New York – Commodities
investors needn’t fear the Federal Reserve. Raw materials perform best when the
US central bank is hiking rates, according to Goldman Sachs Group, which used
the findings of a study to buttress its overweight call on the asset class
while acknowledging risks to its view.
Raw materials do best
during periods of rising interest rates, topping returns from equities and
bonds, analysts including Jeffrey Currie said in a May 8 report that crunched data
going back to 1988 and covered four hiking cycles. The same finding came after
a look a tightening cycles in China, they said.
“This makes intuitive
sense because the reason why the Fed raises interest rates is that the economy
displays signs of overheating,” the analysts wrote. “Strong aggregate demand
and rising wage and price inflation are precisely the time when commodities
perform the best.”
Commodities have dropped
this year amid weakness in crude oil and some base metals even as banks including
Goldman have backed raw materials to do well again after they rallied in 2016.
The losses in 2017 stand in contrast to gains in equities, with US share
benchmarks hitting records, and come as the Fed has started to tighten. US
central bankers will meet in June to decide whether to pull the trigger on a
third rate increase in six months.
‘Perform well’
“The results of the bank’s study
“reinforce our view that commodities should perform well over the coming year
as the Fed increases policy rates with the labour market running at full employment
and inflation moving toward its 2 percent target,” Currie said.
Read also: Markets weaker, nervous on Fed talk
Still, Goldman did see a
trio of risks, including a potential shift in the energy market. US shale may
have fundamentally changed how oil supply responds to demand, it said. A second
risk is the tailwind from China over the past decades is unlikely to repeat
itself, and third, the economic condition of the current hiking cycle may be
different from previous ones, it added.
‘Not equal’
“The evidence from both the US and
China suggests that commodities perform well when central banks are raising,”
the bank said. “To be clear, this relationship is by no means causal. In fact,
all else equal, higher rates tighten financial conditions and slow down the
economy. But all else is not equal: an economy that is in a more advanced stage of the business cycle drives both
the commodities rally and the central bank’s decision to raise rates.”
In addition to raising
rates this year, officials are also debating how to shrink the balance sheet,
which was swollen by asset purchases to support the recovery. “We want to move
our balance sheet down to more normal levels,” Bank of San Francisco President
John Williams said at the weekend.
In a phase of rising US
interest rates, it’s base metals that tend to do best, outperforming energy
commodities, precious metals, livestock and agricultural raw materials, Goldman
said.
“This is consistent with the observation that industrial metals tend to be most
levered to economic cycles,” it said.