Commodity prices usually rally as the Fed enters hiking cycles, but there are three risks that could derail gains, Goldman Sachs said in its latest note. Goldman pointed to U.S. shale oil, diminishing China demand and the Fed’s gradual hiking cycle as risks to its overweight call on commodities.

Historically, commodities perform the best when the Fed is raising rates, Goldman said. This makes intuitive sense because the reason why the Fed raises interest rates is that the economy displays signs of overheating. Strong aggregate demand and rising wage and price inflation are precisely the time when commodities perform the best. The bank added that rising interest rates in China also tend to coincide with better commodities performance, noting the mainland’s “outsized role” in demand.

That’s a driver of Goldman’s overweight call on commodities, with expectations for solid performance over the coming year as the Fed raises rates and the labor market runs at full employment.

But Goldman pointed to three risks that could derail its view.

  1. Firstly, it noted that technology changes and U.S. shale oil production could have “a profound impact” on commodity returns.
  2. Secondly, Goldman said the China tailwind may be waning. As an example, it cited China’s demand for refined copper, which rose to 10.2 million tons in 2015 from 660,000 tons in 1990, totalling 90 percent of the total global growth in copper demand. Going forward, the growth in the Chinese demand for industrial metals is likely to be much more muted, also contributing to lower commodities returns relative to historical experience,Goldman said.

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    Copper imports from China were seen falling to the lowest level in many years. source: Bloomberg

  3. Finally, Goldman also pointed to a risk from the Fed’s hiking cycle itself, noting that the current pace has been much slower compared with previous cycles amid a gradual U.S. and global economic recovery.

So after all the bank expects commodities to rally, but with many risks in sight it’s worth being cautious. For example, we pointed out yesterday that copper may be on the verge of falling futher. 



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