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1 GLOBAL LME cash price % change US /lb day on day Aluminium Copper Lead Nickel Tin Zinc Cobalt Molybdenum Other prices % change day on day Gold (US$/oz) Silver (US$/oz) Platinum (US$/oz) Palladium (US$/oz) Oil WTI USD : EUR exchange rate AUD : USD exchange rate LME/COMEX stocks Tonnes Change Aluminium 4,896,725 29,000 LME copper 237,500-1,675 Comex copper 44, Lead 322, Nickel 115,878-6 Tin 11,660 0 Zinc 966,025-4,375 Source: LME, Comex, Nymex, SHFE, Metal Bulletin, Reuters, LBMA, Macquarie Research, August August 20 Iron ore: Poised for a rebound Feature article In our view, iron ore prices currently at the lowest levels in two and a half years are poised for a rebound that should take them back to cost support levels of around $130/t in the near term. There are several factors that back up our view low inventory levels at mills, the stabilisation of domestic iron ore prices and some improvement in steel market fundamentals. Latest news Base metal prices closed broadly positive on the day, clawing back early losses in the Asian session following better than expected French and German GDP data of 0.3% growth and 0.1% growth. respectively. Despite better than expected growth in the core economies, GDP across the eurozone as a whole shrank 0.2% in Q2, edging closer towards its 2 nd recession in three years. The world's no. 3 platinum producer Lonmin shut its South African mining operations this week after violence caused by a feud between rival unions killed at least nine people at its main mine. Lonmin accounts for ~ percent of global platinum output. Two policemen and two security guards were among those killed in the clashes from Friday to Monday at the Marikana mine, about 100 km (60 miles) northwest of Johannesburg, in a membership turf war between South Africa's dominant National Union of Mineworkers (NUM) and the newer Association of Mineworkers and Construction Union (AMCU). Executives at Lonmin said all its shafts across the South African platinum belt were closed down with only essential services such as ventilation operating. "Until the place is safe we don't want to talk about production," Lonmin Executive Vice President Barnard Mokwena told a press briefing at Marikana. The company said its ore processing division remained operational, but stockpiles were low. Cochilco, Chile's state copper commission lowered price targets and revised production expectations lower on Tuesday. The commission lowered its 20 average copper price outlook to $3.52 per pound, down from a previous estimate of $3.85, and sees prices slipping to $3.48 next year attributing it to lower expectations for global industrial production. In Cochilco's production forecasts, Chile is seen mining 5.4Mt of copper in 20, a 2.7% YoY increase. In our view this number looks too low as YTD production is already up 2.3% through June and due to last years strike at Escondida in July and August YoY comparisons will get easier in the coming months - we expect production to reach 5.55Mt, up 4% YoY. Cochilco also forecast 5.5Mt of production in 2013 due to a recovery in output from Codelco, Escondida and Collahuasi, which is also below our expectations of 5.7Mt. US retail sales rose significantly in July, coming in well above expectations at +0.8% MoM (cons. +0.3; prev. -0.7%), representing the first gain in this series since March. While this release is a clear positive and indicates strength in personal consumption, the large headline beat was somewhat offset by a downward revision to June's number, which previously had come in at -0.5% (revised down to -0.7%). The larger decline in June helped give rise to the dramatic beat in July. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website

2 Sep-10 Nov-10 Mar-11 May-11 Sep-11 Nov-11 Mar- May- Iron ore inventory at 50 smaller mills- days of use Spot iron ore prices - 62% Fe, CFR China, $/t Macquarie Private Wealth Iron ore is poised for rebound In our view, iron ore prices currently at the lowest levels in two and a half years are poised for a rebound that should take them back to cost support levels of around $130/t in the near term. There are several factors that back up our view low inventory levels at mills, the stabilisation of domestic iron ore prices and some improvement in steel market fundamentals. However, we also highlight that a two speed market is emerging in the steel industry, with fundamentals for long products looking significantly better for flats. While this means that headline steel industry data will most likely beat market expectations in the near term, it makes the outlook on a 3-6 month view decidedly unclear. Smaller mills have destocked iron ore aggressively over the last four weeks A key indicator for understanding short-term price moves in iron ore is the level of inventory held at smaller mills in China. Data on stock levels at 50 smaller steel mills shows that there has been substantial destocking over the last four weeks, with inventory dropping from 29 days of use to 21 and volumes of inventory falling 5mt (or an annualised rate of 65mtpa equivalent to 5% of global contestable demand). In our view, this destock has been the key driver behind recent price weakness. Fig 1 Buyers strike! Smaller mills have destocked aggressively very similar to 4Q Iron ore inventory (days of use) and spot prices Iron ore inventory - days of use Spot iron ore prices Source: Mysteel, TSI, Macquarie Research, August 20 The pattern is extremely similar to what we saw over October At that time, just over 20 days of inventory proved to be a floor and mills quickly came back to market to restock and pricing responded, immediately reverting to above cost support. Even if mills were to just stop destocking (never mind restocking), the increase in buying activity that would come from sourcing material from market rather than inventory should be enough to see prices tick up. Indeed there are indications that mills are coming to the end of destocking evidenced in a stabilisation in domestic prices. Domestic iron ore prices rose ~1% WoW last week While seaborne prices continued to decline, China s domestic iron ore prices ticked up last week. Again, this is similar to the pattern during the downturn in This indicates a preference for domestic iron ore for top-up tonnes when markets are moving down quickly and also that producers of domestic iron ore offer more pricing resistance, given their higher cost curve position. 15 August 20 2

3 Imported ore premium, $/t (62% Fe basis, imported ore CFR basis vs domestic ex-works basis) Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Apr-11 Oct-11 Apr- % change in inventory over 4 week period Macquarie Private Wealth There are two key reasons that make domestic iron ore attractive in a falling market. First is that lead times are much shorter, with delivery available in a matter hours rather than the weeks required for imported material. This is obviously an advantage when steel prices are falling as it offers more clarity on what conversion margins are likely to be. The second is that mills can purchase smaller volumes of domestic material at a time useful for topping up. Fig 2 Domestic iron ore prices stabilised while seaborne prices fell domestic ore now at a premium Fig 3 While mills have destocked seaborne ore, they have continued to purchase domestic material 50.0 Imported ore at a premium Change in iron ore inventory levels - 50 smaller mills Imported iron ore Domestic iron ore Domestic ore at a premium -3-4 Sep-Oct 2011 Jul-Aug 20 Source:, Antaike, SBB, Mysteel, Macquarie Research, August 20 Source: Mysteel, Macquarie Research, August 20 Given the arbitrage that has opened up between seaborne and imported material, once mills return to market the incremental purchasing activity will be on the seaborne market, closing the arb as seaborne prices rise. Steel market fundamentals are looking better at least for half the market The news flow on the steel industry in recent weeks has been extremely bearish, dominated by stories of cash strapped mills cutting production and slashing list prices. However we think a twospeed market is emerging where flat product demand from the manufacturing sector remains weak while long product demand from the construction sector is resurgent. As a result, we expect headline steel data to beat market expectations in the near term. Key to better steel demand from the construction industry has been a steady improvement in real estate sales. Sales in tier 1 and tier 2 cities (2 of the China market on a floor space basis) began to recover early in the year and have continued to improve. More importantly, broader market sales are also starting to recover. Sales should be considered the lead indicator of construction activity following a downturn not new starts, which have remained heavily negative as sales have moved towards growth. In China it is very common for developers to begin selling residential property units to customers after only a minimal amount of construction activity has been done. As a result, when developers report inventory of property, that inventory does not necessarily physically exist it is inventory of units licensed for pre-selling. As sales pick up and developers are destocking, they are seeing cash flow increase and are increasing their commitments to customers. They then pick up the pace of construction activity on these projects, leading to increasing steel demand. Results from surveys that we run on the steel industry and construction market have shown that as sales have increased, developers are increasing the pace of construction activity. Steel traders are also reporting increasing orders from the construction sector. 15 August 20 3

4 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb- Mar- Apr- May- Jun- % of traders reporting an increase in orders Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Mar-11 May-11 Sep-11 Nov-11 Mar- May- Reported trader inventory (m t) Mar-10 May-10 Jul-10 Sep-10 Nov-10 Mar-11 May-11 Sep-11 Nov-11 Mar- May- Property sales, 3mma, YoY Macquarie Private Wealth Fig 4 Top tier cities are leading a recovery in property sales Fig 5 As sales improve, developers are increasing the pace of construction activity Tier 1+2 cities Total China How does the pace of construction compare to the previous month? Source:, CEIC, NBS, Macquarie Research, August 20 Source: Macquarie Steel Sector Survey, August Sep- 11 Oct- 11 Nov- 11 Dec- 11 Jan- Increasing no. reporting faster pace of construction Increasing no. reporting slower pace of construction Feb- Mar- Apr- May- Jun- As orders from the construction sector are increasing, trader inventory of rebar a benchmark construction product has been falling. This implies that current production of rebar is undershooting real demand and this should lead to prices firming in the near term. Spot rebar prices have actually risen RMB15/t this week and a host of mills pushed up list prices by RMB20-80/t on Monday. If these price rises hold, this would likely trigger a rebound in iron ore prices as destocking ends. Fig 6 Traders are reporting increasing orders from the construction sector Fig 7 Rebar inventory at traders has been falling for the last three weeks 5 45% 4 35% Which end use sectors are increasing orders? - Traders Construction Infrastructure Reported trader inventory 3 25% % % 3.50 Rebar HRC Source:, Macquarie Steel Sector Survey, August 20 Source: Mysteel, Macquarie Research, August 20 Another potential driver for long product demand would be an increase in infrastructure demand. The level of investment in infrastructure is starting to increase after a very slow start to the year and there is plenty of room for further increases if full year targets for 20 are to be met. Our recent channel checks with the Ministry of Rail indicate that plans are well underway for a big sequential lift in spending over the second half and that they are confident of hitting full year budgets. 15 August 20 4

5 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb- Apr- Jun- YoY Growth Profit margin, % Asset turnover, times Jan-10 Apr-10 Jul-10 Oct-10 Apr-11 Oct-11 Apr- Rmb billion investment Macquarie Private Wealth Fig 8 Infrastructure investment is starting to pick up Fig 9 There is plenty of room in 20 budgets for a significant lift in spending 4 Infrastructure FAI, YoY 1600 Chinese infrastructure investment Target 1H Source:, NBS, Macquarie Research, August 20 Source: NBS, Macquarie Research, August Power grid Rail infrastructure investment Water infrastructure FAI: road & waterway The flat product market looks considerably worse While the construction sector looks healthy, the manufacturing sectors that dominate flat product demand look much weaker. Destocking of finished goods has weighed on demand for steel for the production of new items and in an environment where asset turnover and profitability are falling, industrial companies are reluctant to invest in new capacity meaning demand for machinery has been reduced. Fig 10 Output of manufactured products has been largely negative YoY Fig 11 Falling profit margins and asset turn are weighing on corporate confidence Output of autos, white goods and construction machinery Passenger vehicles Commercial vehicles White goods Excavators Aggregate Profit Margin - Industrial sector (LHS) Asset Turnover - Industrial sector (RHS) H Source:, NBS, Macquarie Research, August 20 Source: NBS, Macquarie Research, August 20 The weaker manufacturing sector poses risks on two fronts. Firstly, if demand for flat product remains weak, flat product producers (China s largest steel mills) will cut steel production. In doing so, they will reduce the volumes of ore they buy, freeing up more material to transfer into the spot market to meet demand from the smaller mills. This shouldn t stop iron ore prices rising on increased spot purchasing but it would certainly cap the upside to any recovery. 15 August 20 5

6 Macquarie Private Wealth Secondly, it is hard to see how such a wide divide between the construction market and the manufacturing sector can be sustained. In very simplistic terms, we see potential for both bullish and bearish outcomes, each with very different implications for commodity prices. If, on the more positive side, rising property sales and construction activity are a lead indicator for improving domestic demand conditions, then weakness in the manufacturing sector should be short lived and commodities demand should be pushing up into 4Q and early On the other hand, the recovery in property sales will only last as long as consumer confidence holds. If the manufacturing sector starts shedding jobs and declines in export demand compound current weakness, then it is very possible that buyers will withdraw from the property market, leading to a slowing of construction and another leg down in commodities demand and steel production. 15 August 20 6

7 Macquarie Private Wealth 15 August 20 7

8 Macquarie Private Wealth Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+1 Neutral expected return from -1 to +1 Underperform expected return <-1 Macquarie First South - South Africa Outperform expected return >+1 Neutral expected return from -1 to +1 Underperform expected return <-1 Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 6 in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 4 in a year. Low medium stock should be expected to move up or down at least 25 3 in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 30 June 20 AU/NZ Asia RSA USA CA EUR Outperform 55.67% % 42.58% 69.23% 46.6 (for US coverage by MCUSA, 9.05% of stocks followed are investment banking clients) Neutral % 36.99% 52.41% 28.02% 33.69% (for US coverage by MCUSA, 8.14% of stocks followed are investment banking clients) Underperform 13.83% 16.89% 9.59% 5.01% 2.75% 19.71% (for US coverage by MCUSA, 0.45% of stocks covered are investment banking clients) Company Specific Disclosures: Important disclosure information regarding the subject companies covered in this report is available at Analyst Certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. 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