Goldman Sachs Q&A

In-depth analysis of the commodities bull market with Goldman Sachs’ head of commodities research Jeff Currie



Until around the mid-point of the year, the commodities sector had been defined by increasing prices almost across the board, in a rare show of uniformity for a market that traditionally sees different asset classes rise and fall in an orderly fashion. The likes of oil, gas, coal, aluminium, gold, nickel and lithium all made substantial gains in near synchronicity, even before the short-term shock of Russia’s military invasion in Ukraine exacerbated the situation across the market.


What we are now seeing is the mid to long-term effects of global monetary policy enacted to stave off financial ruin during the onset of the COVID-19 pandemic: high inflation, stagnant growth (together equals stagflation) and fears of a worldwide recession. This has had the effect of tearing down large swathes of the natural resources market. Of the commodities mentioned in the previous paragraph, only the fossil fuels and lithium can be fairly said to have avoided the downturn. A simple supply and demand equation explains why the aforementioned commodities have withstood the recent barrage.


Pent up energy demand has pushed up prices for fossil fuels, which have received insubstantial investment to maintain supply growth over the last decade, as the world attempts to achieve net zero carbon emissions. An acceleration in the clean energy transition since the beginning of the COVID era has also boosted ‘new energy’ metals, including those required in lithium-ion battery chemistries and, of course, copper. Chronic underinvestment in the mining sector led to inventories around the world nearly running empty in the first few months of the year, with the sector facing rapidly increasing demand for a range of metals. Add in the supply disruption arising from sanctions on Russia – the world’s second largest commodity producer – and the uncertainty that has abounded markets since the conflict began, and we see a perfect storm emerging in the commodities space, if you look beyond the current slump.


The developments of 2022 will have come as no surprise to long-term observers of the sector, not least to Goldman Sachs’ head of commodities research Jeff Currie, who first acknowledged the potential for a ‘commodities supercycle’ in 2020. According to one definition, a commodities supercycle is a sustained period, usually more than a decade, of increasing commodity demand. In the following interview between Currie and RGN’s editor, the concept is fleshed out in greater detail with references to former supercycles alongside the unique context and drivers of the current market conditions.


Jacob Ambrose Willson: Hi Jeff. You first started discussing a potential commodities supercycle back in October 2020. Why was this hypothesis formulated by yourself and the Goldman Sachs commodities team?


Jeff Currie: I think it begins with COVID-19. COVID was the catalyst. The reason being is that COVID was a crisis in inequalities; income inequality, wealth inequality, race inequality, you name it. This forced governments around the world to focus on the disadvantaged groups. And they did this simultaneously. Every country in the world did this at the exact same time and at an incredibly large scale.


In doing this, it shifted macro-economic policy from being focused on financial stability to being focused on social need. Why is this important to commodities? The disadvantaged groups, which are typically the lower income groups, consumed the lion’s share of food, fuel and capital goods – all of which commodities are important inputs. What this did was create a structural increase in the demand for commodities, driven by policy. That really sat at the crux of why we shifted to a supercycle view.


But I want to emphasise that the supply side of the story, which we called ‘the revenge of the old economy’, was always there. The only ingredient missing was the demand side for which COVID was a catalyst that kicked off an entirely different demand trajectory. These governments needed to spend and spend big. What’s the thing they’re going to spend on? Decarbonisation. So you’ve got the green capex boom, plus the redistribution policy that really blossomed coming out of the COVID experience.


JAW: Can any similarities be drawn with the current upcycle and previous supercycles in the commodities space?


JC: Let’s go back to the two previous supercycles – in the 1970s and in the 2000s – and then look at the one most recently. All three have in common the fact that they were driven by disadvantaged/low income groups.


To understand this is to think about commodities versus financial markets. Commodities are what we call ‘volume metric markets’ – they are driven by the volume of demand. For example, how do you determine if you’re bullish on oil? You look at the volume of demand versus the volume of supply. If demand is bigger than supply, you’re bullish. In contrast, when you think about a financial market – they are notional dollar markets. How many dollars do you pump into that financial instrument? So, how do you quote an oil market? 100 million barrels per day. How do you quote an equity market? Billions of dollars of market cap.


The world’s rich control dollars through income and wealth inequality. Can the rich create financial inflation? Yes. Can they create GDP growth? Yes, they just pump money into the system. Can the rich create a commodity bull market or physical goods inflation? Numerically impossible. Why? There are not enough rich guys. When we think about volume, who controls the world volume? It is the lower income groups. So, they are the ones that can create commodity bull markets.


If we go back to the supercycle in the 2000s, what was it? It was a gigantic redistribution from rich Americans and Europeans to 400 million rural Chinese. That was your low income group that created that commodity bull market in the 2000s. What about the supercycle in the 70s? It was LBJ’s ‘Great Society’ and ‘The War on Poverty’ – ie 250 million rural, poor Americans and Europeans that were brought up into the middle classes. It’s the same dynamic over and over when we look at these big structural bull markets. It’s a disadvantaged, lower income group that drives the demand growth.


JAW: Fascinating parallels. Looking at the current market, which specific commodities do you think will drive this supercycle, and what kind of supply headaches are we looking at as the sector tries to respond to growing demand?


JC: Basically all commodities are facing very similar levels of supply constraint. This goes back to why we called it the revenge of the old economy. It’s because investors since 2008-09 have preferred new economy (ie Netflix) opportunities over the old economy (ie ExxonMobil). Part of the reason why is because returns in the old economy were abysmal to say the best over at least the last 10 years. That redirection of capital into the new economy starved the old economy of the capital it needed to grow the supply base, creating the supply constraints that we are seeing today. This was then amplified by ESG concerns that saw capital redirected into new energy investments and other types of constraints like banking regulations.


I want to emphasise, again going back to the cycles of the 70s and 2000s, they were also preceded by a big boom in the new economy. In the 60s, it was the NIFTY 50. In the 90s, it was the dot com bubble, and in the 2010s it was the FAANG boom. These new economy booms led to a massive redirection of capital into the new economy that then set the stage for those structural bull markets in the 70s and 2000s because of the underinvestment in the old economy during that time period.


But what makes this one turbocharged relative to the 70s or 2000s is ESG and other regulatory constraints driven by policy that prevent the flow of capital into the sector. I’d like to point out, we’re right now at US$110 per barrel of oil and $10,000 per tonne of copper and the flow of capital into the sector has been miniscule at best. In any case, what we’ve seen across the sector is outflows, which is making the problem worse in terms of creating more upside in prices.


JAW: On the topic of commodity prices right now, how are they being impacted by more short-term shocks, chiefly the Russian invasion of Ukraine?


JC: Our target on oil before the Russian invasion was $105-115 per barrel. It was already a very tight, bullish backdrop before the invasion. There are three things to think about in terms of the impact of the war in Ukraine:


1) A near-term disruption in supply, which is modest to be honest and will probably have the deepest impact in agriculture.

2) A political response, which we call ‘the revenge of the old political economy’. Europe just unwound two decades of energy liberalisation, went backwards on the energy transition and has created a policy reminiscent of the 70s – ie windfall profit taxes and power price caps. All of that is a more permanent policy shift that’s going to restrict capital flows into the sector.

3) A drop in investment in technology flows into Russia (this is the biggest and most important), which is the second largest commodity producer in the world. This will have a profound impact on Russia’s ability to grow supply going forward.


The net impact of Russia’s invasion of Ukraine going forward is; it takes an already bullish story and turns up the volume.


JAW: Wood Mackenzie recently warned that recent price spikes in the sector could have an enduring impact. To what extent do you agree that the current volatility will have an adverse effect on the market and producers?


JC: What we find is that when you see a market that is as under-invested as all of the commodity sector is, you end up creating a volatility trap. This means the higher the volatility, the less interest that investors have in investing in this space. The drop of capital into the sector reinforces higher volatility, creating this vicious cycle between a drop of investment and rising volatility.


And so when we think about breaking this linkage, the only possible way we solve this supercycle is through investment. You need to get investment. How did we solve the 70s? and the 2000s? Investment. The only way out of stagflation longer term is through investment. The higher the volatility, the lower the incentive, so it’s becoming a higher bar to get the investment, but the only thing that is going to stop that volatility is investment.


Now, what they are referring to is demand destruction. I want to emphasise that demand destruction is not a long-term solution. We saw demand destruction in the 70s four times before we solved it. In, 1970, again in 73-74, 78-79 and 80-81. We finally came out of it after Paul Volcker [former chairman of the Federal Reserve] raised interest rates up to 20%. But, there was already five years of capex when Volcker raised interest rates. Right now, we have no years of capex and we have 70s style inflation.


JAW: Where is this desperately needed investment going to come from across global markets, and to which areas should they be going to in the commodities sector?


JC: If you look at free cash yields on energy companies, they are trading in excess of 30%. That tells you the sector is starved of capital. So the investment needs to be broad-based. Where is it going to come from? It needs to come out of the growth sectors. The new economy has had too much capital pumped into it over the last decade. Ultimately, it’s going to have to come from rotation. People don’t want to hear that. It’s going to be a very painful and violent process. That’s where it came from in the 70s and where it came from in the 2000s and it’s ultimately where it will have to come from in this cycle. I think the question is, how long will it take to get us to that point?


JAW: So how confident are you that the current cycle will last over a multi-decade period?


JC: There are three problems we are dealing with now. We like to call it RED-lining commodity demand. The R stands for redistribution issues. This is the war on income and inequality. Income is as high today as it was in the 1920s. This is not a problem that is resolved in five to 10 years. This is going to take a long time and it’s going to be a very bumpy process.


The E is environmental policies. This stands for the war on climate change. Decarbonisation is not a problem that can be resolved in the next 5-10 years either, it’s a multi-decade process. We estimate that the green capex this decade is worth one China in the 2000s. In the next decade, it’s going to be worth two China’s!


Finally, the D stands for deglobalisation. This means more resiliency in supply chains. You have entities all over the world building out thicker supply chains. The trucking problem in the US is the poster child of deglobalisation. You need warehouses, transportation, truck capacity – all of these types of investment.


None of these issues will be solved in under 10 years, they are decades of investment in the making. I like to point out, if you take the new economy today or the dot com in the 90s, it took a decade for these sectors to get to the point where they could absorb trillions of dollars of capacity. You can’t even grow shale production in the US beyond 1.2 million barrels per day right now, because you run out of pressure pumping capacity, sand, truck drivers, truck chassis – you name it.


So when we think about being able to absorb that capital, you’ve got to move people and resources into the old economy space, and that’s going to take a long time. It’s a multi-decade process and given the size of the imbalances in the goals set forth to achieve, it’s going to be one of the most expensive endeavours the world’s ever embarked on.