The Goldman Sachs blues – how long will it last?

The major factor driving commodity markets during the past week was the recommendation from Goldman Sachs to take profits. While the advice to cash-in profits referred to some specific market, it had an impact cross all commodities. Goldman Sachs has the reputation of being a long-time bull in commodity markets. At the same time, Glencore announced to go public, a move being expected already for a while. Some market commentators concluded that these two events would signal the end of the cyclical bull market in commodities.

Also in commodity markets, buy and hold is not necessarily the best strategy for a financial investor. Taking profits when a market is overheated and likely to enter a correction soon could lead to outperformance. If an expected correction takes place, the investor could go long again in commodities at a lower price. The recommendation to take profits is in particular justified in the case that a bullish move is based more on psychological factors then fundamental supply and demand developments. This appears to be to some extend the case in the oil market.

In the metals markets, there is a typical seasonal weakness during the summer month. Thus, the recommendation to take profit could also be justified against this background. However, for copper, also the fundamentals appear less bullish. The International Copper Study Group estimates that copper would be in a 400,000 tons supply deficit this year, an increase of the deficit by about one third compared to 2010. At the copper week in Chile, the CEO of a mining company even expected a widening of the supply deficit to 500,000 tons. However, if demand exceeds supply, the inventories should decline. But copper inventories in warehouses at the SHFE increased from 87,447 tons in early October to 177,365 in mid-March. Inventories in LME warehouses rose from 349,450 tons in mid-December to 450,425 tons last Friday, while inventories at the COMEX increased from 64,220 to 83,943 tons. Certainly, movements in and out of exchange registered warehouses to free warehouses could distort the picture. Nevertheless, a sustained increase of inventories in a market that should be in a rising demand surplus is a clear warning signal.

Inventories are not the only factor in our quantitative models for copper prices. The various leading indicators have reached levels, where another strong increase appears to be unlikely. Thus, they might rise marginally at best, but this would not be sufficient to push copper prices higher despite the rise of inventories. As China has just recently hiked interest rates, but another step seems rather probable. Therefore, the risk for leading indicators is more biased to the downside.

Another factor in our models is the external value of the US dollar. There are some hawkish comments from FOMC members, which have an impact on money and bond market rates. The markets priced in a rate hike already in the second half of this year. However, the majority of the voting members of the FOMC favors to stick to QE2 as scheduled and to keep the Fed Funds rate at the current low level for an extended period. The ECB on the other hand is likely to hike rates again in the second half of 2011. Therefore, the US dollar might weaken further, which would be a supportive factor for commodities. On the other hand, a strengthening of the US dollar would be another negative factor for copper.

Gold and silver have shrugged off the Goldman Sachs recommendation rather quickly. Both metals reached new highs. Stronger than expected headline inflation figures, as well as the US dollar, remain supportive for the precious metals.