Goldman Calls Commodities Top: Is Now the Time to Sell?

NEW YORK ( TheStreet) -- The freefall in crude oil prices and energy stocks in the past two days is either the beginning of a major market correction that harkens back to 2008 or simply a convenient profit-taking moment for Goldman Sachs, its clients, and any investors who choose to join the Goldman bandwagon.

A Goldman Sachs "sell" call on commodities released late on Monday was the marquee headline in sending energy stocks and commodities into a tailspin, given the investment bank's history as a commodities trading bull.

The Goldman Sachs report released late on Monday announced that it was closing out its commodities basket trade.

"We are recommending closing the commodities position for a 25% return versus a 28% target," Goldman analysts wrote on Monday.

About oil specifically, Goldman's commodities call states, "Near-term crude oil price risk is becoming more symmetric. Although potential contagion risk in the Middle East and North Africa (MENA) remains elevated and has pushed prices above $125/bbl, at these price levels the risks are becoming more symmetric, which shifts the risk/reward of being long oil. Not only are there now nascent signs of oil demand destruction in the United States ... but also record speculative length in the oil market, elections in Nigeria and a potential cease-fire in Libya that has begun to offset some of the upside risk owing to contagion, leaving price risk more neutral at current levels."

Market cynics argue that Goldman is simply booking profits in commodities now to provide itself and its clients with one more profitable entry point and that the long-term trend is still up and to the right. Notably, Goldman said in making its commodities call, "Although we believe that on a 12-month horizon the CCCP basket still has upside potential, in the near term risk-reward no longer favors being long the basket."

In the least, Goldman alluded to the speculation that drives oil trading in its recent outlook, with Goldman Sachs chief energy analyst David Greely writing to clients this week that oil prices weren't justified by supply/demand fundamentals.

"While prices are back at levels of spring 2008, supply-demand fundamentals are significantly less tight," the Goldman analyst wrote to clients. "We believe that the market will experience a substantial correction toward our $105 a barrel near-term target for Brent crude oil in coming months," the analyst predicts. Goldman is far from the first market source to state the opinion that oil prices are above fundamentals, with energy analysts and even OPEC ministers saying that current supply issues don't justify the extent of the oil prices rally.

The Goldman Sachs call, though, can also be viewed as one more headline "piling on" an already vulnerable rally in commodities, energy stocks and crude oil. Other major headlines pressuring the markets include:
  • A new report from the International Energy Agency on Tuesday citing high oil prices as a potential roadblock to further global growth.
  • An IMF report on Monday that lowered its growth project for the U.S. and Japan.
  • The interest rate hikes announced last week by China and the European Central Bank.
  • A Mastercard consumer report released on Monday that showed the 5th consecutive week of spending decline in the U.S. and cited consumers finally easing up on the gas pedal given high prices at the pump.
  • The Tuesday report from the International Energy Agency also noted that Saudi Arabia cut output after Japanese demand fell in the wake of the earthquake and tsunami and that should cut second quarter oil demand, easing the spike in oil prices, according to the IEA, though the agency did not change its 2011 demand forecast at 89.4 million barrels a day, up 1.6% from 2010.

    From a technical trading perspective, the sudden reversal in crude oil trading was not a complete surprise, as it brought back memories of September 2008. The last time that oil reached near the $111 mark, and failed to hold that level, occurred in late September 2008 shortly before the financial crisis. During the week of Sept, 26, 2008, U.S. crude oil hit $110.31, preceding the largest peak-to-valley trough in the oil market ensued.

    In addition, the oil service sector index, the OSX, began selling off last week - after having risen close to 100% since September 2010 - and back in the days of Fall 2008 leading up to the market meltdown, it was a decline in OSX stocks that presaged a larger decline in energy stocks and oil prices.

    So has the market seen the "last gasp" of the bull market rally, or are commodities and oil prices simply catching their breath before moving higher again? Is a little air being let out of the balloon, or is the balloon about the deflate? The heavy selling in energy stocks, commodities and crude oil after the heady start to 2011 ultimately raises the fear-mongering question, is a crash like 2008 on the horizon?

    The U.S. Commodity Futures Trading Commission said that as of last Tuesday, hedge funds and other financial traders held a total net-long positions in U.S. crude contracts equivalent to a near record 267.5 million barrels, suggesting in the least that there is plenty of air to let out and plenty of profits to take.

    The PFG Best market strategist Phil Flynn had told TheStreet last week that a key issue for the oil trade and the markets was how gradually prices moved up. In 2008, oil prices moved up so quickly that a true market shock occurred in terms of the ability of airlines and transportation companies more generally, to respond, whereas the recent run up in oil has been more gradual.

    Taking a similar position on Tuesday, some market experts were arguing that a pullback in oil prices might be a healthy event before another move up by the markets.

    "You get the same resistance on the way up as on the way down," Flynn explained to TheStreet last week.

    Energy stocks were leading the selloff on Tuesday, though the big morning losses eased a little in the afternoon, with the sector down 3% (versus a 1% decline in the Dow and a 0.5% decline in the S&P 500) and with big losses across all of the energy niches, from the super majors to the oil service stocks and independent exploration and production companies.

    ConocoPhillips ( COP) was down 3% on Tuesday, leading losses among the super majors, though trading in ConocoPhillips shares was only slightly elevated. Chevron ( CVX), a day after becoming the first super major to release a glimpse of its first quarter earnings, saying oil prices would buoy results even as production fell quarter over quarter and year over year, was down by 3% on Tuesday.

    All the major U.S. independent energy companies were selling off, led by Chesapeake Energy's ( CHK), Range Resources ( RRC), EOG Resources ( EOG) and Anadarko Petroleum ( APC), with all the independent producers declining by 3.5%.

    The oil service stocks continued a retreat that began towards the end of last week and presaged the bigger reversal in the energy trade, while also harkening back to the cliff these stocks went over in early September 2008. Halliburton ( HAL) was down by 3.5%; while Baker Hughes ( BHI) and Schlumberger ( SLB) declined by 2.5%. Over the past five trading sessions the oil service stocks have declined between 8% and 10%.

    The sudden reversal in the commodities and oil prices outlook raises the question, Should investors be getting out while the getting is good, before getting back in? Take our poll below, and see what TheStreet thinks....

    In light of the Goldman Sachs "sell" call on commodities, should investors be getting out while the getting is good, before getting back in?

    I'm holding on for longer-term gains.
    I'm selling, but to book some profits before buying again.
    I see 2008 conditions on the horizon.

    -- Written by Eric Rosenbaum from New York.

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