Monday, January 19, 2009

Goldman Sachs Predicts Oil Rebound

In today’s Bloomberg News:

Goldman Sachs commodity analyst Jeffrey Currie predicts that oil will close the year at $65 per barrel, a “swift and violent rebound” of 88% over today’s price of roughly $34.50. We may be entering a “new bull market” in oil, Currie says.

“Thirty dollar oil reflects the same imbalances that got us to $147 oil … The problems haven’t gone away. We still believe the day of reckoning is to come … This is not 1982-1983 all over again … The supply picture’s radically different, the demand picture’s radically different,” Currie says.

“The key difference is that today there are no large-scale next generation projects that are going to save the world,” he added. “Commodity demand is exponentially higher than it was.”

This is a compelling argument, especially in light of the experience in oil over the past decade. But, as I have said before, it is important to approach such situations with a healthy degree of skepticism. One should look to, as investor Bruce Berkowitz puts it, “kill” one’s ideas, rather than giddily pump money into them.

Investing is possibly the most competitive game on earth. And if winning such epic stakes relied on parroting widely known information that has prevailed for a decade, in such a huge and liquid market as in oil, then anyone could become wildly rich. Despite being an investor in the commodities market since 2002, I became very skeptical in 2008.

At that time, when crude oil traded only a little beneath its peak, Goldman Sachs analyst Arjun Murti put out a report claiming that oil would surge through the $200 per barrel mark. He arrogantly mocked the idea that speculation played any part in the run up in prices; and spoke for his firm in saying: “Unfortunately, we do not think the energy crisis will be solved by finding and punishing the big, bad speculator.”

Of course, the fact that Goldman released this information to the public shows how valuable it was to them. And it gave the speculators, who were the cause of the spike, even more enthusiasm in aggressively bidding up prices, without asking any questions. If the venerable Goldman Sachs says it, then it must be true. And then the market caved in and oil sank like a stone to $30 a barrel.

In other words, after Goldman’s advice was wrong and made at the peak of a bubble – as it has been so many times before – the new advice is to be a “value investor” and buy low. They’ve got advice for all seasons, even after destroying the people who listened to them last time.

My personal view is that one should be skeptical in venturing into the oil market, remaining cognizant of how many other people are currently eying the same asset. Back in 1999, when the oil market truly bottomed, or even in 2003 when it bottomed again, virtually no one was looking at it. Commodities werent featured in the news or discussed by pundits.

I also question the assumptions that are built into these analysts’ models. For example, one assumption that is virtually certain is economic growth in China running at above 7% or 8% per annum, and strong growth in many other emerging markets. This was a major factor driving up oil prices from 1999 to 2008.

Indeed, there is possibly no greater dogma than strong, continued growth in China. But what if China and the emerging markets simply don’t resume this kind of growth for several years? If the bubble in United States consumerism has popped, and Asian economies are reeling, then why would anyone expect China to be exempt and continue its rapid export-driven growth? What effect does this have on oil demand?

Events never materialize as the vast majority of people expect. For example, the only people who predicted the credit crisis were gloom & doomers (who only ever have one view) and obscure traders from the high-yield space. If Kenneth Griffin at Citadel, far and away one of the smartest people in finance, got slammed with a 50% loss, that sizes up most peoples’ chances of predicting macro events.

Yet no one seems to be approaching the commodities market or national economies with similar sobriety and skepticism. The irony is, what should be more difficult, predicting the trajectories of subprime CDOs and hugely-leveraged mortgage companies, or the trajectories of entire nations and world trade?

Creative Commons License
This work by Nicholas E. Radice is licensed under a Creative Commons Attribution-No Derivative Works 3.0 United States License.