Commodity Opportunities Into 2007 January 2007

Transcription

1 Commodity Opportunities Into 27 January 27 Michael Lewis, Global Head of Commodities Research (44) All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research is available to customers of DBSI in the United States at no cost. Customers can access this IR at or call to request that a copy of the IR be sent to them. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED AT THE END OF THIS PRESENTATION

2 Commodity Scorecard Commodity Spot Returns In 26 Commodity Index Returns In 26 US natural gas Gasoline Heating oil WTI Brent Coal (API#2) Platinum Aluminium Gold Palladium Copper Silver Wheat Lead Corn Zinc Nickel Energy was the worst performing sector during 26 after being the best in 25. Spt returns (%) End 25 - End Commodity index returns Total returns in 26 (%) -15.1% -1.% -2.9% -.5% 2.1% 3.1% 8.1% 17.% GSCI LBCI RJ/CRB MLCI DJA IG RICI DBCLI DBLCI- OY 46.1% DBLCI- MR Source: Bloomberg Many commodity prices have hit record highs during 26. However, there was a significant divergence in the performance of commodity index returns in 26. The winners have been those commodity indices that have either a high allocation to the grains sector such as the Deutsche Bank Liquid Commodity Index-Mean Reversion or indices which use technology to combat the dynamic nature of commodity forward curves such as the DBLCI-Optimum Yield. We expect the DBLCI-Mean Reversion will continue to perform strongly into 27, after a 46.1% ytd rise in 26. 2

3 Commodity Overview Sector View Comment Energy Bearish Oil Bullish Energy Contango and the negative roll return remain a significant hindrance to extract positive returns from a commodity index exposure in the energy sector. Geopolitics offer the best hope for another sharp move higher in the spot price. We expect OPEC quota reductions will work to defend the oil price so long as world growth remains strong, that is above 3% yoy. Base Metals: Base Metals Copper, nickel and zinc were the star performers in the base metals complex last year. Slower world growth and a new Fed easing cycle are a clear risk for the complex. However, like crude oil, the metals complex still has considerable supply bottleneck problems to overcome. Ths suggests forward curves across the complex are set to flatten over the medium term. We recommend bear flattening trades. Precious Metals Precious Metals We expect the gold price rally has a further 24 months to run. This is based on a resumption in US dollar weakness. However, given the improvement in the US s modified basic balance over the past few months, this threatens to deliver pockets of US dollar strength. However, we expect this will prove to be short-lived as the market begins to contemplate weaker US growth, new monetary easing from the Fed and falling real interest rates into 28. Grains Bearish Agriculture Bullish Grains Grain prices remain significantly below their highs in real terms. We expect global droughts, China and India s move to become net importers of corn and wheat respectively as well as a further decline in global inventories will provide further price upside for these markets. An additional 2% rise in prices would only bring this rally in line with historical norms 3

4 New World Order For Oil & Gas Prices We expect oil and natural gas prices to settle lower over the next few years, but not back to the old USD21/bbl and USD3.5/mmBtu means Distribution of Oil Prices Then and Now Number of days Average WTI oil price =USD19.7/barrel Average WTI oil price 2-26=USD39.7/barrel Futures Prices for Oil and Natural Gas US natural gas (USD/mmBtu, lhs) WTI crude oil (USD/bbl, rhs) Scales set to 8:1 ratio Prices at 5-Jan WTI crude oil price (USD) 5 Mar-7 Mar-8 Mar-9 Mar-1 Mar-11 Mar-12 4 Source: NOAA, DB Global Markets Research The WTI crude oil prices averaged just under USD2/barrel in the 199s. So far in this decade, the oil price has averaged nearly USD4/barrel. We expect oil prices will average around USD5/barrel during the current decade, or more than double the average of the 199s. Natural gas prices have been climbing with increased demand, limited domestic supply, tight global LNG markets and rising infrastructure costs; we see price averaging USD7./mmBtu over the next five years. Gas is selling at a discount to crude oil in the long-dated futures. 4

5 Energy: Demand & OPEC Action We expect crude oil prices to trade between USD55-65/bbl during the majority of 27. Global Oil Demand Under Attack Forecast global oil demand (mbd) IEA Global Oil Demand Estimates (24-27) Jul Sep Nov Jan Mar May Jul Sep Nov Month IEA projection was made WTI oil price=1 in the day before quota reduction OPEC Quota Reductions & The Oil Price 15 Mar-93 Apr-98 Jul-98 Apr Feb-1 Apr-1 Sep-1 Jan-2 13 Nov-3 Apr Number of trading days before and after OPEC quota reduction Source: IEA, DB Global Markets Research We believe the days of positive oil demand shocks are over. In our view, the main risk to higher oil prices stems from geopolitics and extreme weather events. For the time being, we expect OPEC will continue to cut production and eventually quota levels to defend the oil price. Since 1993, OPEC have announced ten quota reductions. We find that that the cartel has a 7% success rate of supporting or pushing oil prices higher in the two to three months after such action. Only where global growth is slowing rapidly, for example in 1998 and 21, has the cartel been unsuccessful in defending oil prices. We remain upbeat towards global growth and consequently see oil prices recovering back above USD6/barrel during 27. 5

6 Energy: WTI Term Structure We expect the WTI term structure to remain in contango for most of this year. The WTI Time Spread & Saudi Oil Production Backwardation 1 95 PADD2 Inventories & The WTI Time Spread The change in the crude oil curve since OPEC production cuts st-24th WTI time spread (USD/bbl, lhs) Saudi oil production (kb/d, rhs) Contango Source: IEA, EIA, DB Global Markets Research Historically, Saudi Arabia has taken action to avert contango in the crude oil market has it has tended to signal an oversupplied market and hence a weak physical market. To combat this the Kingdom has tended to cut its own production in order to withdraw oil from the market and to re-establish backwardation. However, since 25 Saudi Arabia appears to have seen contango as a necessary evil to encourage inventory building to limit the upward march of the oil price which if left unchecked could have serious long-term implications for the demand for crude oil. We believe that significant OPEC production cuts hold the best chance of eliminating contango from the crude oil market on a sustained basis. However, this would in our view require a more significant decline in the oil price possibly linked to a downturn in global growth below 3%. We are currently forecasting world growth of 4.1% this year. 6

7 Energy: Non-OPEC Supply A new price risk to the downside in 27 is the expected strong growth in non- OPEC oil production. Non-OPEC Supply Is Expected To Return 1.6 Non-OPEC supply growth (mmb/d) Forecast non-opec supply (mbd) But Will Production Disappoint? IEA Non-OPEC Supply Estimates (24-27) 24 Note that for the past few years non-opec sullpy has always been lower compared to initial market expectations Jul Sep Nov Jan Mar May Jul Sep Nov Month IEA forecast was made Source: IEA, DB Global Markets Research For the first time since 22, non-opec crude oil supply is set to grow more than global crude oil demand. This reflects significant capital investments in the late 199s finally coming to fruition. This is in spite of the postponement of BP s mega project Thunder Horse. However, it is worth noting that for the past few years forecasts for non-opec supply have always disappointed market expectations. The IEA s has already revised its estimate for non-opec supply in 27 by approximately 4kb/d over the past three months. More recently Norwegian production is expected to fall to 2.6mb/d this year, against the Oil Ministry s original expectations of 3.mb/d. 7

8 Energy: Tail Events The options market has become relaxed about the risk of an energy price spike. 6% 5% The Options Market & Oil Price Spikes Jun -7 De c- 7 De c % 43.9% The probability of a selection of W TI contracts expiring above/below different oil price levels The Options Market & Gas Price Spikes 6% Jun % 54.2% Dec-7 5% Dec-8 4% 35.53% 4% 3% 3% 22.85% 23.5% 2% 2% 19.1% 16.1% 1% % 1.7% 8.1% 4.6% 2.%.13% 1.93% <USD3 >USD65 >USD9 1% % 1.2% 8.3%.78% <USD5 <USD8 >USD15 Source: DB Global Markets Research Lower oil demand growth, rising non-opec supply and an easing in geopolitical risk recently have led the WTI crude oil and US natural gas options markets to downgrade the probability of an oil and natural gas price spike over the coming year. Currently, the options market attaches a less than one-in-twelve chance of the Dec-7 WTI contract expiring above USD9/barrel. Throughout most of last year, crude oil vol has trended lower. We believe vol is now trading cheap and the options market has become too complacent towards geopolitical risk and the potential of world growth to snap back. 8

9 Oil: Geopolitical Risk Geopolitical problems remain a constant and significant risk in oil and natural gas. Non-OPEC Oil Supply Risk 25 26E 27E 28E 29E 21E Angola Kazakstan United States Azerbaijan Russia Canada Brazil Sudan United Kingdom India Chad Norway Mauritania China Iran Production and Exports Sinking million b/d Q1995 1Q1997 1Q1999 1Q21 1Q23 1Q25 Production Exports Source: IEA, DB Global Markets Research Non-OPEC growth is increasingly coming from countries with a higher level of geopolitical risks such as Angola, Kazakhstan, Azerbaijan, Russia, Sudan, and Chad. Although 27 could be an exception, the days of growth in the North Sea and US are essentially over. Canada is growing, but, the scale of infrastructure required for tar sands is substantial. Brazil s growth will be partly absorbed by domestic use, and the same situation is true in India if they have more exploration success. OPEC supply risks are large too. Beyond the geopolitical problems in countries like Iran, Nigeria, Venezuela and Iraq, there are serious underlying problems associated with oil investment and production in a number of the key OPEC nations. Saudi Arabia remains the exception to this in view of that country s massive investment program underway for both upstream and downstream capacity. 9

10 Energy: Product Prices Buzzard & The WTI-Brent Spread Canadian Oil Exports To The US 8 WTI-Brent spread USD/barrel 2 Thousand b/d Source: EIA, DB Global Markets Research Historically the WTI Brent spread has traded at around USD1./bbl. This year Brent has traded at a premium to WTI. This has reflected shut-ins of Nigerian production and as well as the opening of the Spearhead Pipeline from Alberta to Oklahoma which has brought additional crude to the US market. In July 22, the Forties and Oseberg crude oil blends were rolled together to form the Benchmark Brent crude oil contract. Forties blend production currently stands at approximately 5,barrles/day. The next phase of this blending process is to occur when the UK Buzzard oil field comes on stream. At full production in 27-8 this filed should produce 19,b/d. This has therefore important implications for the Brent price relative to WTI and Dubai, the other two benchmark crude oil contracts since Buzzard is significantly heavier and of a higher sulphur content relative to Forties and Oseberg. We are therefore positioning for the WTI-Brent spread to widen and the Brent-Dubai spread to narrow. 1

11 US Natural Gas: Storage & Weather Risks We expect US natural US Natural Gas Storage Levels Average Net Demand Elasticities (%) gas prices to move higher into 27 as 4 billion cubic feet the storage surplus is 1% Change in Price 1% Change in DD slowly resolved. 35 WTI Oil HH Gas Winter Summer Petroleum 3 Total Gasoline Distillate Other Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 7-Yr Normal Actual 27 Projected Natural Gas Total Residential Commercial Industrial Electric Power Source: DOE/EIA, DB Global Markets Research During the last three months of 26, US heating degree days (HDDs) were 11% below normal. Using demand elasticity estimates from the US Department of Energy Our we find that a 17% drop in natural gas prices and 21% drop in oil prices would balance out the demand losses from 1% lower HDDs. At USD6.16/mmBtu, natural gas is already down over 2% from its USD8. November 26 average price. At USD55.5/bbbl, oil prices are down about 11% from the Dec-6 average of USD62/bbl. 11

12 US Gas Production: Rig Count We expect US natural gas prices will surprise to the upside this year are US gas production disappoints. US Gas Production & Rig Counts 6 US gas production (% yoy, lhs) Gas rig count (% yoy, rhs) US Natural Gas Price Source: Baker Hughes, EIA We are cautiously bullish natural gas prices during the remainder of the year as we expect to see domestic US gas production surprise to the downside. We find that over the past six years it has required 13% compound annual average growth in the US gas rig count just to keep gas production levels flat. If this relationship holds in 27, it will require an average of 1,5 to 1,6 domestic rigs just to keep gas production flat. This would represent at least a 14-rig (1%) rise from current levels. In addition, production of exiting wells have a very high decline rate. For example, for every Pinedale well that come on at 9MMcfe/d last summer, it will be producing roughly 2.5MMcfe/d by this summer. The reduction in drilling investments in Canada are also expected to limit Canadian imports into the US. 12

13 Energy: Renewables and Reserves Alternate fuels are likely to grow strongly, but still only contribute a small part to total energy consumption. Global Energy Demand by Fuel OPEC Holds Bulk of Remaining Reserves Reserves (billion bbl) OPEC Non-OPEC Russia Saudi Arabia Production (mmb/d) Source: ExxonMobil 26 World Energy Source: BP Statistical Review, DB Global Markets Research Fossil fuels account for about 8% of the world s total energy use. Most forecasts (DOE/EIA, ExxonMobil, IEA) expect this percentage to remain relatively stable over the next 2-25 years. Even with double-digit growth in wind and solar power, and a strong effort on biofuels, the necessity continues for conventional oil and natural gas to meet requirements for population and economic growth. One of the key issues for the oil markets over the next two decades is that most of the world s remaining oil reserves are in OPEC countries- many of which apply significant constraints on access by the traditional international oil companies. This would not necessarily be a problem for development of reserves, but a number of the OPEC producers have government polices that tend to limit the ability of their own national oil companies to efficiently develop their reserves. Reserve-to-production ratios are generally much higher in the OPEC nations than in the non-opec countries. 13

14 Energy: Price Forecasts We believe that price elasticities of demand and supply are likely to result in lower prices in 21 than consensus forecasts were assuming in late 26. Oil Price Forecasts for 21 Natural Gas Price Forecasts for WTI price (USD/bbl) 7 65 Consensus mean 6 55 Deutsche Bank Survey participants USD/mmBtu 12 Consensus Mean 11 Deutsche Bank Survey Participants Source: Reuters, DB Global Markets Research Source: Reuters, DB Global Markets Research Many academic studies have shown that futures markets are poor predictors of future prices. Furthermore, we believe that analysts forecasts are significantly biased by current prices. In our view, current consensus estimates for oil and gas have likely been set too high because to the sharp increases in oil and gas prices that have occurred over the last few years. We believe that margins supply costs for oil point to mid-cycle prices near USD45-5/barrel (real 25), and equivalent prices for natural gas near USD7./mmBtu. 14

15 Wet Freight: The Role Of OPEC Wet freight rates have come under pressure from lower OPEC oil production. Million barrels/day OPEC Quotas & Wet Freight Rates 29 OPEC-1 Quota 28 VLCC rate OPEC Quota reductions US D/da y Worldscale OPEC-6 Oil Production & TD3 Wet Freight 35 Saudi Arabia to Japan wet freight (TD3, lhs) 22 3 OPEC-6 crude oil production (mbd, rhs) Source: Bloomberg, DB Global Markets Research Wet freight rates have fallen sharply during the second half of last year. This reflected deep production cuts announced by OPEC over this period. W expect further production cuts as well as strong fleer growth to sustain downward pressure on wet freight rates in the first half of this year. 15

16 Dry Freight: The Role Of The US Dry freight rates doubled in 26. We expect rates will drop by around 2% this year. US Business Confidence & Asian Exports ISM (3MMA, lagged 6 month) (lhs) Asian export growt h (ex-japan) (% yoy, 3MMA, rhs) Baltic Freight & Asian Export Growth Baltic Freight Index (% yoy, lhs) Asian export growth (ex-japan) (% yoy, 3MMA, rhs) F' cast Mar-94 Mar-96 M ar-98 M ar- M ar-2 Mar-4 Mar Source: Bloomberg, DB Global Markets Research Dry freight rates, which are the costs associated with transporting coal, iron ore and grains around the world, doubled last year. However, the slowdown in US manufacturing sector activity, which is expected to drive Asian export growth lower over the coming six months, is introducing new headwinds for the sector. Moreover, new fleet supply is another hazard for dry freight rates during

17 Industrial Metals: China s Trade Position China s Trade Balance In Copper China s Trade Balance In Aluminium 2 Kt 16 Kt Oct-96 Oct-98 Oct- Oct-2 Oct-4 Oct-6-8 Oct-96 Oct-98 Oct- Oct-2 Oct-4 Oct-6 China net visible trade balance (+/- (export/import)) 12 month moving average Net visible trade balance (+/- export/import) 12-month moving average Source: DB Global Markets Research, CEIC The moderation in China s trade deficit in copper during 26 is, in our view, a reflection of the State Reserve Bureau s inventory release programme. However, we believe Chinese de-stocking is coming to an end and that this will provide strong support to copper prices at what are still elevated levels. Spot alumina prices are set to fall further under the weight of rapidly rising alumina capacity in China. This also raises the risks that after moderating during 26, Chinese net aluminium exports could start to increase again. However, from November 1, China will cut import tariffs on 58 products and impose (or raise) export taxes on 11 resource products. For example, import tariffs on coal, refined oil and alumina will be cut to -3% from 3-6%. A 5% export tax will be levied on coal, coke and crude oil; a 15% export tax will be imposed on copper and aluminium and a 1% export tax will be levied on pig iron and semi-finished steel products. These measures will aim to contain the indirect export of energy and mineral resources. 17

18 Industrial Metals: Forward Curves The WTI Forward Curve Over Time Metal Forward Curve Dynamics 14 Year to date returns (%) 3M 27M Curve flattening Nickel Zinc Copper Aluminium Source: DB Global Markets Research Typically there has been a positive relationship between the spot price of a commodity and the degree of backwardation, namely curves steepen and a commodity price rallies. However, over the past two years the crude oil forward curves have flattened substantially as the market believes oil prices will remain stronger for longer. We expect the low and declining level of inventory to consumption ratios across the industrial metals complex will eventually lead to a similar flattening in the forward curves for these markets. In fact, the copper curve has been flattening since the beginning of the year. 18

19 Global Growth: A New Fed Easing Programme The current US expansion is expected to become long in the tooth from December 27. Expansion length (months) Timing the Next US Recession y = x R² =.839 Excluding the expansion would raise the R² to forecast Number of months from leaving recession and the FOMC raising interest rates Copper spot price=1 when US rates peak Copper Prices & Fed Easing Copper Number of months before/after the Fed stops hiking interest rates and starts a new easing programme Source: University of Columbia, DB Global Markets Research Sine 1954 we find that the longer the US Federal Reserve cuts interest rates and then keeps monetary on hold after a recession, the more durable the eventual US expansion. The last US economic recession troughed in November 21, but the US prime rate did not start rising until June 24 (32 months later). This would imply the next US recession will begin in December 27, or 72 months after the US moved out of recession in 21. We find that a programme of Fed easing has typically been bearish for industrial metal prices. We examined the performance of base metal prices in the months before and after the Fed stops hiking rates and begins a new easing cycle. We find industrial metals prices are hit hardest when US interest rats are being cut aggressively, presumably because US growth is slowing sharply. However, this cycle is complicated by the increasing role of non-oecd countries, and specifically China, driving global growth. 19

20 Precious Metals: Bullish On A Weaker US Dollar The gold price is likely to benefit from renewed USD weakness and a moderation in US real interest rates. The Favorable Gold Price The correlation between the gold price and the US dollar has increased to 55% on a daily returns basis. While the US basic balance has moved in favour of a stronger US dollar suggesting ongoing headwinds for the gold price, we recommend investors build long gold exposure from the end of the first quarter of this year. The Gold Price vs. EURUSD DB end 28 EURUSD f orecast We expect EURUSD to rise to 1.4 in 28 which should help to push the gold price towards USD72/oz. In the event of a more pronounced US slowdown we would expect this target to be reached even earlier. Indeed a new Fed easing cycle would tend to imply a moderation in US real interest rates. We find that gold performs well in environments where real rates are low or negative. Given the strong positive correlation of the gold price to silver and platinum as well as strong fundamentals in both these markets it also implies further gains in other parts of the precious metals complex. Real Interest Rates & Gold Gold yoy returns (%) Year-on-year returns Gold performs well in low or negative US real interest rate environments Real short-term Fed funds rate (%) Source: DB Global Markets Research, Bloomberg 2

21 Precious Metals: The US Basic Balance The US dollar is forecast to hit new lows against the euro and Japanese yen during 28. The Gold Price & The US Basic Balance * The modified US basic balance of payments is defined as net foreign puchases of US stocks and bonds (excluding US Treasuries) less the US trade deficit Excess capital inflows ` Long-Run US Dollar Cycles USDDEM 7-year US$ downtrend 5-year US$ uptrend 1-year US$ downtrend 5-year US$ uptrend -4 Modified basic balance* (USD bn, lhs) -8 EUR/USD (rhs, inverted) Capital shortfall Source: US Treasury, DB Global Markets Research We track net foreign purchases of US equities, corporate and agency debt less the monthly trade deficit to assess whether the US is over- or under-funding its external deficit. Since the end of last year, the US has enjoyed a significant improvement in its basic balance. This suggests that the US dollar is well supported for the time being. However, we expect this to change as the Fed embarks on a new monetary easing programme. The US dollar has exhibited long-run cycles of rising and falling for extended periods of time. On average each cycles has persisted for an average of seven years with the turning points occurring where the US dollar is more than 2% over- or under-valued on a purchasing power parity basis. Since the last turning point in the US dollar only occurred in 21/22 it suggests this US dollar bear cycle will not become mature until the end of

22 Precious Metals: Seasonality The first four weeks a new year have tended to be hazardous for the gold price. Seasonal Patterns In The US Dollar 2.% 1.5% 1.%.5% Average monthly change in the DXY US dollar index since % 3% 2% Seasonal Patterns In The Gold Price Average monthly change in the gold price since 1976 This figure is distorted by the 27% gain in the gold price in Jan-8. Excluding this date, the gold price has posted an average decline of.3% since % 1% -.5% -1.% % -1.5% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec -1% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: DB Global Markets Research, Bloomberg Sine 1976 there have been a strong tendency for the US dollar to weaken in the last four weeks of the year for this to be reversed dramatically in the first four week of a new year. 22

23 Precious Metals: Gold Rallies Compared The Gold & Silver Price In Real Terms Gold & Silver Rallies Compared Deflated by US PPI Real gold price (25 US dollars, lhs) Real silver price (25 US dollars, rhs) Source: IMF, DB Global Markets Research Gold and silver prices have risen substantially in real term, but, still lie significantly below the highs that were hit in 198. The duration of the current gold rally is now in its 67 th month and consequently marks this cycle out as the most durable rally since the gold price become freely floating following the collapse of the Bretton Woods agreement in August

24 Precious Metals: Geopolitics & Central Banks As European central banks are selling gold, Asian central banks are considering increasing their gold holdings. Cumulative change in crude price (USD) The Gold Price & Geopolitical Events Terrorist attacks on the US Sep-1 Bali bomb Oct-2 Casablanca bombing May-3 Istanbul bombing Nov-3 Madrid bombing Mar-4 London bombing Jul-5 Israel-Lebanon conflict Jul Days after the event Central Bank Holdings Of Gold 1.4% % share of gold to total reserves 3.3% 3.5% 4.6% Gold reserves (April 26, tonnes) 14.% 2.% 3.% 1.5% 1% 5.1% 2.1% 25% 13% China Taiwan Russia India Philippines Singapore Thailand Pakistan Kazakhstan Argentina Ukraine Belarus Tajikistan Source: World Gold Council, DB Global Markets Research Terrorist attacks on western targets highlight the increased level of geopolitical risk facing global investors during this decade. However, unlike the late 197s we find that the after-shocks of geopolitical events on the gold price have tended to be shorter in duration and more muted in magnitude. The extension of the five year Washington Agreement in September 24 is sustaining market confidence in the programme of European central bank gold sales. Attention is now turning to central banks across the emerging markets, and specifically in Asia, following the substantial accumulation of FX reserves over the past few years. This has push gold to total reserve ratios to record low levels in a number of countries. Russia has already declared its intention to raise its gold to total reserve ratio to 1%. 24

25 Grains: Real Prices & Global Inventories Grain prices are cheap on an historical basis. Rising shortages for these commodities are appearing across Asia. Corn & Wheat Prices In Real Terms 25 US dollars/bushel (deflated by US PPI) 2 Real wheat price 18 Real corn price Days of use Global Inventories For Corn & Wheat Corn stock-to-use ratio Wheat stock-to-use ratio Total available stocks divided by daily consumption Source: USDA, IMF, DB Global Markets Research Despite the recent rally, in real terms we believe corn and wheat prices are still cheap. Corn and wheat market fundamentals have been tightening for the past five years. The number of days of available inventories relative to consumption have fallen to 47 days for corn and 75 days for wheat to stand at their lowest levels since the early 197s. 25

26 Grains: Falling US Production Falling US corn and wheat production have contributed to the bullish outlook for corn and wheat. US Corn Production By Year 12. US corn production US Wheat Production By Year 2.4 US w heat production Bushels (billions) Bushels (billions) M J J A S O N D J F M M J J Month US corn production estimate by the USDA w as made M J J A S O N D J F A M J J Month US w heat production estimate w as made by the USDA Source: USDA, DB Global Markets Research Global droughts have also led to a significant downgrade in global wheat production, most notably in the US and Australia. Indeed severe droughts occurred in 7% of the US producing states in the US belt and has pushed US wheat production 2% lower since last year. Since September estimates for the US corn harvest have also been revised lower. This is expected to lead to a further moderation in US corn exports, which constitute 7% of world exports. 26

27 Grains: Changing Diets Across Asia Corn is an important animal feed. The rising demand for protein in China is expected to lead to an increasing reliance on imported grains going forward. China & India: A Move Towards Protein Other Fruits/Veg. Cereals M eat India China Developed countries Fats S we ets Kg of meat per capita Rising Incomes Imply More Meat Demand 14 Meat consumption as function of income China 26 2 China Korea Japan GDP PPP per capita Source: FAO Source: USDA, DB Global Markets Research Diets in India and China are heavily skewed towards cereal consumption. As these economies develop so their diets and calorific intake will improve and converge towards those in the developed world. The difficulty is that to produce 1kg of beef requires 1kg of grain. Since the world is farmland and water constrained, we expect this increase in demand will require not only greater efficiencies in agriculture, but, also lead to strong real price appreciation for corn and wheat going forward. 27

28 Grains: Shortages Across Asia Grain prices are cheap on an historical basis. Rising shortages for these commodities are appearing across Asia. China s Trade Balance In Corn Chinese net exports in corn (s tonnes) India s Trade Balance in Wheat 8 Net wheat exports/imports (tonnes) Source: USDA, DB Global Markets Research Over the next 12 months we expect China will become a net importer of corn. History would suggest that such a shift in the country s trade position is likely to trigger a strong turnaround in corn prices. India has become a net importer of wheat for this first time this decade and is contributing to a significant decline in global wheat inventories. 28

29 Grains: Bull Cycles Compared The current bull run in grains is still in its infancy. This rally would only become long in the tooth beyond December 27. Corn Price Rallies In Comparison Wheat Price Rallies In Comparison Source: Bloomberg, DB Global Markets Research If the magnitude and duration of the current corn and wheat price rallies conforms to historical averages, it would imply a price peak of USD4.15/bushel for corn and USD6.75/bushel for wheat, or an additional 25% increase from current levels. These targets would be reached in July 27 and December 27 respectively if the duration of these rallies conforms to historical averages. If the current upswing in grain prices is of a similar magnitude to the one that unfolded in the mid-197s, it would imply corn and wheat prices hitting USD6.3/bushel and USD13.3/bushel respectively, or an additional 1-145%. 29

30 Grains: Biofuels & Corn-Based Ethanol Agricultural exports constituted more than 3% of total exports for New Zealand, Argentina and Brazil in 25. Million of barrels of oil equivalent Global Biofuels Production Gasoline & Ethanol Demand In Biofuels Other 1 NGL Oil Sands 8 Crude & Condensate Million barrels of oil equivalent Gasoline Ethanol US Brazil Source: ExxonMobil Total worldwide biofuel production stands at just under 1 mmb/d. 75% of which are produced in the US and Brazil and is predominately ethanol. According to ExxonMobil, this is expected to rise towards 3mmb/d by 23. However, in energy equivalent volume this is closer to 2 million barrels/day of oil equivalent. At that level, biofuels will represent about 2% of overall liquids demand in 23. The US produces about 4 billion gallons of corn-based ethanol. This meets 2% of US gasoline demand and absorbs 13% of the US corn crop. By 212, the US government has mandated that ethanol supplies reach 7.5 billion gallons which would meet around 3% of US gasoline demand and require 21% of the US corn crop. 3

31 Grains: The Expected Winners Agricultural exports constituted more than 3% of total exports for New Zealand, Argentina and Brazil in 25. The World s Major Agricultural Exporters New Zealand Argentina Brazil Ecuador Peru Australia Ukraine Colombia Canada US Chile Mexico Agricultural exports as a proportion of total exports (25, %) Equities Exposed To Agricultural Markets January 3, 25=1 Sygenta AG 15 Agrium Inc Bunge Ltd 14 Monsanto Co Potash Corporation Dec-5 Feb-6 Apr-6 Jun-6 Aug-6 Source: DB Global Markets Research, Bloomberg The beneficiaries of rising agricultural prices are expected to be the major agricultural exporters such as New Zealand, Argentina and Brazil. Expressing a bullish corn and wheat view from an equity perspective is relatively challenging. One route would be to gain exposure in agrochemical-crop protection companies such as Agrium, Syngenta, Bunge, Monsanto, Potash Corporation or Yara International. 31

32 Overview Benchmark Indices Sector Allocations DBLCI-OY DBLCI-MR Deutsche Bank is a market maker for all leading commodity indices (swaps / options) and their sub-indices. Precious Metals 1.73% Base Metals 12.85% Agriculture 2.47% Livestock % Energy 54.62% Livestock % Agriculture 82.87% Energy 17.32% Base Metals 7.35% Precious Metals 5.88% GSCI DJ AIG Precious Metals 2.31% Agriculture 9.88% Livestock 4.55% Livestock 8.56% Agriculture 28.98% Energy 29.88% Source: Base Metals 11.4% DB Global Markets Research, Bloomberg December 26 Energy 69.48% Precious Metals 8.72% Base Metals 23.88% 32

33 Commodity Index Composition & Returns Sector Allocation of Benchmark Indices 26 Commodity Index Returns Compared 1% 8% Commodity index returns Total returns in 26 (%) 46.1% 3 6% 2 17.% 4% 1 2.1% 3.1% 8.1% 2% -1-1.% -2.9% -.5% % DBLCI DBLCI-MR GSCI DJ-AIG DBLCI-OY Energy Industrial Metals Precious Metals Agriculture & Livestock % GSCI LBCI RJ/CRB MLCI DJAIG RICI DBCLI DBLCI- OY DBLCI- MR Performance of Commodity and other Benchmark Indices USD terms Sharpe DBLCI-OY DBLCI DBLCI-MR Performance of other benchmark indices GSCI DJ-AIG S&P EFFAS US Bond Source: DB Global Markets Research Note: 1 The Sharpe Ratio is calculated from year -on-year returns as of 29 December 26; For quotes and compositions see Reuters: DBLCI and Bloomberg: DBCM Past performance is not necessarily indicative of future results 33

34 Forward Curves: The Roll Return & The WTI Term Structure Investment conclusion: Choice of commodity markets with positive price outlook and / or positive roll yield or negative roll yield to be compensated by strong spot price performance WTI Crude Oil Curve January 25 WTI Crude Oil Curve January 27 Source: DB Global Markets Research 34

35 Optimum-Yield Technology The Optimum-Yield technology tends to outperform traditional commodity indices in contango markets. In backwardated markets the Optimum Yield roll rules are likely to match a traditional roll mechanism Hold The Roll-Return Sell Buy The roll return WTI (USD/barrel. lhs) Gold (USD/oz, rhs) 34 Nov-4 Jan-5 Mar-5 May-5 Jul-5 Sep-5 total return = spot return + roll return + collateral return The roll return is positive when the term structure is backwardated, or downward sloping. The roll return is negative in a contangoed market. Sector Returns Of the DBLCI & DBLCI-OY The Optimum-Yield Technology Up to now, energy futures contracts have been rolled monthly and metal and agricultural futures contracts have been rolled annually in the DBLCI. This approach was adopted to maximize the positive roll yield in traditionally backwardated energy markets and minimize the negative roll yield in contangoed metal and agricultural markets. However, the changing pattern of commodity term structures has made it necessary to adapt this strategy. Rather than select the new future based on a predefined schedule, the DBLCI- Optimum Yield index rolls to that future which generates the maximum implied roll yield, from the list of tradable futures which expire in the next 13 months Total returns on the base components of the DBLCI Total return using the Optimum Yield technology Total returns End-5 to End-6 The DBLCI-OY index therefore aims to: maximise the positive roll yield in backwardated markets and 2 minimise the negative roll yield in contangoed markets WTI Heating Oil Aluminium Gold Corn Wheat Source: DB Global Markets Research 35

36 Long DBLCI Optimum Yield vs. Short DBLCI Relative Value Trade In order to monetise the view that contango will persist, we recommend a non-directional relative value trade on commodity Indices: Long DBLCI-Optimum Yield vs. Short DBLCI Both indices have the same base weights; they only differ in the rolling mechanism. Historic Return: 3 years Historic Return: Last 12 Months Bloomberg Tickers DBLCI Optimal Yield ER DBLCI ER DBLCOYER <Index> DBLCMACL <Index> Source: DB Global Markets Research 36

37 Long DBLCI-MR vs. Short GSCI* Relative Value Trade The recent sell off in the energy sector as well as the negative roll return have resulted in losses on the GSCI due to a high allocation in the energy sector compared to the DBLCI-Mean Reversion. The DBLCI-Mean Reversion is forecast to rise a further 2% in 27. DBLCI- Mean Reversion vs. GSCI Returns Spread Source: DB Global Markets Research * This trade was first recommended by DB Global Markets Research on 13 January 26 37

38 DBLCI-Mean Reversion Technology The DBLCI-MR currently has a significant allocation to the grains sector. DBLCI-MR Index Details Components: 6 Roll Frequency Energy: Monthly Roll Freq. Metals: Yearly DBLCI-MR vs. GSCI Agricultural Index 25 GSCI Agricultural Index Total returns: 2 January 23=1 DBLCI-Mean Reversion Investments via: Swaps (ER +TR) UCITS III Investment Fund Certificates Structured Notes Options Roll Freq. Agriculture: Rebalancing: Rebalancing Rule: Available Currencies: Yearly dynamic The index overweights cheap commodities and underweights expensive ones compared to their respective 5y moving averages vs. 1y moving average (rule-based). USD, EUR, GBP, JPY / hedged, un-hedged Jan-3 Jun-3 Nov-3 Apr-4 Sep-4 Feb-5 Jul-5 Dec-5 May-6 Oct-6 Historical Asset Allocation of the DBLCI-MR Specific Commodity Allocation 1% 9% 8% 7% Crude Oil 1.1% Heating Oil 5.65% 6% 5% 4% 3% Corn 41.1% Aluminium 7.4% Gold 6.13% 2% 1% % Dec-88 Dec-9 Dec-92 Dec-94 Dec-96 Dec-98 Dec- Dec-2 Dec-4 Dec-6 Energy Industrial Metals Prec ious M etals Agricultural Source: DB Global Markets Research, Bloomberg 5th January 27 45

39 Commodity Index Returns: Looking Into 27 The DB Commodity Index Suite DB Forecast For Commodity Returns In 27 We believe the DBLCI-Mean Reversion is best placed to exploit the bullish outlook for the grains market. Currently, the MR index has an 84% allocation to corn and wheat. For those investors looking to benefit from the low or negative correlation of commodity returns versus more traditional asset classes, such as bonds and equities, we recommend exposure to the DBLCI-Optimum Yield Expected total returns in 27 (%) The DBLCI-OY has a 55% allocation to the energy sector, but, rather than adopting a pre-defined monthly rolling schedule, it rolls to that future which generates the maximum implied roll yield from the list of tradable futures which expire in the next 13 months GSCI DBLCI DJ-AIG DBLCI-OY DBLCI-MR The Expected Roll Return On Current Term Structures Composition on Commodity Index Returns in 27 2% 1% % -1% -2% -3% -4% -5% Expected roll return on the DBLCI subcomponents (annualised, %) Expected roll return on the DBLCI- Optimum Yield sub-components (annualised, %) Commodity Spot Return Roll Return Total Return Crude Oil Neutral/Positive Negative Negative Heating Oil Neutral/Positive Negative Negative Gold Positive Negative Positive Aluminium Neutral/Bearish Neutral/Positive Positive/Neutral Corn Positive Positive Positive Wheat Postive Postive Postive -6% Heating Oil Crude Oil Gold Corn Wheat Aluminium Source: DB Global Markets Research 46

40 DBLCI-OY Commodity Membership List Index Commodity Symbol Exchange DBLCI-OY Weight Sector Weight Inception Date BBG Excess Return Ticker BBG Total Return Ticker DBLCI-OY Overall 2-Dec-88 DBLCOYER DBLCOYTR Energy DBLCI-OY Energy Sector 4-Jun-9 DBLCYEEN DBLCYTEN DBLCI-OY CL Light Crude CL NYMEX 35.% 22.5% 2-Dec-88 DBLCOCLE DBLCOCLT DBLCI-OY HO Heating Oil HO NYMEX 2.% 22.5% 2-Dec-88 DBLCOHOE DBLCOHOT DBLCI-OY RB RBOB Gasoline RB NYMEX.% 22.5% 2-Dec-88 DBLCYERB DBLCYTRB DBLCI-OY NG Natural Gas NG NYMEX.% 1.% 4-Jun-9 DBLCYENG DBLCYTNG DBLCI-OY LCO Brent Crude LCO IPE.% 22.5% 3-Jan-9 DBLCYECO DBLCYTCO DBLCI-OY LGO Gasoil LGO IPE.%.% 5-Jul-89 DBLCYEGO DBLCYTGO Precious Metals DBLCI-OY Precious Metals Sector 2-Dec-88 DBLCYEPM DBLCYTPM DBLCI-OY GC Gold GC COMEX 1.% 8.% 2-Dec-88 DBLCOGCE DBLCOGCT DBLCI-OY SI Silver SI COMEX.% 2.% 2-Dec-88 DBLCYESI DBLCYTSI Industrial Metals DBLCI-OY Industrial Metals Sector 3-Sep-97 DBLCYEIM DBLCYTIM DBLCI-OY MAL Aluminium MAL LME 12.5% 33.33% 3-Sep-97 DBLCOALE DBLCOALT DBLCI-OY MZN Zinc MZN LME.% 33.33% 4-Aug-97 DBLCYEZN DBLCYTZN DBLCI-OY MCU Copper - Grade A MCU LME.% 33.33% 4-Aug-97 DBLCYECU DBLCYTCU DBLCI-OY MNI Primary Nickel MNI LME.%.% 4-Aug-97 DBLCYENI DBLCYTNI DBLCI-OY MPB Standard Lead MPB LME.%.% 4-Aug-97 DBLCYEPB DBLCYTPB Agriculture DBLCI-OY Agriculture Sector 2-Dec-88 DBLCYEAG DBLCYTAG DBLCI-OY C Corn C CBOT 11.25% 25.% 2-Dec-88 DBLCOCNE DBLCOCNT DBLCI-OY W Wheat W CBOT 11.25% 25.% 2-Dec-88 DBLCOWTE DBLCOWTT DBLCI-OY S Soybeans S CBOT.% 25.% 2-Dec-88 DBLCYESS DBLCYTSS DBLCI-OY SB Sugar # 11 SB NYBOT.% 25.% 2-Dec-88 DBLCYESB DBLCYTSB DBLCI-OY KC Coffee "C" KC NYBOT.%.% 2-Dec-88 DBLCYEKC DBLCYTKC DBLCI-OY CT Cotton #2 CT NYBOT.%.% 2-Dec-88 DBLCYECE DBLCYTCT DBLCI-OY CC Cocoa CC NYBOT.%.% 2-Dec-88 DBLCYECC DBLCYTCC DBLCI-OY KW Kansas Wheat KW KBOT.%.% 4-Jan-89 DBLCYEKW DBLCYTKW Livestock DBLCI-OY LC Live Cattle LC CME.%.% 2-Dec-88 DBLCYELC DBLCYTLC DBLCI-OY LH Lean Hogs LH CME.%.% 2-Dec-88 DBLCYELH DBLCYTLH DBLCI-OY FC Feeder Cattle FC CME.%.% 2-Dec-88 DBLCYEFC DBLCYTFC Source: DB Global Markets Research 4

41 DBLCI-OY & DBLCI Excess Returns Index Statistics Historical Return Summary* Monthly Return Analysis* Annualised Return Data Annualised Return Volatility Sharpe Ratio Avg. Monthly Return No. +ve Months % of +ve Months 15 Years 1 Years 5 Years 3 Years DBLCI-OY 9.58% 15.38%.62.86% % 9.28% 11.88% 23.1% 32.19% DBLCI 9.6% 18.95%.48.86% % 8.% 9.26% 17.13% 21.62% Energy DBLCI-OY Energy 15.46% 23.1% % % 14.98% 21.23% 32.5% 44.78% DBLCI-OY CL 19.31% 25.45% % % 16.81% 22.89% 37.4% 47.5% DBLCI CL 16.3% 31.62% % % 12.65% 15.53% 23.64% 28.28% DBLCI-OY HO 13.84% 24.8% % % 13.42% 2.39% 33.17% 48.69% DBLCI HO 1.77% 31.5% % % 7.41% 12.19% 22.22% 3.45% DBLCI-OY RB 14.13% 26.6% % % 12.3% 2.63% 29.15% 42.5% DBLCI-OY NG 11.73% 27.2% % % 14.5% 16.86% 2.56% 21.57% DBLCI-OY LCO 14.37% 26.81% % % 15.3% 2.14% 34.3% 48.93% DBLCI-OY LGO 12.54% 24.26% % % 1.48% 17.18% 3.83% 5.16% Precious Metals DBLCI-OY Precious Metals -1.7% 13.75% % % 1.43% 3.39% 19.15% 23.89% DBLCI-OY GC -1.57% 12.77% % %.43% 2.14% 17.45% 2.2% DBLCI GC -1.41% 12.77% % %.61% 2.27% 17.54% 2.34% DBLCI-OY SI.2% 22.15%.1.14% % 4.76% 7.42% 24.48% 37.5% Industrial Metals DBLCI-OY Industrial Metals 9.2% 15.67%.58 1.% % 27.35% 5.99% DBLCI-OY MAL 5.77% 15.32%.38.51% % 14.71% 26.9% DBLCI MAL 5.29% 16.44%.32.46% % 15.17% 27.13% DBLCI-OY MZN 5.44% 19.2%.29.75% % 24.72% 51.65% DBLCI-OY MCU 13.92% 19.62% % % 41.6% 73.79% DBLCI-OY MNI 15.41% 3.58%.5 2.3% % 32.49% 36.69% DBLCI-OY MPB 7.52% 2.73%.36.63% % 23.1% 4.95% Agriculture DBLCI-OY Agriculture -.76% 14.9% % % -.28% -4.11% 5.34% 1.43% DBLCI-OY C -7.43% 17.84% % % -8.35% % -9.15% -6.65% DBLCI C -7.31% 18.21% % % -7.88% % -8.13% -5.59% DBLCI-OY W -4.68% 19.15% % % -3.2% -1.8% -.9% -1.75% DBLCI W -2.72% 2.5% % 16 5.% -1.18% -9.71%.54% -5.45% DBLCI-OY S -2.29% 18.37% % % -1.68% -2.69% 5.64% 9.25% DBLCI-OY SB 8.67% 25.83%.34.89% % 9.73% 6.96% 21.95% 37.4% DBLCI-OY KC -5.43% 33.79% % % -2.93% -1.% -.58% 7.75% DBLCI-OY CT -4.73% 18.22% % % -7.61% % -7.94% % DBLCI-OY CC -7.58% 26.88% % % -5.58% -3.72% 12.54% -.52% DBLCI-OY KW -1.3% 17.57% -.6.8% % 1.14% -6.1% 1.32% 5.% Livestock DBLCI-OY LC 1.19% 9.56%.12.16% %.59%.44% 3.82% 5.81% DBLCI-OY LH 4.66% 17.67%.26.56% % 3.75%.83% 8.2% 23.12% DBLCI-OY FC 2.49% 1.18%.24.3% % 1.57% 3.22% 4.3% 1.55% Source: DB Global Markets Research Past performance is not necessarily indicative of future results 41

42 DBLCI-Mean Reversion TM Reweighting rules for the index For each Commodity, each day, the number of Divergence-Ticks is calculated A reweighting is only triggered when the divergence goes through a multiple of the divergence hurdle rate f d i, t 1 a i, t = trunc 1 f Ai, t Aluminium Divergence % 7.% Divergence % 5 year av. I year Av Spot 25 2 For f = 5% d = 6 d =2 Divergence % 5.% 3.% 1.% 15 1 $/MT -1.% 5-3.% Nov-93 Apr-95 Aug-96 Jan-98 May-99 Oct- Feb-2 42

43 DBLCI Mean Reversion TM Index reweighting rule Each time the number of divergence-ticks for a Commodity changes, the weights are recalculated: W i, t = n W i, W exp( d i, t exp( d k) k) i, i, t i= 1 As the divergence increases, the weight of the commodity is reduced (and vice versa) - if the divergences are all zero, the weights are simply those of the base DBLCI index The constant k is the weighting factor and determines the degree of reweighting; the DBLCI-MR will uses the following constants: f ( divergence-hurdle-rate ) = 5%, k ( weighting factor ) = 3% The rule is entirely mechanical, no judgements are made 43

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