You do not hear Godman Sachs admitting that it made mistakes very often, but that is exactly what it is doing today. Goldman was not the only one to misjudge the direction of commodities prices this year, but according to the bank “this still leaves the question of how did we (and the market) get it so wrong?”. The bank says it misjudged some of the fundamentals of commodities pricing in making its forecasting error. In particular, it says that they underappreciated price differences in some “contacts”, which is a key driver of determining whether the market is under- or over-supplied.
FINSUM: We have been bearish on oil all year, and our own view is that banks completely misjudged the ability of OPEC to actually lower total global output.
After all the hype, the various rallies, and hopes for higher prices because of an OPEC oil price hike, a sad reality is gripping the oil business—it is back in a bear market. Oil prices have once again fallen over 20% from their most recent peak on February 23rd as OPEC cuts have failed to stem the supply glut that has overwhelmed the globe. The US shale industry and other non-OPEC producers have kept output high, which has offset any impact by OPEC and driven prices lower. US oil currently sits at just $43.23 per barrel. One oil commentator summarizes the bleak outlook, saying “We’re seeing this decline amid some major OPEC production restraints … That’s the huge difference” compared to previous bear markets.
FINSUM: The oil market is looking bleak because: 1. the world figured out that it had much more oil than it thought (thanks to fracking) and 2. OPEC no longer has a stranglehold on global production, which means the market is actually competitive.
OPEC has fallen from grace. Its exalted status has carried it for decades, but its power is now so deeply diminished that it cannot push prices up even with a large coordinated output cut. The group hoped its efforts to reduce supply would clear the glut from the market and raise prices along the way. However, its efforts have been undermined by growth in output outside of OPEC, such as from US shale. Because of this, crude stockpiles are remaining stubbornly high, showing that the oil market is not improving.
FINSUM: we have been saying this for months, but want to reiterate it—the structure of the oil market and the fact that the resource is abundant means there is an effective price ceiling on oil around $50.
The oil market has been a big disappointment this year. There has been a great deal of hype about coordinated OPEC output cuts since November, but despite the cartel’s best efforts, it has not been able to sustainably raise prices. The reason why is heightened production outside of OPEC, such as from US shale. The market has returned to deep contango, when oil contracts for immediate delivery are lower than for forwards. The 1-year Brent spread is also shattered, with Brent for delivery in Dec 2018 significantly lower than that due in Dec 2017.
FINSUM: This seems like a signal that bullish oil investors have finally given up. The wall of US output and OPEC’s inability to control supply are just too overwhelming for prices to rise.
OPEC renewed its output cuts recently, but to no avail. Oil prices have since fallen back to the level they were before the cut—a level which was already signaling that the first cut had failed. Futures are down 4.3% this week, as the market continues to worry about the exact same thing—excess supply from non-OPEC producers, such as the US. One oil market commentator summarized the situation perfectly, saying “It’s the ongoing theme of increasing supply and relatively high stockpiles, which can’t seem to fall”. He continued, “The inventory build in the U.S. spooked the market with such a huge miss on expectations. There is a clear lack of any bullish catalyst at the moment”.
FINSUM: We have said it many times before, and we maintain our position: oil is too abundant and the market too competitive for the commodity to maintain price levels much higher than at present.
Gold is supposed to be a hedge for the stock market, falling as stocks rise, or gaining when they weaken. However, the current path for gold has run counter to that notion, as the metal is rising alongside stocks. Barron’s contends that the reason why is that while stocks are not driven by politics (rather earnings and growth), gold is. Therefore, since earnings and growth look strong, and politics looks poor, both stocks and gold can benefit.
FINSUM: Since stocks keep doing well even as the geopolitical situation worsens, the rise of both asset classes makes perfect sense to us.