3 d's of macro push deflation, divergence and deleveraging reinforce oversupply

8/19/2019 3 D's of Macro Push Deflation, Divergence and Deleveraging Reinforce Oversupply

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Commodity Watch

The 3D’s of macro pushcommodity markets lower

Commodities Research

Deflation, Divergence and Deleveraging reinforce oversupply

Finding new equilibria to balance forward marketsThe search for new equilibria in commodity markets has once againresumed, following a mid-year pause that was beginning to createcomplacency that the spring rally had established the new set of equilibria.We have remained firm that long-term surpluses in most commoditymarkets require prices to remain lower for longer to balance both the near-term physical supply and demand, but more importantly, the longer-termsupply and demand for capital to fund future investments in physicalproduction capacity, which is more severely imbalanced. Simply put,commodity markets still have access to far too much capital relative tofuture demand and a declining cost structure.

The 3D’s are Deflation, Divergence and DeleveragingIn late May we argued that the spring rally would likely prove transient asthree reinforcing macro trends, a decade in the making, are likely to takeyears (not months) to resolve. We refer to these drivers behind our bearishviews as the three D’s: Deflation in costs and commodity prices, followinga decade of investment in commodity productive capacity. Divergence ingrowth as the US remains on a divergent growth path relative to the rest ofthe world, reinforcing a strong US dollar. Deleveraging in EMs to achieve

a balanced growth environment, following a decade of economic boomthat generated significant macro imbalances and debt, such as in China.

Deleveraging has weakened China’s CapEx demandDespite the focus on weakness in the Chinese domestic equity markets, weview it as a catalyst and continue to believe that underlying demandweakness, particularly in the commodity-intensive sectors, remains farmore important. Recent data suggest that investment’s contribution to GDPgrowth declined from 50% of growth to 15% in the first quarter, helping topush “CapEx” commodities like copper to new lows for 2015.

Deflation and divergence reduce the need for capitalCost deflation reinforced by weaker commodity currencies due to thedivergence in US growth lowers the capital requirement for commoditymarkets. However, capital availability is too high, as $60/bbl oil, strong highyield and equity energy markets have generated an increase in US drillinglast week in already oversupplied markets, which only lower prices will fix.

Jeffrey Currie(212) 357-6801 [email protected], Sachs & Co.

Michael Hinds(212) 357-7528 [email protected], Sachs & Co.

Damien Courvalin(212) 902-3307 [email protected], Sachs & Co.

Max Layton+44(20)7774-1105 [email protected] Sachs International

Christian Lelong+61(2)9321-8635 [email protected] Sachs Australia Pty Ltd

Abhisek Banerjee+44(20)7552-9350 [email protected] Sachs International

Yubin Fu+44(20)7552-9350 [email protected] Sachs International

Amber Cai+852-2978-6602 [email protected] Sachs (Asia) L.L.C.

Caroline Lu(212) 934-0799 [email protected], Sachs & Co.

Raquel Ohana+44(20)7552-4055 [email protected] Sachs International

Investors should consider this report as only a single factor in making their investment decision. For Reg AC certificationand other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html.

The Goldman Sachs Group, Inc. Global Investment Research


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Goldman Sachs Global Investment Research 3

Exhibit 1: Deflation – after a decade of global productivecapacity investment in commoditiesAverage age of US capital stock (years)

Exhibit 2: Divergence – after nearly a decade since thelast interest rate hike in the USReal GDP (index, 2008Q4 = 100)

Source: BEA, Goldman Sachs Global Investment Research Source: Haver Analytics, Goldman Sachs Global Investment Research

See: FX Views: “While you were Greeking…” June 30 2015

To recap, the three mutually-reinforcing macro drivers behind our bearish views which werefer to as the three D’s are:

1. Deflation: A decade of investment in commodity productive capacity and newtechnologies has created excess capacity in most commodity markets, which will weigh onboth costs and commodity prices, creating a deflationary impulse globally (see Exhibit 1).

2. Divergence: Following nearly a decade since the last interest rate hike in the US and theUS’s relatively quick implementation of a QE program, the US is on a divergent growthpath relative to the rest of the world, which reinforces a strengthening US dollar (seeExhibit 2).

3. Deleveraging: Following a decade of economic boom in emerging markets, significantmacro imbalances were developed. This will require deleveraging debt levels andrebalancing growth to achieve a balanced growth environment (see Exhibits 3 and 4).

Exhibit 3: Deleveraging – after a decade of credit growthoutpacing GDP growth…Credit to GDP gap (current minus trend level)

Exhibit 4: …across most EM economiesCredit to GDP gap (current minus trend level)

Source: Goldman Sachs Global Investment ResearchSee: Emerging Markets Weekly: “The EM Credit Cycle, Measuring the gapbefore crunch time” June 25, 2015

Source: Goldman Sachs Global Investment ResearchSee: Emerging Markets Weekly: “The EM Credit Cycle, Measuring the gapbefore crunch time” June 25, 2015

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As we discussed in May, copper is the one commodity that is the most exposed to thesethemes and illustrates the importance of the negative feedback loop. Deflation lowers theenergy and material input cost to producing copper while divergence weakens the Chileanpeso in US dollar terms, which puts downward pressure on local labor costs in Chile. Andthen deleveraging in China reduces the demand for copper, al l reinforcing the downsiderisk in copper prices.

A decade ago, our confidence in the bull case for commodities was driven by the samethree macro themes in reverse – short the dollar, long commodities and long emergingmarkets. Commodity markets were facing significant underinvestment in productivecapacity with the need to attract capital while the US economy was facing a significantleverage problem and relatively slower growth that was weighing on the US dollar. At thesame time, emerging markets had a tailwind driven by clean balance sheets. Today theseroles have been reversed.

The EMs look like the US did a decade ago, and commodity markets are facing substantialoverinvestment. Just like these themes reinforced each other in reverse to the upsideduring the last decade, today the three D’s are reinforcing each other to find a new set ofequilibrium prices that are likely far lower than current levels. Ultimately rebalancing will

likely be achieved, but it will take years, not months to achieve, which reinforces ourbearish commodity views and our underweight recommendations.

Metals take a leg lower on weak China demand, as “Deleveraging”trend continues

While we have been expecting lower prices for CapEx commodities (copper, iron ore) forsome time now, the speed of the recent declines has been unexpected, taking pricesrapidly towards our bearish 12 month forecasts. Furthermore, the metals where we hadbeen expecting higher prices later in 2015 on diverging supply fundamentals (nickel and

zinc) have also seen similar rapid prices declines over the last few days.Weakness in the Chinese domestic equity markets has recently become a talking point.However, we continue to believe that the equity sell off was mostly a catalyst in commoditymarkets and that the more far reaching implications are more erosion in the confidence inChinese policy makers. For commodity markets, what really matters is underlying demandweakness that started before the policy generated equity rally, particularly in thecommodity-intensive fixed investment and heavy industry sectors. As such, while recentmetals price action poses significant downside risks to our metals forecasts, it is stillconsistent with our bearish macro views, as our “Deflation, Divergence and Deleveraging”macro themes continue to play out.

Our suite of indicators continues to paint a downbeat picture for Chinese commoditydemand. Our China Current Activity Indicator (a broad-based alternative measure to GDP)is tracking growth around 6%, FAI has fallen to 11.4%yoy (down from over 17% a year ago),apparent steel demand continues to decline, and our GS China copper demand indicator isalso in negative territory.


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Exhibit 5: Our economists’ alternative activity measurepoints to even greater weakness in China activity…GS China “Physical Industrial Output” index vs. official IP(%yoy)

Exhibit 6: …consistent with weak metals demand andlower pricesS&P GSCI™ Industrial Metals Spot Index vs. GS China“Physical Industrial Output” index

Source: NBS, Goldman Sachs Global Investment ResearchSee: Asia Economics Analyst: “Gauging China Growth”, June 22, 2015

Source: Bloomberg, Goldman Sachs Global Investment Research

Our Asia economics team has also recently published several new alternative measures ofactivity in China (see Asia Economics Analyst: “Gauging China Growth”, June 22, 2015 formore details). Among these is a Physical Output indicator (see Exhibit 5), which uses rawquantity measures of output (e.g. kilograms of a good produced), as well as a series of GDPgrowth implied from commodity consumption. In both cases our indicator is more volatilethan the official statistic, but most importantly, both have been significantlyunderperforming the official statistic over recent months. Among the “guts” of the data,weakness in our Physical Output indicator has also been most pronounced in commodity-intensive “heavy” industries, such as Machinery production.

Exhibit 7: Chinese steel and copper demand remains veryweak…% change yoy, 3mma

Exhibit 8: …and Chinese easing has been muted once weaccount for domestic equity market moves…% yoy growth (lhs), GS China Financial Conditions Index(>100 = tight conditions, rhs)

Source: Goldman Sachs Global Investment Research, CEIC. Source: Goldman Sachs Global Investment Research, CEIC

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Finally, regarding Chinese policy easing, the recent improvement in the GS China FinancialConditions Index (FCI) pointed to an improvement in metals demand over the comingmonths. However, the vast bulk of this easing had, up until two weeks ago, been driven byan improvement in the (domestic) equity market component of the FCI. While the FCI hashistorically been strongly correlated with metals prices, domestic equity markets have notbeen. Excluding equity markets from the FCI, year-to-date easing has been minimal.

Looking ahead, with credit still growing at double the rate of GDP, it appears that the trendslowing in metals demand may last for years, highlighting further downside risks to ourmetals price forecasts. In particular, copper is heavily exposed to the (late) Chineseconstruction cycle, dollar strength and oil price declines, as well as having a strong supplygrowth profile over the next 12 months. Yet, we continue to see supply-side differentiationamong metals prices later in 2015 and into 2016. Current nickel prices represent abuying/hedging opportunity (at c.$11,700/t). On zinc we are modestly bullish from here,though we are waiting for prices to stabilise, while we expect aluminium prices to remain low.

Exhibit 9: …given the lack of historical correlationbetween domestic equity and metals prices…China A Shares Index vs. Metals price (S&P GSCI™ IndustrialMetals) spot index

Exhibit 10: …the reduction in copper net speculativepositioning is more reflective of bearish commoditydemand, not equity movesmt (lhs), $/t (rhs)

Source: S&P, Bloomberg, Goldman Sachs Global Investment Research Source: LME, Comex, Bloomberg, Goldman Sachs Global Investment Research

Lower oil prices on weak fundamental outlook and continuation of“Deflation” and “Divergence” macro trends, not Greece

Our bearish oil view has been driven by our forecast that after a decade of productivecapacity investment and development of shale technology, the global market remains in

surplus with rising OPEC/low-cost production and resil ient US output exceeding resurgentdemand in 2015. Simply put, we do not find that the amount of pressure that the industryhas faced - either through cash flow/oil prices or through access to capital - has beensufficient to ration the forward surpluses.

While last week’s decline in oil prices coincided with the escalation of the Greek crisis andweakness in other macro markets, the catalysts for crude’s move lower have little to dowith Greece, in our view. Instead, last week’s oil data pointed to a still oversupplied market:a surge in OPEC production, a rise in the US oil rig count and weakening refining margins.While we acknowledge the volatility of each of these series, we also view these data pointsas the key short-term symptoms of our view that the oil market has yet to rebalance.

On the supply side, June preliminary data pointed to production well above our forecast:

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Iraq production reached a record high of 4.30 mb/d, with OPEC surveyed production of32.10 mb/d and Russia production growth at 150 kb/d yoy. OPEC production at suchlevels would come in above our forecast 2015 and 2016 OPEC production growth andadd 1.10 mb/d of inventory build relative to our current forecast for an already 0.60mb/d global oil market surplus in 2H15.

An agreement with Iran in the coming days could potentially lead to lift of oil sanctionsby year-end. Such a timeline would put at risk our forecast for stable but high oilinventories in 2016 since we had intentionally and conservatively assumed no increasein Iranian flows in 2016. The impact of sanctions relief on Iran’s production couldinitially be a drawdown of floating storage of c.30 mb and production increasing byseveral thousand barrels per day.

Finally, the US oil rig count rose by 12 last week for the first time since December 5,2014. This increase in the rig count suggests that at WTI prices near $60/bbl, producerscan ramp up activity given improved returns with costs down nearly 30% andproducers increasingly comfortable at the current cost/revenue/funding mix. Wetherefore view the spring rally in prices to $60/bbl as premature and self-defeating as itwill ultimately lead to higher US production.

Exhibit 11: Non-US supply has been growing rapidlyProduction in kb/d

Source: Platts, IEA, Bloomberg, Goldman Sachs Global Investment Research.

With production exceeding even our aggressive forecast, oil demand growth is becomingcritical to the oil price outlook in 2H15. But while oil demand has so far this year come ineven above our out-of-consensus bullish forecast, we view this demand strength as partlyweather driven and broadly consistent with the expected response to the large observeddecline in prices. Importantly, we expect this response to remain short-term in duration,leaving us comfortable with our current oil demand growth forecast of 1.4 mb/d in 2015.

To quantify the expected demand response to the large drop in oil prices over the pastyear, in Exhibit 12 we present the impulse response function from a VAR model 1,which estimates the positive impulse to oil demand from a 1% change in prices and 1%sequential acceleration in activity. Using OECD total products demand, WTI prices andOECD Industrial Production, these results show that stronger growth translates roughly1-for-1 into stronger demand, while a much larger (negative) price move is required to

1 As oil prices, oil demand and growth are all self-reinforcing, a VAR model attempts to control for the interrelatednature of the data.

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move demand as much. In other words, oil demand is relatively inelastic in price, butrelatively elastic to growth. The majority of these effects are also expected within thefirst six to nine months.

Exhibit 12: Our VAR analysis shows that demandresponses occur within 9 to12 months…

Estimated oil demand response (in %) to +1% shock to pricesor industrial production

Exhibit 13: …and OECD demand appears to havefollowed this trajectory over 2014H2 and early 2015

Estimated oil demand response (in %) from -45% oil priceshock & +1.3% Industrial Production shock vs. realizeddemand

Source: Goldman Sachs Global Investment Research Source: IEA, Goldman Sachs Global Investment Research

In Exhibit 13, we use these results to approximate the demand response to the lowerprices and stronger growth seen over 2014H2. This exercise suggests that that it takesnine months to translate a one-time 45% oil price shock and a 1.3% shock to IndustrialProduction into incremental demand. This is important as i t suggests that strongerdemand now requires another large fall in prices or persistently strong economicgrowth. Importantly, neither our bearish oil price forecasts nor our economists’economic growth forecasts are large enough to absorb oil production growth at itscurrent level in 2H15.

Finally, while this analysis only looks at OECD oil demand, there has been increasedmarket focus recently on a large and growing “miscellaneous to balance” oil demand.This is oil disappearance in excess of identified demand (supply minus OECD demand,non-OECD demand and changes in inventories). Our analysis shows that historicallythis miscellaneous series has been price sensitive and likely driven by tertiaryinventory builds (Exhibit 14). However, if this recent increase had been caused bydemand, refining margins would now be higher (not lower) as we near the peak inrefinery runs. Instead, Singapore complex refining margins have declined sharply overthe past weeks, with European refining margins holding up well only because of the

weakness in Brent prices (Exhibit 15).Net, we forecast the global oil market surplus will materialize in a product surplus this fall,pushing refining margins lower with higher OPEC production further overwhelming evenstronger demand growth (see European diesel needs to cool its engines , June 3, 2015). Asa result, we reiterate our fundamentally driven forecast for lower oil prices into this fall (seeReality of oil market will trump perception and positioning , May 25, 2015).

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Exhibit 14: “Miscellaneous to balance” historically pricesensitive and mean revertingIEA Miscellaneous to balance (kb/d) vs. Brent price changes(QoQ, %, rhs)

Exhibit 15: Weaker refining margins also suggest it’s notall demandRefining margins in $/bbl

Source: IEA, ICE, Goldman Sachs Global Investment Research. Source: Platts, IEA, Goldman Sachs Global Investment Research.

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Commodities in a nutshell

Energy

Crude Oil: We maintain our bearish views

Fundamentals: Crude oil prices have declined sharply over the past week on growingevidence that the market is still oversupplied. Specifically, June preliminary productiondata came in well above our forecast with a surge in OPEC production, in particular Iraq.Further, the first rise in the US oil rig count since December suggests that producers canramp up activity given improved returns at $60/bbl WTI with costs down nearly 30%. Withproduction exceeding even our aggressive forecast, oil demand growth is becomingcritical to the oil price outlook in 2H15. While oil demand has so far this year come in evenabove our out-of-consensus bullish forecast, we view some of this demand strength as (1)weather related, (2) front-loaded, and (3) concurrent with non-observable stock builds. Inparticular, our modeling suggests that most of the positive demand impulse from lower oil

prices has now passed through. Further, had the miscellaneous to balance been realdemand, refining margins would be higher, not weaker, as observed this past week sincewe are nearing the peak in runs. Net, we continue to forecast the global oil market surpluswill materialize in a product surplus this fall, pushing crude oil prices and refining marginslower with higher OPEC production further overwhelming even stronger demand growththan we forecast. As a result, while developments in Greece after this Sunday’s surprisereferendum result could exacerbate oil price volatility in the short-term, we reiterate ourfundamentally driven forecast for lower oil prices into this fall.

Price Outlook: Oil rebalancing remains in its early stages with the current cash flow andfunding mix stalling it. As a result we believe that as fundamentals reassert themselvesand we move past the seasonal peak in demand, oil prices will continue to sequentiallydecline with our October price WTI forecast at $45/bbl. We keep our Brent-WTI spreadunchanged at $6/bbl at 3 and 6 months and at $5/bbl at 12 months.

Timespread Outlook: Evidence of a growing market surplus should weigh ontimespreads going forward

Source: NYMEX, ICE, Goldman SachsGlobal Investment Research

RBOB Gasoline: Demand driving US market

Fundamentals: Stocks have been drawing with demand growing at 3% on average.However, imports have picked up with the arbitrage open from Europe. The strong RBOB– heating oil spread is also incentivising refiners to maximize their gasoline yields at theexpense of distillate, though the scope is limited given that this incentive has persisted fora while, limiting incremental switching. From mid-August to September we get into

hurricane season, which can see a lot of volatility in RBOB. Thereafter, we start the nextseason of maintenance. In particular, Irving St John will be shutting their 70 kb/d FCC – agasoline making unit - and one of its crude distillation units from mid–September. Thiswill reduce imports into New York Harbor supporting RBOB. The end of the year shouldsee builds in gasoline inventories as demand drops seasonally and supply rises fromrefineries returning from maintenance.

Price Outlook: We expect RBOB to remain supported and volatile in the coming monthsdue to strong demand and hurricane risk followed by the fall turnaround season.Counterbalancing these factors is European resupply and yield shift by the domesticrefining system albeit with limited scope. Weakness will set in after refineries return from

Source: NYMEX, Goldman Sachs GlobalInvestment Research

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UK NBP Nat. Gas: Despite currently tight fundamentals, we still expect prices to fallthrough 2015-16

Fundamentals: Despite the latest announcement of Dutch production cuts at Groningen(to 30 Bcm/y, 6 Bcm below our previous estimate) which have yet again tightened the 2015outlook for northwest European gas markets, we maintain our bearish UK NBP into 2016

on a softer fundamental outlook driven by significant oversupply in LNG markets andsubsequently higher imports into European markets.

Price Outlook: UK NBP has rallied 5% over the past month, with low storage volumesand the announcements of more cuts at Groningen driving demand for Russian imports.As Brent has traded lower than we forecast in back in March, we now expect oil-indexedRussian gas prices will remain steady through 2015 rather than falling further. Accordingly,we now forecast NBP to stay at 42 p/th through 2H15. Current tight fundamentals onlyprovide limited upside risk as (i) our forecast for 2015 is close to the oil-indexed `ceiling’price, (ii) should prices rise, the UK coal-to-gas switching demand we forecast for 3Q15would fall accordingly. Based on our oil team’s latest forecast profile, we modestly lowerour 2016 NBP forecast by 5% to 38 p/th. We continue to expect that surplus LNG cargoeswill find their way to Europe in 2016 as a large wave of supply comes to market, keeping

prices low.

Timespread Outlook: As the global LNG market becomes increasingly oversupplied overthe course of the next 18 months, a softer European gas balance will likely be consistentwith weakening timespreads.

Source: ICE, Goldman Sachs GlobalInvestment Research

Industrial Metals

Copper: China construction cycle, crude, and currency outlook = sell

Fundamentals: Visible copper inventories (LME, SHFE, Comex and bonded) havecontinued to fall slightly over the past month, in line with seasonal draws which tend tooccur each year between April and September. However, year on year growth in visibleinventories is clear cut, with stocks rising c.420kt yoy (including our assumptions of SRBpurchases) and c.200kt yoy (excluding them). Net speculative positioning on the LME andComex has fallen very sharply over the past month, though it remains above the Januarylows.

Price Outlook: We believe that current prices represent a selling opportunity forproducers and investors alike. China’s ‘new normal’ of weakening commodity demandgrowth, forecast sustained weakness in late-cycle China construction completions (owingto the property inventory build-up – N.B. China steel demand declines over the past six

months are the ‘canary in the copper market’), lower oil prices (shale), a stronger dollar,and above-trend supply growth. The recent modest easing in Chinese financial conditionsand pick up in property sales will not result in a strong enough pickup in demand to offsetthe strong acceleration in mine supply growth we expect over the coming 6-12 months.

Timespread Outlook: LME spreads remained soft over the past month. This has notbeen associated with a rise in LME stocks, and as such we believe this reflects theweakness in the physical market evidenced by low or falling physical premiums. The near-term copper spread outlook continues to be complicated by the combination of physicalweakness and expected seasonal inventory draws.

Source: LME, Goldman Sachs GlobalInvestment Research

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relative lack of exposure to dollar strength (marginal output costs are in China), and c) theclosures of the Century and Lisheen zinc mines.

Timespread Outlook: LME zinc spreads remained loose over the past month. LME zincspreads may tighten somewhat over the next 6-12 months should the market tighten.

Lead: Set to continue to trade alongside zinc

Fundamentals: Alongside zinc, lead prices have moved sharply higher in recent weeks,after reaching their lowest levels since 2010. The China lead import arbitrage is closed, andlead supply and demand fundamentals in our view remain weak.

Price Outlook: We continue to forecast lead at 2,200 in 12 months

Source: LME, Goldman Sachs Global

Investment Research

Precious Metals

COMEX Gold: Maintaining our bearish view

Fundamentals: We continue to expect continued strengthening of the dollar and gradualincrease in US real rates (as growth recovery resumes after a disappointing Q1 and wemove closer to the first FED rate hikes) to push gold prices further down.

Price Outlook: Gold prices remained in a relatively tight range in June and early July,with concerns over Grexit, a weakening of the US dollar against the euro, and rising USreal rates having little overall impact on pricing. Our gold price forecasts remain $1,180/ozin 3 months, $1,150/oz in 6 months and $1,050/oz in 12 months.

Timespread Outlook: We expect the current 1-2 month and 1-12 month timespreads toremain broadly unchanged until later in the hiking cycle. Source: COMEX, Goldman Sachs Global

Investment Research

COMEX Silver: Downside risks as interest rates normalize

Fundamentals: Over the long run, silver prices tend to track gold prices. Accordingly, our

forecasts for interest rate hikes to kick off in 2015, continues to point to lower preciousmetals prices. At the same time, the downturn in global economic activity since mid-2014has seen the silver to gold price ratio fall as silver demand weakens.

Price Outlook: We expect the silver/gold price ratio to normalize as global growth beginsto recover later this year and accelerates further over 2016/17. However, on net, we expectthe bearish factors to dominate and silver prices to fall over the next 12 months.

Source: COMEX, Goldman Sachs GlobalInvestment Research

1,500

1,700

1,900

2,100

2,300

2,500

2,700



1,000

1,050

1,100

1,150

1,200

1,250

1,300

1,350

1,400


$/toz Spot PriceCurve3m Forecast12m Forecast

14.0

15.0

16.0

17.0

18.0

19.0

20.0

21.0

22.0

23.0

24.0




15/22

July 8, 2015 Global


COMEX Platinum: Prices into the cost-curve as producers fail to respond

Fundamentals: The platinum price is trading near its six-year lows, in our view reflectinga structural fundamental surplus, rather than a temporary above-ground de-stockingprocess. We believe this price weakness reflects disappointing demand and a ramping-upof supply, not inventory liquidation, confirmed by the significant underperformance of

platinum despite strong ZAR and gold. With significant low-cost supply due online overthe next 2-4 years, and wi th gold prices expected to come under pressure, we believe thatthe platinum price will remain under the marginal cost of production, which we see atUS$1,050-1,150/oz, in order to incentivise closures.

Price Outlook: Over the next 12 months we expect platinum to average c. $1,175/oz;however if autos data disappoint or supply was to surprise to the upside there would bedownside risk to our forecast.


COMEX Palladium: Major selloff on China demand weakness

Fundamentals: Palladium prices have underperformed on disappointing auto sales numbers

from China and media reports of increased supply from both primary and secondary sources.Net speculative positioning has declined sharply over the past month, and more broadly, overthe past 6 months, in line with the deterioration in Chinese growth over that period.

The fundamentals of palladium remain attractive in our view given we expect areacceleration in automotive output in China and have a positive outlook for gasolineoutput growth in other markets. In addition, the fall in oil prices spurs larger engine sizecar sales – which have higher metal loadings. On primary supply we see little scope forsurprise. Regarding secondary supply there have been media reports that 30% of supply isexpected to come from secondary sources. On our estimates secondary supply is expectedto account for 30% of total supply yet we see the metal in a sustained deficit.

Price Outlook: Over the next 12 months we expect the palladium price to rise to $863/oz.


Agriculture

CBOT Corn: Weather adds uncertainty to acreage and yields, but bearish outlookremains unchanged

Fundamentals: A bullish USDA June corn stock report (June 1 stocks 108 mil bu belowthe consensus estimate) and 15/16 corn planted acreage below expectations saw pricesrise above $4 last week. While crop conditions remain favorable for now, there has beensome sequential deterioration over the last few week and risks to yields from overly wetweather, particularly in the Eastern Corn Belt, remain in place for now.

Price Outlook: Despite the recent stock adjustments we continue to see robust 2015/16total supply (as 14/15 carry-out still remains high globally). This keeps our forecastsanchored below $4 in the absence of a further deterioration in weather. With most of thekey growing period still ahead, and with El Niño conditions introducing greater weatheruncertainty, pricing remains sensitive to weather forecasts over the coming weeks.However, recent weather forecasts have been indicating cooler temperatures (which wouldbe supportive of yields) for most of the key US states.

Timespread Outlook: We continue to expect high global carry-out stocks and hencecontinue to see negative roll yields persisting.

Source: CBOT, Goldman Sachs GlobalInvestment Research

900

1,000

1,100

1,200

1,300

1,400

1,500

1,600



600

650

700

750

800

850

900

950

1,000



2.50

3.00

3.50

4.00

4.50

5.00

5.50


$/bu Spot PriceCurve3m Forecast12m Forecast


16/22

July 8, 2015 Global


CBOT Soybean: Planting delays in the US, but we continue to see robust 2015/16production

Fundamentals: US planting progress got off to a fast start in May, but subsequent wetweather saw progress fall below the 5Y average. Prices rallied last week above $10/bu asthe June USDA report put June 1 stocks at 625 mil bu (45 mil bu below the consensus

estimate). While planted acreage estimates were revised upwards in the same report(85.1mil acres, 0.5 mil acres above March planting intentions), this number may end upoptimistic as wet conditions may lead to high soybean prevent planting. Just as for corn,key growing conditions lie ahead but recent forecasts for US weather have been favorableas temperatures look set to cool in key growing states.

Price Outlook: Record 14/15 production from South America still points to elevatedglobal carry-in for 15/16, despite the recent US stock estimate revision. Global acreage isalso very likely to be higher than last year, helping to keep production elevated globally.Accordingly, we remain bearish for 15/16.

Timespread Outlook: Large global 14/15 carry-out stocks points to inventories remainingelevated for some time. We continue to see timespreads weaker than current marketpricing.


CBOT Wheat: El Niño continues to pose weather risks

Fundamentals: The USDA’s June stock report saw higher than expected wheat stocks(753 mil bu on June 1, 35 mil bu above the consensus estimate) and a larger planted area(56.1 mil acres, 0.2 mil above consensus). However, wheat prices followed corn andsoybeans higher. Weather remains a key concern and, while lower precipitation inAustralia has not yet posed a major risk to yields (thanks to cool temperatures), the Indianmonsoon has been in rainfall deficit.

Price Outlook: For now we maintain our forecasts at 530c/bu in 3, 6 and 12 months.Careful monitoring of global weather conditions will be required as the current El Niñoepisode progresses.

Timespread Outlook: Large 2014/15 carry-out stocks and robust production estimates for2015/16 points to large inventories for longer. However, adverse weather on the back of ElNiño could see these stocks drawn more rapidly than expected.


NYBOT Cotton: Prices unchanged as supply weakness and uncertainty is matched bydemand

Fundamentals: Planting in the US lagged the 5Y average for almost the enti re period, butunlike corn & soybean prices, cotton has not been rallying on the back of this weak

planting data – keeping planting incentives skewed towards other crops. Non-US supply isalso likely to decline as China acreage estimates are at their lowest level since 1949, andIndia (now the number one producer globally) faces significant weather risks from El Niñoand a rainfall deficit monsoon.

Price Outlook: The lack of market reaction to the current supply situation is likely due to:(1) Uncertainty over the pace of global growth and; (2) China’s cotton policy shift, whichwill substantially reduce import demand. For now we maintain our forecasts at 60c/lb over3, 6 and 12-month horizons, assuming broadly normal weather and a recovery in US andglobal growth in line with our economists’ estimates.

Timespread Outlook: Timespreads and roll yields are likely to remain relatively weakuntil more progress is made in reducing global stockpiles.

Source: NYBOT, Goldman Sachs GlobalInvestment Research

7.0

8.0

9.0

10.0

11.0

12.0

13.0

14.0

15.0

16.0



3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0



50

55

60

65

70

75

80

85

90

95

100


c/lb Spot PriceCurve3m Forecast12m Forecast


17/22

July 8, 2015 Global


NYBOT Coffee: Weather uncertainties (past and future) remain key

Fundamentals: Coffee continues to trade sideways in a 120c – 140c/lb range. The keyuncertainty remains the Brazil harvest as CONAB production estimates (44.3m bags)diverge substantially from USDA estimates (52.4m bags). In our view, this ultimatelyreflects the still uncertain impact of drought in 2014.

Price Outlook: While the next few months will show the outcome of last year’s weather,adverse weather on the back of El Niño (which is forecast to persist for the remainder of2015) remains a risk for this year and next. For now we maintain our forecasts at 150c/lbover 3, 6 and 12 months.


NYBOT Cocoa: Supply concerns remain key, but demand may now be reaching a turningpoint

Fundamentals: Cocoa prices rallied by more than 20% over Q2 as production estimatesfor Ghana have been revised substantially lower over the last few months, offsettingupward revisions to Ivory Coast, Cameroon and Ecuador. Strong Harmattan winds earlierin the year and reduced fertilizer application (GHS has depreciated by 36%ytd) were thekey drivers behind the downgrade. Current El Niño conditions also point to continueddownside risks to global production this year and next.

Price Outlook: While prices are now far above our $3,000/mt forecasts, and supply risksare likely still skewed to the downside owing to El Niño conditions, we remain cautious onprices. Weaker GDP growth saw Q1 grindings slow (particularly in Asia, -9.3%yoy). Withprices now up over 12%ytd, further demand destruction may be seen over the comingmonths.


NYBOT Sugar: Prices near seven year lows, but El Niño still poses upside risks

Fundamentals: Harvest estimates for Brazil have been pointing to robust 2015/16production, thanks to more supportive weather conditions in 2015Q1. While recent datareleased by Unica has shown greater ethanol production and lower sugar production byCentre South Brazilian sugar mills (driven by price differentials), the cumulative 17% BRLdepreciation year to date, and reintroduction of export subsidies in India is likely to keepthe sugar market well supplied for some time, provided weather conditions remainnormal.

Price outlook: El Niño continues to pose the most significant downside risks to

production. While the Indian monsoon began with relatively high intensity, forecasts arenow pointing towards an eventual deficit. For now we maintain our forecasts at 13.0 flatover a 3, 6 and 12-month horizon.


100

120

140

160

180

200

220

240

260



2,500

2,600

2,700

2,800

2,900

3,000

3,100

3,200

3,300

3,400

3,500



10

11

12

13

14

15

16

17

18

19

20




18/22

July 8, 2015 Global


Livestock

CME Live Cattle: Herd rebuilding and weak demand keep prices rangebound

Fundamentals : After peaking at just over 170c/lb in late 2014 cattle prices have remainedin a 145-155c/lb range since February. The latest USDA survey was in line with analystforecasts and continued to show feedlot placements down significantly year-on-year. Thisweakness in placements is largely reflective of a combination of herd re-building throughheifer retention and limited feeder cattle supplies. Slaughter is also significantly downyear-on-year – consistent with higher dressed weights, as cattle remain on feed for longer.

Price Outlook: Given the competition from alternative meat supplies, such as pork, wecontinue to see prices declining moderately over the next 12 months and maintain ourforecasts at 150, 145 and 140c/lb on a 3-, 6- and 12-month horizon, respectively. Source: CME, Goldman Sachs Global

Investment Research

CME Lean Hog: Herd recovery and US$ strength to keep downward pressure on prices

Fundamentals: After reaching a 85c/lb peak in May prices have moderated, counter-seasonally, to just below 80c/lb. The recent Quarterly Hogs and Pigs Report showed astrong post-PEDv recovery: inventories are up +9%yoy (to 66.9 million head) and pigs perlitter have recovered to 10.4, a record level.

Price Outlook: We maintain a moderately bearish outlook on prices for two key reasons:First, there could still be more in the post-PEDv recovery, albeit this is likely now mostlyplayed out. Second, our FX strategists foresee additional dollar strength, which wouldcontinue to weigh on exports. We roll our forecasts to 70, 70 and 75c/lb in 3, 6 and 12months, from 80, 70 and 70 c/lb . Source: CME, Goldman Sachs Global

Investment Research

Bulks

Iron Ore: Rally living on borrowed time(62% fines CFR China)

Fundamentals : On the supply side, we expect the weaker than expected exports fromBrazil and Australia during April and May to normalize in the coming months. Past supplyunderperformance appears to be caused by temporary factors such as weather disruption,and the recent increase in freight activity at major export terminals, together with rising

freight rates, should result in a recovery in Chinese inventories and continued pressure onspot prices. Meanwhile, mines that had been previously flagged for closure in Australiaand Sierra Leone are now due to restart operations. On the demand side, steel millmargins have declined to a 5-year low as prices for steel and iron ore have diverged,creating downside risks to demand.

Recent Market Activity: Spot prices declined for nine consecutive days to $49.75/t CFRChina amid broad sell-off of China equities and commodities. Fundamentally, we seeincreased freight activity at major iron ore terminals and a halt of port inventory drops lastweek.

Price Outlook: At this level, prices are below to our US$60/t estimate of all-in marginalproduction costs, but we see limited upside as low prices are required to trigger adequate

120

130

140

150

160

170

180



40

50

60

70

80

90

100

110

120

130

140




19/22

July 8, 2015 Global


amount of closures in the resumed oversupplied environment. We expect prices to declineover our forecast period down to US$44/t in next year and US$40/t in 2017.

Timespread Outlook : The forward curve should remain in backwardation given ongoing

hedging by producers and the combined impact of cost deflation and structuraloversupply. Inventory levels in China are low and declining due to weak exports, butstocks should normalize in the coming months as we expect the disruptions to betemporary.

Metallurgical Coal: Finding price support after two years of cuts(Premium HCC, FOB Queensland)

Fundamentals: After two years of mine closures, total supply cuts are equivalent to 10%of seaborne supply. Given the ramp up of new mines in Australia and Mozambique, furtherproduction cuts are likely and the lower cost miners shall continue to displace higher costones. On the demand side, we don't expect seaborne demand to grow further during ourforecast period to 2019, and China will inch closer to self-sufficiency in the medium termbut it is unlikely to become a net exporter. The imports by China in May was weaker than

many expected with only 1.88 Mt of coking coal imported, down 68% yoy.

Recent Market Activity: Prices improved 7% from their recent lows in May and wasrelatively stable in the recent sell-off of commodities, currently at $87.75/t FOBQueensland, still below the marginal cost. The 3Q benchmark price was concluded inJapan at $93/mt FOB Australia, a $16/ t qoq drop from the previous benchmark.

Price Outlook: Prices improved 9% from their recent lows, currently at $89/t FOBQueensland, but it’s still below the marginal cost. The 3Q benchmark price was concludedin Japan at $93/mt FOB Australia, a $16/t qoq drop from the previous benchmark. Webelieve prices may have bottomed. However, any price upside is likely to be limited amidmuted demand and new projects in Australia and Mozambique ramping up.

Timespread Outlook : With prices trading below marginal cost, an eventual recovery islikely but the timeframe for a sustained increase in prices is subject to a recovery in theChinese domestic market.

Thermal Coal: short term support from supply disruptions(6,000kcal/kg NAR, FOB Newcastle)

Fundamentals: Low prices have caused a steep decline in Indonesian exports but themarket remains well supplied because these production cuts are offset by weaker Chinesedemand. Although China’s role as the buyer of last resort may not continue indefinitely,Chinese domestic coal prices remain the key anchor point for seaborne coal. Indiandemand remains strong but any price upside is limited by persistent overcapacity in Chinaand a dwindling number of growth markets in other regions.

Price Outlook: We believe prices have limited upside to US$65/t, provided that theChinese coal industry consolidates and domestic prices normalise.

Timespread Outlook: In a similar vein to metallurgical coal, the eventual recovery inthermal coal prices is subject to the consolidation of the Chinese coal sector; excesscapacity must close in order for domestic prices to recover and provide some headroomfor seaborne prices.


20/22

July 8, 2015 Global


Price actions, volatilities and forecasts

Source: Goldman Sachs Global Investment Research

units 06 Jul Change Implied 2 Change Realized 2 Change 1Q 14 2Q 14 3Q 14 4Q 14 1Q 15 2Q 15 3m 6m 12m

Energy

-6.60

-6.77

-0.11

-0.16

0.17

0.31

Industrial Metals 4

-55

-347

-1475

-116

5

Precious Metals

5

-23

-26

-75

Agriculture

79

77

66

3

-10

162

0.4

-0.1

-5.11 Monthly change is difference of close on last business day and close a month ago.2 Monthly volatility change is difference of average volatility over the past month and that of the prior month (3-mo ATM implied, 1-mo realized).3

Price forecasts refer to prompt contract price forecasts in 3-, 6-, and 12-months time.4 Based on LME three month prices.

746 816

2.06 24.9 5.33 CME Lean Hog

20.5 19.6

1,429

cent/lb 76.0 25.4

-1.75 ICE Sugar -0.32

825

55 60

875

1,449 1,200

850 861

375 375

556528652 530

875990

530523 530504

375

70.0 75 .067 70.0

142 142 154 166 145.0 140.0

100 122 113

154

77

150.0156

91

965

366

65

134

3,025

12

63.50

2.00

1.90

2.74

43.32

1,788

6,047

13,082

2,191

15.2

3,000

150 150150

13.0

16.4

26.0

CME Live Cattle cent/lb 150.5 11.5 -0.82 13.8

19.7 16.5 16.7 16 .4 16.2

1,434 1,231 1,192 1,128 1,170 1,170

863 788 786 758

ICE Cocoa $/mt 3,278 20.6 0.51 16.1 1.49

0.76

13.014 13.0

2,881 3,004 3,180 2,962 3,000 3,000

16 17 16 16cent/lb 12.5 22.2

2,889

-3.09

385452 479 360 3720.89 33.5 15.49

ICE Coffee cent/lb 125 34.0

62 55 ICE Cotton cent/lb 67 19.4 0.88 20.9 1.10 62668788

190181185153 152-1.95 32.1

617

CBOT Soybean cent/bu 1,015 21.4 1.61 27.4 14.28

1.31 43.1 3.58

1,356

CBOT Corn cent/bu 427 25.5

1,471 1,149 1,008 875

COMEX Silver $/troy oz 15.8 24.3 -0.84 15.9 -9.92

CBOT Wheat cent/bu 596 28.5

COMEX Palladium $/troy oz 676 19.98 0.43

COMEX Platinum $/troy oz 1,066 17.2 -0.27 14.5 -1.85

22.3

-0.87 12.0 -0.93 COMEX Gold $/troy oz 1,173 13.8

3.32

1,150 1,0501,217 1,180

2,200 2,500

1,294 1,289 1,281 1,202

1,820 1,800 1,900 2,2001,948

1,193

2,121 2,194 2,011

$/mt 11,700 30.0

2,090 2,100 LME Zinc $/mt 2,014 20.6 -2.04 13.3 -5.46 2,025 2,079 2,315 2,242

LME Copper $/mt 5,590 20.8

14,000 15,00014,437 14,000

7,001 6,764 6,976 6,575 5,500 5,2001.11 19.0 5.23

14,702 18,519 18,670 15,926-2.25 30.8 LME Nickel

98.614.84 57.00

NYMEX Nat. Gas $/mmBtu 2.76 42.2

1.801.57 37.6 6.49

4.72

NYMEX Heating Oil $/gal 1.71 30.7

3.95 3.830.16

1.74 1.811.58

Volatilities (%) and monthly changes 2Prices and monthly

changes 1

WTI Crude Oil $/bbl

Price Forecasts 3

52.53 31.4 -0.65 40.3 50.00 49.0073.20 48.5797.25102.99

Historical Prices

57.95

2.78 3.00

4.01

30.9 -0.16 35.9 0.91 107.87 56.0055.13

1.60 1.401.95 33.1

77.07103.46109.76

-0.40

2.81 2.80

3.01

6.37

2.95 2.83

62.00

1.812.75 1.98

55.00

3.30 3.50

2.32

4.58

1.49

1,800 1,9001,814 1,800

42.00 38.0047.58 43.00

-0.86 12.7 -6.56

-0.66 19.6

5,805 5,500

2.63

54.7243.7745.0360.72

1,753 1,838 2,009 1,976

LME Lead $/mt 1,766 20.7 -2.41 18.8 -6.00 2,124

Brent Crude Oil $/bbl 56.54

RBOB Gasoline $/gal 1.92 32.4

43.5

LME Aluminum $/mt 1,695 17.4

UK NBP Nat. Gas p/th 42.86 17.6


21/22

July 8, 2015 Global


S&P GSCI® Enhanced Commodity Index and strategies’ total return and forecasts 1


Performance of S&P GSCI Enhanced Commodity Index and Strategies through July 6, 2015


Current 12-MonthWeight Forward

(%) 2013 2014 2015 YTD¹ 12-mo Forecast

S&P GSCI Enhanced Commodity Index 100.0 -0.8 -31.1 -6.6 0.6

Energy 60.8 5.6 -42.2 -6.8 3.5Industrial Metals 8.7 -13.0 -7.3 -11.5 6.0Precious Metals 3.8 -29.7 -4.1 -1.0 -10.0

Agriculture 17.9 -18.0 -9.3 -3.7 -12.0Livestock 8.8 -2.8 27.0 -8.2 6.0

¹ YTD returns through Jul 06, 2015

Index and strategies Dollar Base Date 6-Jul-15 1-Month 3-Month 12-MonthWeight = 100 Level 2013 2014 2015 YTD Change Change Change

S&P GSCI Enhanced Index 100.00 Dec-69 455.8 -0.8 -31.1 -6.6 -4.8 -2.7 -38.8Energy 60.82 Dec-82 856.7 5.6 -42.2 -6.8 -8.9 -4.2 -48.2 Petroleum 57.70 Dec-82 967.6 5.8 -43.1 -6.7 -9.5 -4.4 -48.9

Industrial Metals 8.68 Dec-76 165.8 -13.0 -7.3 -11.5 -5.8 -7.0 -20.9 Precious Metals 3.81 Dec-72 304.4 -29.7 -4.1 -1.0 0.2 -4.3 -13.4 Agricultural 17.95 Dec-69 106.2 -18.0 -9.3 -3.7 9.2 3.9 -14.0 Livestock 8.75 Dec-69 216.8 -2.8 27.0 -8.2 -1.5 0.5 -9.5CommoditiesEnergy WTI 19.82 Dec-86 924.4 6.3 -42.3 -10.6 -11.2 -5.8 -52.8 Brent 19.98 Jan-99 1128.8 8.1 -44.3 -10.2 -10.8 -6.9 -51.3 Unlead/RBOB Gas 6.03 Dec-87 1667.9 3.8 -44.2 13.8 -3.8 6.9 -38.9 Heating Oil 5.16 Dec-82 690.3 0.7 -36.6 -7.0 -8.4 -5.6 -40.8 Gasoil 6.70 Jan-99 768.7 3.5 -46.1 2.5 -5.6 -0.6 -42.8 Natural Gas 3.12 Dec-93 91.1 2.0 -23.3 -9.4 3.1 0.0 -32.8Industrial Metals Aluminum 2.80 Dec-90 50.3 -21.1 -2.6 -11.0 -4.1 -7.1 -16.5 Copper 3.80 Dec-76 479.6 -7.9 -12.6 -11.1 -5.9 -6.8 -20.9 Lead 0.59 Jan-95 393.4 -7.8 -18.6 -5.8 -7.4 -6.7 -20.8 Nickel 0.61 Dec-92 214.8 -20.1 7.4 -23.4 -11.3 -10.5 -42.1 Zinc 0.88 Dec-90 115.2 -7.4 3.8 -8.3 -5.6 -5.8 -11.8Precious Metals Gold 3.39 Dec-77 302.7 -28.6 -1.7 -1.2 0.4 -3.8 -11.5 Silver 0.41 Dec-72 309.1 -36.6 -20.4 0.2 -1.7 -8.4 -26.5Agriculture CBOT Wheat 4.32 Dec-69 59.6 -26.5 -12.5 -1.5 14.2 11.0 -6.9 KBOT Wheat 0.98 Jan-99 56.8 -26.9 -4.7 -8.2 8.5 0.9 -18.5 Corn 5.11 Dec-69 111.3 -29.0 -7.8 -1.4 12.6 3.5 -7.8 Soybeans 3.26 Dec-69 468.9 10.2 -3.2 0.5 11.0 5.8 -10.7 Cotton 1.34 Dec-76 30.6 5.7 -21.0 10.4 3.7 2.6 -6.2 Sugar 1.58 Dec-72 117.8 -20.5 -29.0 -17.7 0.5 -3.5 -41.0 Coffee 0.83 Dec-80 29.1 -30.8 38.3 -28.9 -8.9 -17.5 -34.0 Cocoa 0.51 Dec-83 122.0 18.8 7.0 12.6 5.3 17.3 6.2Livestock Live Cattle 5.09 Dec-69 227.3 -6.1 26.6 -1.4 0.7 2.1 2.4 Feeder Cattle 1.31 Jan-02 180.9 -3.8 33.0 -0.2 -2.2 -0.5 3.8 Lean Hogs 2.35 Dec-75 179.9 3.0 21.9 -25.2 -5.6 -2.5 -35.0

All data as of July 06, 2015 close

Total Returns (%)


22/22

July 8, 2015 Global

Disclosure AppendixReg ACWe, Jeffrey Currie, Michael Hinds, Damien Courvalin, Max Layton, Christian Lelong, Abhisek Banerjee, Yubin Fu, Amber Cai, Caroline Lu and RaquelOhana, hereby certify that all of the views expressed in this report accurately reflect our personal views, which have not been influenced byconsiderations of the firm's business or client relationships.

Unless otherwise stated, the individuals listed on the cover page of this report are analysts in Goldman Sachs' Global Investment Research division.

Disclosures

Global product; distributing entitiesThe Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs on a globalbasis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research onmacroeconomics, currencies, commodities and portfolio strategy. This research is disseminated in Australia by Goldman Sachs Australia Pty Ltd(ABN 21 006 797 897); in Brazil by Goldman Sachs do Brasil Corretora de Títulos e Valores Mobiliários S.A.; in Canada by either Goldman SachsCanada Inc. or Goldman, Sachs & Co.; in Hong Kong by Goldman Sachs (Asia) L.L.C.; in India by Goldman Sachs (India) Securities Private Ltd.; inJapan by Goldman Sachs Japan Co., Ltd.; in the Republic of Korea by Goldman Sachs (Asia) L.L.C., Seoul Branch; in New Zealand by Goldman SachsNew Zealand Limited; in Russia by OOO Goldman Sachs; in Singapore by Goldman Sachs (Singapore) Pte. (Company Number: 198602165W); and inthe United States of America by Goldman, Sachs & Co. Goldman Sachs International has approved this research in connection with its distribution inthe United Kingdom and European Union.European Union: Goldman Sachs International authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authorityand the Prudential Regulation Authority, has approved this research in connection with its distribution in the European Union and United Kingdom;

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3 d's of macro push deflation, divergence and deleveraging reinforce oversupply

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