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Warning: Don’t Trust Goldman (Especially on Oil)

by | published May 18th, 2016

An open public market requires an even playing field. Some participants may have bigger computers, or a millisecond head start on data.

But at least all investors theoretically have access to the same information and analysis.

The idea is that each participant is able to balance risk and reward to suit their own tastes, using the same data.

Unless, that is, some players are allowed to put a thumb on one side of the scales for their own advantage…

On Monday of this week Goldman Sachs issued an interesting reversal of the firm’s normal bearish stance on prices. The investment bank released what most are calling a mildly bullish report on the price of crude.

Now, I normally ignore what Goldman is saying, and so should you. The reasons are simple: (1) their estimates are hardly objective; and (2) they usually miss the boat.

In this case, that’s more true than ever…

Reason #1

Goldman Sachs Makes Money from Their Own Predictions

Goldman Sachs is the “investment sage” you might recall that boldly proclaimed $20 a barrel oil was coming. That never happened, of course, but Goldman won the race to deception anyway.

That’s because the investment bank has been one of the largest runners of oil shorts.

That’s where point (1) from above comes in: if Goldman can get even a segment of investors to believe what its saying and bail on oil, the investment bank promptly makes a profit. This is not detached analysis – it’s self-serving spin.

This has been a pet peeve of mine for some time.

Talking heads on TV are usually obliged to disclose any personal conflicts. Often appearing on the screen below the bellowing pundit is a box. That box states whether the pundit owns any of the stocks or commodities being discussed, any relationship in which the analyst (or his/her firm) makes a market for or advises the company, and the like.

These are also intended to extend to the pundit’s or analyst’s family members, although that has always been a matter difficult to pin down for anything beyond straight stock ownership.

There is usually even an “other conflict” category. Yet even if this one was ticked, it remains difficult to determine what that would really mean.

“Long” positions (the buying of a stock or commodity with the hope that its value will increase) are included (via declaration of share ownership).

Unfortunately, unless the moderator or reporter asks about “short” positions specifically (something that almost never happens), they go undetected – despite such devices comprising one of the primary challenges to objectivity in analysis.

A short occurs when a trader believes a share (or commodity) will decline in value. Shares (or derivatives on contracts) are borrowed from a broker and then immediately sold in the market. Later, the short runner buys what was shorted at market and returns it to the lender.

If the initial assumption – that the security’s value would fall – was correct, a profit is made. For example, a stock trading for $10 is borrowed, immediately sold (gaining $10), later repurchased for say $7 and returned to the broker. The result is a $3 profit.

The flip side is that being wrong on a short can cost money. Short runners are exposed to loss if the underlying stock or commodity increases in value. Remember, at some point a short runner must go back into the market to buy back the security, so they can return it. If at that point the security costs more than when originally sold (at the beginning of the short), a loss is incurred.

In fact, this loss is theoretically unlimited, as there is in principle no upper bound to the value of a security.

Which is why short runners often use options to temper the upside risk.

But all of these moves are shielded from the audience when the short artist appears on TV. Instead, the pundit (or as I like to call them, Chicken Little from “The Sky is Falling” brokerage) merely exhibits consternation about the stock or commodity, sounds alarmed about it on the air – and promptly whistles all the way to the bank as scared viewers sell and drive the price down.

This is Goldman personified.

But that’s not all…

Reason #2

Goldman Sachs is Only Right on Oil When They’re (Really) Late to the Party

Reason number two for not trusting Goldman Sachs is easier still: the investment bank has consistently misread the underlying dynamics in oil, or ignored them altogether.

When crude prices were taking a nose dive, it was easy enough for Goldman to keep the fall going longer by repeating what the market had already accepted: there’s a massive global buildups in excess volume; no cuts coming from OPEC or Russia; the culprit is the new guys on the block (U.S. shale and tight oil producers).

Goldman Sachs: A History of Bad Predictions
September 2015
With WTI trading at $45, Goldman Sachs calls for a drop to $20.
WTI has never traded lower than the high $20s since.
May 2008
With WTI trading at $116, Goldman Sachs called for $200 oil.
WTI ended up reaching just above $145, and has stayed lower than that since.

Put simply, their “analysis” has just not been very good. And on the few occasions that it has been, it’s largely because they hopped on the bandwagon late in the process and repeated what everyone else was saying.

And that brings us back to Goldman’s report on Monday. It talks about a global balance forming between production and demand. This balance may absorb new production, but it does little to offset the surplus overhang already present.

Of course, we have had such surpluses consistently, even when prices were in excess of $100 a barrel. The difference these days, as I have observed several times before here in Oil & Energy Investor, is the readily available excess recoverable reserves globally that can be easily brought forward.

As Goldman observed, as we reach $50 a barrel, additional production will start coming online.

With that observation, I agree. That is why my high-side in estimating the price of crude by the end of June remains $50 in New York.

But remember, it is not the rising pricing ceiling but the rising floor that stabilizes oil prices.

And be wary. Goldman is giving with one hand here and setting the stage for something else with the other.

The bank makes a point of noting that rising oil prices are largely the result of exogenous factors such as the Libyan civil war, unrest in Nigeria’s Niger Delta, and wildfires in Western Canada.

When these recede, Goldman implies that the price decline will kick back in. A stabilization of the pricing environment would require this. Overheated prices are neither sustainable nor healthy.

So don’t be surprised if the Goldman Chicken Little appears again as soon as oil stops moving up.

They do not seem to be able to make money any other way. Case in point: in the first quarter of 2016, the investment bank’s revenue was down 40% from the same period in 2015.

In short, be wary of any “advice” coming from Goldman Sachs.

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  1. Peter
    May 18th, 2016 at 20:39 | #1

    What an excellent article Kent. Right on the nail. Same applies to gold.

  2. Robert fox
    May 19th, 2016 at 07:32 | #2

    Agree100%. Lucky to be right 1/2 the time with their “coin-flip” strategy. Big rep though.

  3. May 19th, 2016 at 14:27 | #3

    I’ll immediately clutch your rss as I can not find your e-mail subscription hyperlink or e-newsletter service.

    Do you have any? Kindly permit me realize in order that I may just subscribe.

    Thanks.

  4. Jerry
    May 24th, 2016 at 19:27 | #4

    Great article
    There is so much spin out there
    Glad to see you take it on
    Keep up the good work!

  5. June 21st, 2016 at 21:55 | #5

    Goldman may have a “legal” problem some day with their actions. Upon viewing Janet Yellen’s interview by the Senate Banking Cmte today (21JUN)some senators, and notably Wyden (D-OR) questioned Ms Yellen about when the FED was going to do something besides talk about the fact that some of the members of the FED were being allowed to hold large natural resource companies, particularly in Aluminum. Other questions arose about steel production from the Pennsylvania Senator. Sen. Tester (D-MT) rose serious questions about the banking rules requiring small banks in his state to spend millions of $ to comply with the regulations and having insufficient funds to lend to Montanans, thereby forcing them to go to the big banks to borrow. (See how well it works when you can operate in commerce and regulate yourself, and maybe regulate your competition out of business?)

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