Goldman's commodity outlook buckles under threat of deflation

[TOKYO] Cheaper energy and the US dollar's advance are darkening the outlook for commodities, according to Goldman Sachs Group Inc.

The US bank cut its forecasts for metals and mined raw materials including copper, gold and iron ore over the next three years by about 10 to 20 per cent as production costs shrink, according to an e-mailed report on Friday.

Oil has led a collapse in commodities after a decade-long bull market boosted output, spurring gains in inventories. Falling prices are threatening to prolong the rout as they make it cheaper to produce more, worsening the oversupply that triggered the slump, according to Goldman.

"The primary reason for the changes to our forecasts is cost deflation," the bank's analysts including Max Layton wrote in a report dated Jan 23, citing "actual and anticipated US dollar strength, cheaper energy and other input costs and our expectation of an improvement in mining productivity."

The Bloomberg Dollar Index, which tracks the currency against ten major peers, is set for its highest level since it started in 2004 amid speculation the Federal Reserve will become the first central bank among major economies to raise interest rates this year.

As the greenback appreciates against the currencies of commodity-producing nations, the relative cost of production on a dollar-basis drops. The Bloomberg Commodity Index of 22 raw materials slid 17 per cent last year, the most since the 2008 financial crisis, and is 2.4 per cent lower in 2015. Brent crude has fallen 60 per cent since a peak in June last year.

The dollar is surging against currencies including the yen and euro as the Fed take steps to tighten monetary policy while central banks in other developed economies inject further aid to boost growth and stave off deflation.

"We are seeing the start of a US dollar bull market," the Goldman analysts wrote. "We see this as a bearish backdrop to mining commodity pricing over the next 12 months." Credit constraints in China, the world's biggest user of metals and energy, is curbing growth and slowing demand for mined commodities. The nation's economy expanded at the weakest pace since 1990 last year. A gauge of manufacturing showed a second month of contraction in January.

Copper, gold and iron ore are at risk of falling the most, Goldman Sachs said. It's most bullish on palladium, nickel and zinc.

Copper is passing through a once-in-20-year supply cycle as demand weakens amid a slowdown in China's property market, the bank said. It cut its forecast to US$5,542 a metric ton for this year from a previous projection of US$6,400. Copper was at US$5,557 on the London Metal Exchange on Friday, tumbling 23 per cent in the last 12 months.

"We remain bearish on copper for 2015 despite the price declining more than 20 per cent over the past year," the Goldman analysts wrote. "We expect the fundamentals to weaken further over the coming 12 months."

The iron ore market faces a sustained period of oversupply and the bank now sees the steel-making ingredient averaging US$66 a ton in 2015, down from an earlier estimate of US$80, according to the report. Iron ore with 62 per cent content delivered to Qingdao, China, cost US$66.42 a ton on Friday. It has lost 47 per cent in the last 12 months.

Gold will decline from the third quarter of 2015, when the bank predicts the US will start raising interest rates. Prices will slide through 2016 as the US economy continues to expand while easing lending conditions and lower oil prices will help growth in other developed economies.

Goldman reduced its bullion forecast for next year to US$1,089 an ounce, from US$1,200 previously. Spot prices in London fell to US$1,293.39 an ounce on Friday, trimming a third weekly gain.

Lower oil and cheaper bank loans are helping to extend a rebound in US automobile sales, pushing palladium further into a supply deficit, according to the bank. Small amounts of the precious metal are used to reduce harmful exhaust emissions. Goldman forecasts prices to rise 24 per cent in the next 12 months and sees them at US$988 an ounce in 2016, unchanged from its previous projection. Palladium was at US$773.25 an ounce on Friday.

Nickel will advance as ore supplies tighten and inventories shrink in China, the biggest consumer, according to Goldman. The full impact of Indonesia's ban last year on unprocessed minerals hasn't yet been felt in the market, which is swinging into a deficit, it said.

The bank lowered its forecast for the metal this year to US$16,550 a ton from US$17,500 previously because of weaker global demand even as it still sees "significant upside" to prices. It was trading at US$14,580 a ton on Friday.

"A few outliers are likely to buck the trend of falling prices," the analysts wrote.

"Commodities that were out of favor in the last bull market and which, consequently, were starved of capital, will now be out of phase with major commodities such as iron ore and copper."

BLOOMBERG