The Goldman, Sachs & Co. squad directed by Jeffrey Currie scores a first-place debut in the Commodities sector on Institutional Investor’s 2015 All-America Fixed-Income Research Team. The crew — which includes Damien Courvalin (energy and agriculture research), Maximilian Layton (metals) and Christian Lelong (coal, iron ore) — is bearish on all commodities, owing to the fact that in most cases supply far outpaces demand. II Director of Research Thomas W. Johnson asked Currie, who is based in New York, to explain his negative outlook and discuss how investors should position their portfolios accordingly.
The International Energy Agency recently warned that oil prices are likely to fall further. Do you share this view?
Yes. Continued growth in low-cost production, from countries like Saudi Arabia, Iraq and Russia, in the face of resilient U.S. production and sharply declining production costs leaves the market oversupplied despite a decent demand response so far. Across commodities we believe that long-term surpluses in most markets require prices to remain lower for longer to balance both the near-term physical supply and demand but, more importantly, the longer-term supply and demand for capital to fund future investments in physical production capacity, which is more severely imbalanced. Simply put, commodities markets still have access to far too much capital relative to future demand and a declining cost structure.
As of mid-July the price of West Texas intermediate was roughly $51 a barrel; Brent crude, $57 a barrel. How low do you think the price of oil will go?
We currently forecast that WTI prices will reach $45 a barrel in October, with Brent prices at $50 a barrel. While we then expect a gradual recovery in 2016 to reach $60 a barrel for WTI by year end, the strong recent growth in Saudi, Iraqi and Russian production, as well as the potential increase in Iranian oil exports next year, leave risks to our forecast skewed to the downside.
Slower growth in China (among other emerging markets) has dampened demand for such commodities as copper, iron ore and coal. Is this downturn likely to last?
Yes. China’s commodities demand is slowing, especially for ‘capital expenditure’ commodities that are exposed to infrastructure development. The gradual shift to a consumer-driven economy will help offset some of this slowdown but will benefit consumer-exposed commodities like oil and nickel most, with iron ore and copper facing sustained weaker demand growth going forward.
What about agricultural commodities — are there any bright spots for investors?
While agricultural commodities have rallied recently, this is driven by U.S. Midwest weather conditions. Beyond this weather impact we expect the deflationary forces of lower energy prices as well as weakening currencies in emerging markets to lead to declining agricultural prices as well.
What strategy are you urging clients to adopt in the short term? The long term?
We remain underweight commodities from a short-term perspective, as we believe that prices need to decline to achieve the required rebalancing. Over the long term we believe that this rebalancing will go hand in hand with greater producer hedging, as historically occurs once commodities markets shift from the investment to the exploitation phases of their supply cycles. While we expect range-bound spot commodities prices, this hedging will deliver positive carry to investors. Finally, we continue to believe that commodities are uniquely well suited to hedging a diversified portfolio from inflation.
