberg

Thanks to commodities, the Fed meeting is more likely to be the death knell for reflation trades rather than mark their moment of victory.

  • This week is set to provide confirmation that we’re in the midst of a true tightening cycle in the U.S., with rate hikes in consecutive quarters for the first time since 2006
  • 10-year Treasury yields hover just below the two-year high, but I don’t see them breaking higher in an environment where commodity prices are plunging
  • Oil was just the latest victim last week, with prices falling the most in four months. The broader Bloomberg Commodity Index topped out a month ago, with everything from metals to agricultural goods turning sharply lower since then
  • This undermines the reflation trade in three ways. Most directly, it’s hard for inflation to keep accelerating when input prices are slumping
  • It also suggests that real demand is not growing as quickly as hoped, which provides caution on economic optimism. Finally, while cheaper commodity prices are a long-term positive for economic growth, the more immediate wealth/portfolio effect is negative
  • Price data from the U.S. this month has validated the suspicion that inflation is not rising as fast as forecast, with the PCE deflator coming in below expectations
  • This isn’t an environment that supports much higher long- term yields. Add in the context that speculative short positions in Treasuries remain near record levels and it appears to be a market ripe for a squeeze

The Only Commodity Supply-Demand Indicator That Matters

By Steve Saville

For an industrial commodity with a liquid futures market, the “term structure” of the futures market is the most useful — perhaps even the only useful — indicator of whether physical supply is tight, abundant or somewhere in between.

The term structure of a commodity futures market is the prices of futures contracts for the commodity over all available expiration months. It can be displayed as a chart, with price along the vertical axis and the expiration months along the horizontal axis. Here are examples for oil and copper.



If a market is in “contango” then the later the delivery month the higher the price, resulting in the chart of the term structure being an upward-sloping curve. If a market is in “backwardation” then the earlier delivery months will have the higher prices and the term structure will be represented by a downward-sloping curve. It is also possible for the curve representing the term structure to have an upward slope over some future delivery periods and a downward slope over others. This often happens with commodities that experience large seasonal swings in production (e.g. grains) or consumption (e.g. natural gas), but it can also happen with other commodities.

Continue reading The Only Commodity Supply-Demand Indicator That Matters

Commodities: New Year’s Promises Vs. Elliott Wave Patterns

By Elliott Wave International

2011, 2014, and 2016: The year’s performance has consistently followed its Elliott wave script

It’s that time of year again, when before us an entirely new blank slate is laid, which we eagerly fill with promises of better health, habits, and life choices.

But, according to, only 8% of people successfully carry through with their New Year’s resolutions — or as I like to call them, Maybe-lutions.

It reminds me of the frequent promises made by the mainstream finance regarding the future of specific markets — and how so many of those promises go unfulfilled.

Take, for example, commodities. In the last five years, the popular pundits twice resolved that commodities would make a comeback. And twice the sector failed to fill the bullish bill.

The first instance was in 2011. At the time, the bellwether Thomson Reuters/Jefferies CRB Index stood at its highest level in two years, while commodity exchange traded funds experienced their highest ever inflow on record.

According to the news-focused analysts, commodities as a whole had resolved to quit their bear habits in 2011, and soar:

  • “The bull market in commodities is likely to continue for some time.” (Dec. 8, 2010, Wall Street Journal)
  • “The crash of 2008 in commodities was a mere blip… The rally in prices shows no signs of slowing.” (March 9, 2010, National Post)
  • “All of the elements that contributed to the long bull run in commodities from October 2001 to August 2008 are in place.” (Jan. 6, 2011, The Telegraph)

From the perspective of our January 2011 Elliott Wave Theorist, however, “all of the elements” were in place for a re-commitment to the downside:

“The current juncture in … commodities markets is the flip side of early March 2009… Now we have a completed counter-trend Elliott wave structure (three waves up), extreme bullishness among all types of investors, blatantly diminishing upside momentum, and (according to the majority of economists) bullish fundamentals. This year should begin a multi-year period of outsized gains for those on the short side.”

In the months that followed, the “worst raw materials slump since 2008” sent everyone from individual investors to behemoth investment banks to the commodity exits. From its April 2011 high, the CRB Index turned down in 20%-plus, three-year long bear market.

Continue reading Commodities: New Year’s Promises Vs. Elliott Wave Patterns

Bi-Weekly Economic Review: Is the Fed Behind the Curve?

By Joseph Calhoun of Alhambra

Is the Fed Behind the Curve?

Economic Reports Scorecard


There was little improvement in the economic data the last couple of weeks, the Citigroup Economic Surprise index still well below zero (-8.1). And frankly, where there was improvement such as the GDP report, it doesn’t look sustainable…unless the US is about to become a soybean exporting powerhouse. Anything is possible I suppose but counting on Brazil to have a lousy soybean crop every year doesn’t sound like much of a growth plan. Neither does adding to inventories when shelves are already more than fully stocked, inventory to sales ratios at recession levels.

I said in the last report that it appeared that, based on what we were seeing in the bond market, real growth expectations were rising. It took a mere two weeks to make me look a fool on that front. Bonds have continued to sell off but it is nominal bonds leading the way with TIPS outperforming. In other words, the bond selloff isn’t about real growth, it is about inflation fears. Those fears have been bolstered by some data such as the Case Shiller and FHFA house price indexes (+5.1% and 6.4% YOY respectively), a CPI that is rising closer to the Fed’s alleged target and the Employment Cost Index, up 2.2% YOY. But more than that I think is the new meme coming out of the Fed about allowing the economy to “run hot” for a while to make up for lost ground in the inflation indices. Janet Yellen, in a recent speech, touted the supposed benefits of operating a “high pressure economy”, one with inflation higher and unemployment lower than what the Fed believes to be appropriate in normal times.

Of course, this tradeoff between inflation and unemployment is one that, while oft alleged, has been tough to see in a real, actual economy. The alleged benefits of a high pressure economy are so extensive – raise consumer spending and business investment, raise the labor participation rate, increase R&D spending and new business formation according to Yellen – that to not pursue them would seem to be monetary malpractice. Of course, all the reckonin’, allowin’ and speculatin’ (as my father used to say) about such a high pressure economy presumes that the two variables are in some way linked and can be easily controlled by the Fed. The market seems to have no problem believing the Fed will let inflation run beyond its target but is much more skeptical about any benefit to the real economy.

I am frankly horrified that the leader of the Federal Reserve has such reverence for the old, rough Keynesian distortion of the A.W. Phillips study of labor markets and real wages. The original study did nothing more than prove that the forces of supply and demand apply to labor markets like any other. It had nothing to say about general inflation or any alleged trade-off with unemployment. The idea that more people working creates inflation is one that should spring only from the mind of a simpleton with limited critical thinking skills or a politician with an agenda – often one and the same for sure. It is as if the new person working adds to aggregate demand but has no impact on aggregate supply – which if true should limit their employment to a very brief period. The productivity figures in the new century are nothing about which to brag but they aren’t that bad.

Anyway, the point is that inflation expectations are on the rise and may or may not be a result of Janet Yellen’s inane mental maundering. As I said above, there is some evidence of inflation pressures in the economic data but it is unlikely to be anything other than – to use Yellen’s favored phrase – transitory absent a supporting move in the dollar. Inflation is about the purchasing power of money and a sustained burst of higher inflation isn’t going to happen without the dollar falling in value. Which it may do and indeed our momentum indicators say is likely. If so, this initial move higher in bond yields may be just that – initial and subject to further rises. For now though, the rise in inflation expectations is modest although the losses in the long end of the curve are not. Which makes me wonder if Ms. Yellen has considered the impact of higher bond yields in a world that thinks her daft and inattentive to the one thing over which she has some control – inflation.

Continue reading Bi-Weekly Economic Review: Is the Fed Behind the Curve?

An Inflationary Message From Gold-Commodities Ratios

By Biiwii

An exclusive post over at TalkMarkets from some guy you might know…

Gold established an uptrend in ratio to virtually all commodities during the global deflationary phase that began to bite hard in 2014.  Since then gold has broken down vs. silver and later, palladium.  What does this mean?

Well, I find it interesting that gold broke down vs. the two commodity-ish precious metals, Ag and Pd but held up against other commodities that are more positively correlated to the global economy.  This is as it should be during a phase of global deflationary pressure.  But the first signal was the Au-Ag breakdown, and the next was Au-Pd.  We then began to scout for an inflationary phase out on the horizon.

Before we go on, let’s review the multi-ratio chart of gold vs. these items.

Continue reading at TalkMarkets →

Gold Has Peaked for the Year

By Steve Saville

Relative to the Goldman Sachs Spot Commodity Index (GNX) the peak for this year most likely happened back in February

Gold has probably peaked for the year. Not necessarily in US$ terms, but in terms of other commodities.

In fact, relative to the Goldman Sachs Spot Commodity Index (GNX) the peak for this year most likely happened back in February. The February-2016 peak for the gold/GNX ratio wasn’t just any old high, it was an all-time high. In other words, at that time gold was more expensive than it had ever been relative to commodities in general.

Also worth mentioning is that when the US$ gold price spiked up to its highest level in more than 18 months as part of the “Brexit” mini-panic late last week, the rise in GNX terms was much less impressive. As illustrated below, last Friday’s move in the gold/GNX ratio looks more like a counter-trend bounce than an extension of the longer-term upward trend.

gold_GNX_270616 gold and commodities

The February-2016 extreme in the gold/GNX ratio had more to do with the cheapness of other commodities than the expensiveness of gold, and the subsequent relative weakness in the gold price was mostly about other commodities making catch-up moves. This is actually the way things normally go at cyclical bottoms for commodities. The historical sample size is admittedly small, but it’s typical for gold to turn upward ahead of the commodity indices and to be a relative strength leader in the initial stage of a cyclical bull market. Gold then relinquishes its leadership.

Perhaps it will turn out to be different this time, but over the past 8 months the story has unfolded the way it should based on history and logic. An implication is that if the US$ gold price made a major bottom last December then the general commodity indices aren’t going to get any cheaper in US$ terms or gold terms than they were in January-February of this year.

Around cyclical lows, gold leads and the rest of the commodity world follows.

Canada Dollar and Commodities

By Biiwii

There is a lot of talk lately about the Canadian dollar and commodities that seem to be ignoring its return to weakness.  Being a ‘commodity currency’ the CAD is being talked about as a leading indicator on commodities, which I as well believe need to take a breather (disclosure: I own Agri fund DBA, per NFTRH highlight last weekend, as my only commodity holding) and against my XLE holding I shorted crude oil yesterday.

Anyway, I don’t see the ‘leading indicator’ aspect of this.  CDW and DBC (commodity fund) bottomed together in January.

cwd and dbc, canadian dollar and commodity fund

What’s more, using a weekly chart we see that they had dropped together pretty reliably as well.

canadian dollar and dbc

The test of the support going on in CDW right now is probably pretty important to the commodity case, however.