“Not all commodities are created equal,” a Goldman Sachs Goal Kickstart report under the same name observed. On the week, copper and oil, both with economic correlation factors to various degrees, went in opposite directions and represented extremes in both highs and lows. While both assets are used to gauge economic activity, their Commodity correlation, however, is at a relatively low 0.16, a fact both commodities put on display. Those are not the real divergent commodities, however. Gold, known as a crisis performer, is the rare commodity Goldman expects to underperform over the near term despite overall Commodity correlation. When lack of crisis appears, however, risk parity is a strategy that succeeds, which is currently the case.
Goldman bullish amid Commodity Correlation, likes copper and oil, gold not so much
Copper was the best performing commodity over the week, up 2.5% -- outperforming all other commodities and asset classes by reasonably significant degrees. In local currency terms, the next best performers, the Topix and MSCI Emerging Market index, were both up less than 1%. Gold was nearly flat, up 0.1%, while WTI crude took the hardest fall, down 4.5%. Showing overall weakness in the commodity sector, the GSCI Total Return index was down near 3% on the week.
Goldman’s commodity analysts are generally bullish with the exception of gold. The report examines nuanced performance drivers, some of which a systematic computer program likely would not have picked up due to the lack of repeatable Commodity correlation patterns.
Goldman thinks lower returns in US equity should support “a more defensive investor allocation,” which benefits gold and puts a floor in place. The report didn’t get deeper into the façade of low volatility in a negative interest rate environment and what might mean for gold during a market crisis. The emerging markets are the spot to watch, where “GDP acceleration would add purchasing power to EM economies,” residents of which have had a propensity to acquire gold when flush with assets. While a bout of inflation may hit emerging markets, there could also be a gold mine supply peak in 2017, the report projected. “Gold has been increasingly trading as a ‘risk off’ asset, with its correlation with global bonds at the 100th percentile since 2002,” the report noted.
For gold support, the emerging markets are also a spot to watch, where “GDP acceleration would add purchasing power to EM economies,” residents of which have had a propensity to acquire gold when flush with assets. While a bout of inflation may hit emerging markets, there could also be a gold mine supply peak in 2017, the report projected. “Gold has been increasingly trading as a ‘risk off’ asset, with its Commodity vorrelation with global bonds at the 100th percentile since 2002,” the report noted.
While gold is expected to move lower, Crude oil is expected to diverge higher by more than 20%. Goldman’s three-month spot target is $57.50 and the six-month expected price at $55 per barrel, basis WTI. Relative to gold, oil is more consistently correlated to the German, Japanese and UK ten-year note, at 0.88, 0.72 and 0.73 respectively. However, it is only correlated to the US ten-year note at 0.60 while it is more correlated to US investment grade bonds and high yield debt at 0.75 and 0.90, respectively.
Such correlations could become noteworthy as Goldman sees interest rates around the world rising, with the US ten-year note hitting 2.64% in three months, 2.75% in six months and 3.00% in one year. Japanese rates are expected to climb up from the gutter and move to 0.05%, 0.10% and 0.20% over the same periods, while German rates are anticipated to climb to 0.59%, 0.70% and 0.90% respectively.
In the calm and tranquil world without apparent risk, risk parity doing well
In a relatively calm market environment, when the CBOE VIX index is knuckle dragging near all-time lows, risk parity portfolios have done well since the start of the year. European risk parity funds are all up nearly 7% since mid-December 2016 while the US is up near 5% over a similar period. The strategy’s leverage adjustment mechanism has come under criticism during crisis – by definition, many of the funds reduce exposures as markets fall – the strategy is working just swimmingly in calm periods, the prevailing market environment in a negative real interest rate environment. Meanwhile, a 60% / 40% equity / bond portfolio is up near 6% in both regions over a similar period, as would be expected.
After peaking near November 2016, risk appetite for stocks and bonds has fallen to near the flat line, the report noted. Goldman expects the S&P 500 to move lower, with three, six and 12-month targets at 2350, 2325, and 2325 respectively. The Euro Stoxx 600 index, by contrast, is expected to move higher over this period, with targets at 390, 400 and 410 respectively, a rare outperformer. The MSCI Asia-Pacific Ex-Japan and the Topix index, meanwhile, are expected to move lower.