Image source: Caterpillar.

Investors in Caterpillar (CAT 0.83%) have suffered from the heavy equipment company's slump for a long time now, so Wall Street analyst giant Goldman Sachs(GS 3.30%) downgrade of the stock on Monday only added insult to the extensive injury long-term shareholders have already felt. Yet even though Caterpillar has already seen its earnings fall, Goldman thinks the equipment maker could have a lot further to fall, and it could take a lot longer to recover than most investors currently hope.

Should Caterpillar shareholders be afraid of Goldman's latest predictions? Let's take a closer look.

What Goldman sees ahead for Caterpillar
Goldman Sachs downgraded Caterpillar to sell, which in itself is fairly remarkable. Outright sell recommendations are rare among analysts, among whom even the previous neutral rating on the stock communicated a lack of interest in the company. Moreover, reductions in price targets to below where the stock currently trades are also fairly uncommon, with the setting of a $51 per share target for Caterpillar representing about 15% downside from where the stock closed Friday.

Analysts cited several reasons for Caterpillar's potential decline, and all of them are familiar. Weakness in emerging-market economies like China could reduce demand for commodities like oil and metals, and that, in turn, would put further pressure on mining companies and energy producers to reduce capital expenditures on the equipment that Caterpillar has traditionally provided to them.

What's new in the analysis, though, is that Goldman Sachs sees a less robust rebound than many investors. The company believes the next upturn in the business cycle for construction and infrastructure will likely be muted due to what it called "extended rationalization in global infrastructure [capital expenditures]" and already-heightened levels of capacity in the markets.

Given how much many of Caterpillar's customers spent during the previous boom times, when oil traded above $100 per barrel and many metals were at multi-year highs, Goldman's concern is that companies still have plenty of equipment on projects they've delayed and therefore won't need to turn to the equipment-maker for replacements.

Where will commodity markets end up?
In the end, Goldman Sachs' thesis relies on its call on the commodity markets. In general, Goldman sees the huge drops in commodity prices as being only the initial part of a longer downward trend for the market. That view stands in stark contrast to other commodity-following investors, many of whom believe commodities are already artificially cheap and that long-term equilibrium prices will push those markets higher.

Interestingly, Goldman's view is consistent with its own business practice. In recent years, Goldman has dramatically reduced its own internal exposure to the commodities markets, responding to regulatory pressure and allegations of questionable practices in the markets in which the company participated. Over the past six years, revenue from Goldman's commodity unit has fallen by more than half. In addition, the company has shifted its strategic gears, moving more toward providing financing and away from trading physical commodities in advance of expected Federal Reserve guidelines limiting the ability of banks to participate directly in the commodity markets.

Can Caterpillar bounce back?
The primary argument favoring Goldman's position is just how extensive the decline in commodities prices has been. Ordinarily, a modest-sized rebound would be enough to get commodity producers into a more bullish mood. Yet especially in the oil market, projects that were profitable at $100 per barrel won't necessarily make money even if crude prices double from $30 to $60 per barrel. Even those projects that do make money won't necessarily make enough to justify the massive capital expenditures that Caterpillar benefited from in its heyday.

To prove Goldman Sachs wrong, Caterpillar will need to see more optimism from its customer base in its willingness to keep production levels relatively high, even in the face of lower prices for its products. The biggest thing Caterpillar has going for it right now is that there's so much pessimism surrounding the stock that even a modest surprise could be enough to send share prices moving higher. If Caterpillar's customers let it down, Goldman could well turn out to be right in its skeptical view on the equipment-maker's future.