Commodities Ride Record Rally Into 2018

January 03, 2018

Positive Roll Yields

Meanwhile, Goldman Sachs is also sanguine on the asset class, but for different reasons. The firm recently released a research report in which it recommended that investors overweight commodities, expecting a 7.5% return over the next 12 months.

Goldman cited robust demand and falling inventories as supporting its bullish view.

"Real assets, such as commodities, have historically outperformed as the business cycle matures," Goldman analysts led by Jeffrey Currie wrote in a note published for clients in December. "The diversification case for commodities is also very strong as cross-asset and cross-commodity correlations are now near zero."

Interestingly, Goldman expects nearly all of the returns for commodity investments in 2018 to come from roll yields―the gains picked up from selling near-dated futures contracts and buying later-dated contracts when futures markets are in backwardation.

"We find that it pays to be late and enter commodity markets as the business cycle matures and after backwardation has occurred (in oil it occurred in August of [2017])," Goldman analysts said. "The reason for this is that once the returns are based upon carry and less on price appreciation, the persistence of the carry delivers more stable and dependable returns."

Goldman said that the opposite situation, contango, ate away at much of the returns from price appreciation that commodities saw in 2017. That shouldn't be a problem in 2018, and is the reason the firm expects solid returns for the group even as prices stay largely flat during the year.

More Balanced View

Not everyone believes commodities are off to the races in 2018. Societe Generale has a more balanced outlook for the group, which includes a call for Brent crude oil prices to fall to $56 a barrel by the second quarter. Prices were last trading closer to $67.

"We continue to project a moderate global stockbuild for 2018. As a result, on both Brent and WTI, we are bearish with respect to current front-month prices and current forward curves," analysts at the firm said.

They also expect copper, which is at a multiyear high, to pull back despite supportive supply and demand fundamentals. "The long-term price outlook for copper is undoubtedly very positive," Societe Generale analysts said, but prices "have moved slightly ahead of fundamentals."

The firm projected copper prices would hit $6,600/ton in half a year, notably below the $7,200 level at which copper currently trades.

Corn and gold are other commodities Societe Generale is bearish on. It expects December 2018 corn futures contracts to drop to $3.50/bushel from current levels of $3.86, and for gold to slip to $1,225/oz. from current prices near $1,313.

"U.S. monetary policy is likely to prove a significant headwind for gold, as a rising interest rate environment and still-subdued inflation levels lower the real return on the precious metal," analysts at the firm said.

On the other hand, Societe analysts are particularly bullish on natural gas, lead and tin in 2018.

Sumit Roy can be reached at [email protected]

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