Colin Barr

Following the money in banking, economics, and Washington

Goldman plays taps for crude rally

April 12, 2011: 10:27 AM ET

Spiking U.S. gas prices spell doom for this year's crude oil rally, Goldman Sachs said.

The brokerage firm said oil prices could drop as much as $20 a barrel this spring, in a replay of the flight from risk that swept markets last May as Greek finances imploded. It recommended that clients sell crude and some other commodities and wait for lower prices to buy in again.

Time for a breather?

The call comes at a time when Wall Street is betting oil prices will continue their surge. If Goldman is right, it could bring a bit of relief to policymakers who are struggling to convince people high gasoline prices don't mean a return to 70s-style stagflation.

Crude is trading at $108 a barrel in New York and $123 in London, amid worries that the Middle East will once again erupt in political strife, threatening the global supply of crude oil. The 17% rally this year has brought memories of 2008, when oil briefly soared $147 before plunging as the economy slowed and the financial system collapsed.

But Goldman analysts David Greely and Jeffrey Currie say the market's focus on supply is misguided and that what people should be looking at is demand, which is already declining thanks to high U.S. gasoline prices. Accordingly, they say the risk of a further oil price spike "is increasingly balanced" by the risk of a sharp correction.

"While the market remains focused on the upside price risk from the potential for more supply losses, we are becoming increasingly concerned at the potential downside risk from a sharp deterioration in demand at current price levels," Greely and Currie wrote in a note to clients Tuesday.

The thin cushion between supply and demand in global petroleum markets this week prompted the International Monetary Fund to raise its oil price forecast by 20%. But Goldman predicted high pump prices will push cash-strapped U.S. drivers off the road and force speculators to unwind massive bets on a further oil price rise.

U.S. gasoline price hit $3.79 a gallon Monday, despite a monthlong decline in car mileage, and Goldman says it is this factor that is likely to drive commodity prices this spring.

When the market gets wind of the demand shortfall, the unwind could be ugly: Net speculative positions in oil are four times their level in the summer of 2008, Goldman said. The crude price has dropped $6 in New York since it hit a midday peak Monday.

The call suggests Goldman hasn't forgotten the loss of face it suffered in 2008, when it continued calling for oil to hit $200 a barrel even after crude price went into free fall as the financial system unwound. The firm "suffered some credibility loss" then, says Olivier Jakob of Petromatrix, and "it seems they are not ready to repeat that."

Goldman also closed out bullish calls on cotton and copper, which have risen 84% and 16% since last October, reasoning that the risk-reward profile of those trades has deteriorated. It also closed out a buy call on platinum, up 6% over that span, while maintaining a buy recommendation on soybeans, up 15%.

"Copper and platinum will face near-term headwinds as higher oil prices potentially translate into a negative demand shock for the metals and as these commodities are exposed to supply chain problems resulting from the earthquakes in Japan," Currie wrote in a note to clients Monday.

But Goldman hasn't grown bearish on commodities. It says that the long-run story of rising global demand and stretched supplies "remains intact, and we would look for new entry points to establish new longs."

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for Fortune.com since November 2007. Previously he was a writer and editor for TheStreet.com, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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