The cynics say Goldman Sachs's sudden distaste for commodities is short-term opportunism. Maybe. But the forward-looking economic indicators say there's method to that opportunity.
The influential investment bank sparked a mini-fury last week when it ended its buy recommendation on major commodities. Yet commodity prices quickly bounced back, as their proponents continue to point to tightness of supplies, growing physical demand from an expanding global economy, rapid modernization of key emerging markets and the massive reconstruction effort in Japan as ample drivers to keep commodity prices strong.
But are the underlying fundamentals really so solid? There is a set of key global economic indicators that commodities have tracked remarkably closely for years - and those numbers suggest commodities are in for a significant slowdown.
The LEI doesn't lie
UBS Securities Canada Inc. strategists George Vasic and Garry Cooper said in a recent report that global commodity prices have closely mirrored global leading economic indicators (LEI) for the better part of two decades. Going back to 1995, UBS's trade-weighted commodity price index and the global LEI measure (combining LEIs for OECD countries plus six major emerging markets) have shown a convincing 0.78 correlation. (A reading of 1.00 indicates a perfect correlation of two sets of numbers; a correlation of zero implies no relationship at all between the two data sets.)
The recent stumble of commodities dovetails with a downturn in the growth pace of the global LEI. The UBS strategists said the slower LEI still indicates expansion of the world economy this year, but the pace is moderating - suggesting "a deceleration in commodities, rather than outright decline."
But it's no golden rule
The implication is that the commodity bull might be in for a sideways drift in the coming months - a good reason, as Goldman recommended, to take profits in commodities and move on to more promising trades. But Mr. Vasic and Mr. Cooper point out that some commodities are much more sensitive to the slowdown in the global LEI than others.
Copper - often referred to as "Dr. Copper" for its Ph.D.-like ability to signal global economic trends - is, indeed, fairly highly correlated to the global LEI. Curiously, though, its correlation - at 0.61 - is less strong than the overall commodity basket. Base metals in general have some of the highest correlations, reflecting their sensitivity to industrial demand.
Gold, on the other hand, has an LEI correlation of just 0.19 - in other words, there's almost no relationship at all between the two.
"This reinforces UBS's global commodity team's preference for precious metals over bulks over base metals in the months ahead," they wrote.