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					     APRIL 30,2012
     VOLUME 4         ISSUE 16                   The Diapason Capital Markets Report
      Key economic data this week                                                           Chart of the Week: Pending home sales jump 4.1%
 •    March Pending Home Sales jump 4.1% m/m
 •    March Durable Goods Orders lower on aircraft
 •    February Case-Shiller House Price Index rise
 •    March New Home Sales gave back February gains
 •    April CBO Consumer confidence index falls
 •    Q1 initial jobless insurance claims gains gone
 •    Mar China HSBC “flash” PMI higher — still sub-50
 •    Mar China imports lower on payback to Jan-Feb gains


       The commodity supercycle is ending? China isn’t all that matters, Part 2
 •    There has been a lot of debate about the end of the "Commodity Supercycle" in recent days. The subject came up along
      market speculations that a hard landing will take place in China, and that the "miracle" is "over. The premise here is that
      if the infrastructure development of China is over, then surely the so-called "Commodity Supercycle" is over.
 •    Could this meme be correct? We disagree with those notions on five counts: (1) We do NOT believe that China is in for a
      hard landing (we expect higher growth in Q2 2012), and (2) even if China’s growth ratchets down from "boiling" to
      "simmering" that does not necessarily mean an end to the upward trend in commodity prices as other emerging countries
      and even OECD economies would soon take up the "slack" from Chinese demand moderation;
 •    (3) a China paradigm shift from investment to consumption does not necessarily derail the commodity gravy train -- it
      just rearranges the order and the number of the train cars; (4) the Fed’s reaction function almost guarantees that rates
      will stay low too long again, and will likely re-ignite inflationary pressures in a 1970 context; and (5) the "commodity su-
      percycle" being discussed is not really a "Supercycle", but only a “boom” in a longer, larger, higher-amplitude period of
      economic activity (the “Long Wave” or “Kondratief (K) Wave”) which could top out in sometime in 2022-2026.
For important Disclaimers and Disclosures, please refer to the last two pages of this publication
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Commodity supercycle ending? China isn’t all that matters, Part 2
    The supercycle that is supposed to end is just a “boom” in a much longer, larger “Supercycle”
By Robert Balan and Alessandro Gelli
There has been a lot of debate about the end of the "Commodity Supercycle" in
recent days. The subject came up along market speculations that a hard landing
is happening in China, and that the "miracle" in the Middle Kingdom is "over. The
premise here is that if the infrastructure development of China is over, then
surely the so-called "Commodity Supercycle" is over. The pace of Chinese eco-
nomic growth has gradually slowed over the past year as the economic stimulus
has faded and government has tightened policy to ward off a surge in inflation.
Not surprisingly, as growth has moderated, views on the outlook for both GDP
and basic material consumption have become more pessimistic. An implosion in
growth in China, the line of reasoning goes, will surely spell an end to the com-
modity price boom seen in recent years.
Could this meme be correct? We disagree with those notions on five counts: (1)
We do NOT believe that China is in for a hard landing (we expect higher growth
in Q2 2012), and (2) even if Chinese growth ratchets down from "boiling" to
"simmering" that does not necessarily mean an end to the upward trend in com-
modity prices as other emerging countries and even OECD economies would                                lags in the economy, information limitations, and bounded ra-
soon take up the "slack" from a China demand moderation, (3) a China paradigm                          tionality in economic decision-making -- all of which creates/
shift from investment to consumption does not necessarily derail the heavy com-                        causes potential/actual oscillatory behavior; and second, a
modity gravy train -- it just rearranges the order of the train cars, (4) the Fed’s                    wide range of self-reinforcing processes exist which amplify
reaction function almost guarantees that rates will stay low too long again, and                       the inherent oscillatory tendencies of the global economy
will likely re-ignite inflationary pressures in a 1970 context, and (5) the current                    (e.g., capital investment, labor markets and workforce partici-
"commodity supercycle" being discussed is not really a "Supercycle", but merely                        pation, real interest rates, inflation, debt, savings and con-
a “boom” in a longer, larger and higher-amplitude period of economic activity.                         sumption, and international trade) leading to so-called "Long
Supercycles do not turn on/off at the flick of a switch                                                Waves" or as is more well-known in economic circles, the
                                                                                                       "Kondratief (K) Waves".
In the first place, history tells us that a full-scale Commodity “Supercycle” does
not turn on or off at the flick of a switch, and the travails of any one country --                    It is important to understand that a full-scale Commodity Su-
even a humongous commodity user like China -- will not stop this heavy freighter                       percycle within the K Wave is not comprised of one continuous
train on its tracks. "Supercycles" by definition, arise from the interaction of two                    uptrend in prices, but is composed of several booms or boom-
fundamental facets of a modern global economy: first, the existence of physical                        lets, with different economic signatures and profiles. The com-
                                                                                                       monality that binds these booms and boomlets is the process
For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                        2
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Commodity supercycle ending? China isn’t all that matters, Part 2
                                                                                                             the booms and boomlets that occurred after WW II
                                                                                                             due to the paucity of data before that.
                                                                                                             The three commodity booms after WW II
                                                                                                             Three major commodity booms since the Second World
                                                                                                             War had taken place, and in all three, demand shocks
                                                                                                             predominated as triggers to the commodity price rises.
                                                                                                             However, as we will later see, these commodity booms
                                                                                                             do not always have the same characteristics.
                                                                                                             The first boom, in 1949–51, was caused by the mas-
                                                                                                             sive inventory build-up in response to the Korean war.
                                                                                                             The second boom, in 1968–80, was accentuated by
                                                                                                             widespread harvest failures and by OPEC’s price man-
                                                                                                             agement, which tripled the price of oil. The third
                                                                                                             boom started in 2002 and may not have run its course




or combination of processes that cause the "Long Wave" in the first place. The variances
in the signatures or profiles of these booms and boomlets within the "Long Wave" is con-
sistent with the evolution of macro-economic conditions and their effect/consequences
(the phases or the "seasons") within the broad sweeps of a 50-60 year long (Super)Cycle
of economic activity.
An in-depth discussion of the "Long Wave" or "K Wave" is not germane at this point, and
we will leave it for another report in the near-future. What we want to accomplish in this
study is to pinpoint where we are in the current cycle, and whether or not we expect the
boom/boomlet to continue, and if yes, for how long. To borrow a phrase once used about
business cycles, it can be said that "the study of commodity booms necessarily begins
with the decomposition of these booms". For our purposes, we will limit our analysis to
For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                 3
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Commodity supercycle ending? China isn’t all that matters, Part 2
                                                                                                             coincided with a sharp weakening in the growth of GDP
                                                                                                             and industrial production (M. Radetzki, 2006).
                                                                                                             It remains to be seen whether a similar coincidence
                                                                                                             will mark the end of the third boom, which is, from
                                                                                                             several points of view, very peculiar. Commodity prices
                                                                                                             fell sharply in late 2008 but the decline was brief, and
                                                                                                             by early 2010, commodity prices have gone higher
                                                                                                             than the highest levels they attained in 2008 before
                                                                                                             the GR. In contrast to the above uniformity as it per-
                                                                                                             tains to growth and industrial output, the booms oc-
                                                                                                             curred in periods with highly contrasting inflation and
                                                                                                             commodity/asset price performance. The evidence is
                                                                                                             reviewed below for each boom in turn.
                                                                                                             The first commodity boom (1949-1951)
                                                                                                             This boom was clearly and strongly related to the Ko-
                                                                                                             rean War, which broke out in June 1950, with an armi-
                                                                                                             stice reached in July 1953. The impact of the war on
                                                                                                             commodity markets was both direct and indirect. The
                                                                                                             direct impact arose from the insecurity felt about in-
                                                                                                             dustrial materials supply, amplified by the painful ex-
                                                                                                             periences of the Second World War that ended only 5
yet. In this boom, the explosive growth of China’s and India’s raw materials demand has                      years prior to the new conflict, and by the importance
played a key role. The first two booms collapsed as the world economy went into reces-                       of South and East Asia in the proximity of the war
sion and excessive inventories were sold out. The third boom wobbled in 2008 at the                          theater, as supplier of many agricultural and mineral
height of the Great Recession (GR), but higher commodity prices since then resumed their                     industrial materials. The rebuilding of Europe and Ja-
course, made new highs in 2011 and may extend once more on loose global monetary                             pan, no doubt, also played a role in this commodity
policy, even as commodity inventories remain under tight supply constraints.                                 boom, but the U.S. material requirements as it pre-
                                                                                                             pared for the Korean war did the most heavy lifting.
Macroeconomic contexts of the three booms
                                                                                           The insecurity prompted a widespread build-up of stra-
It is a noteworthy observation that the growth of GDP and industrial production/capacity
                                                                                           tegic raw materials inventories, which added to de-
utilization accelerated strongly in the periods just preceding or marking the beginning of
                                                                                           mand and pushed up prices. Purely speculative de-
the three commodity booms. It is equally interesting to note that the end of the first and
                                                                                           mand also contributed to the asset markets' strength,
second booms characterized by substantial falls in commodity prices in 1952 and 1980,
For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                   4
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Commodity supercycle ending? China isn’t all that matters, Part 2
                                                                                                             1951, a rise of roughly 55%. There clearly was poten-
                                                                                                             tial for the inflation variation to be wider, but the in-
                                                                                                             crease in prices during the period proved surprisingly
                                                                                                             benign (more or less). This may be linked to the sharp
                                                                                                             fall in the 1950 dollar prices of manufactured exports,
                                                                                                             primarily in consequence of the European devaluations
                                                                                                             in late 1949.
                                                                                                             When measured by the aggregate commodity index,
                                                                                                             this boom does not appear to be particularly strong.
                                                                                                             Commodity prices peaked in the first quarter of 1951
                                                                                                             at a level 45.4% above 1949, used as the base year in
                                                                                                             analyzing the first boom. Neither is it particularly dura-
                                                                                                             ble. By the second quarter of 1952, the constant price
                                                                                                             increases had reduced to only 16% above the base
                                                                                                             year. The boom was limited, by and large, to seven
                                                                                                             quarters.
                                                                                             The prices of both commodity groups fell back later in
                                                                                             1952 as it became clear that the Korean war would not
                                                                                             spread into a world-wide conflict, and with the sharp
                                                                                             slowdown in economic growth recorded in that year. In
                                                                                             addition, dramatic reductions in the strategic stock lev-
but it probably played a lesser role than during the commodity booms of later times. This els added to supply, and so contributed to the ensuing
is because stock markets were buoyant in the early 1950s, and offered ample opportuni- price weakness.
ties for profits.                                                                            An important explanation to the relatively weak ampli-
Furthermore, flexible instruments for speculation in commodity markets had not yet been tude of this commodity boom is that the major con-
developed at that time. The indirect impact to commodity prices arose from the boost to suming countries were relatively self-sufficient in en-
economic growth and industrial output that resulted from the war operations, which re- ergy and food at the time, and that in any case there
sulted in extremely strong macroeconomic performance in 1950 and 1951.                       was little export of these materials from the proximity
                                                                                             of the war scene. The OPEC cartel had not yet come
Inflation characteristics of the first boom                                                  into existence, the US was still a net oil exporter, while
The inflationary performance during the first boom follows a somewhat unusual path. domestic coal dominated Western Europe’s energy
Available inflation indexes indicate only moderate inflation for the whole of the 4-year pe- needs. All of these, of course, changed during the sec-
riod under scrutiny. The Consumer Price Index increased from 6.2 in 1948 to 9.59 in          ond commodity boom.
For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                     5
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Commodity supercycle ending? China isn’t all that matters, Part 2
                                                                                                            The second trigger was of course the very sharp price
                                                                                                            increases instituted by OPEC late in 1973. Given the
                                                                                                            heavy weight of oil in international commodity trade,
                                                                                                            this had a strong repercussion on the aggregate com-
                                                                                                            modity index.
                                                                                                            The third trigger was the loose monetary policies of
                                                                                                            the Federal Reserve at that time, which we documented
                                                                                                            in last week's report (see "Commodity supercycle end-
                                                                                                            ing? Not if the Fed runs true to form" Part 1, The Diapa-
                                                                                                            son Capital Markets Report, April 19, 2012). The ensu-
                                                                                                            ing surfeit of liquidity for periods longer than necessary
                                                                                                            triggered a massive inflationary run.
                                                                                                            The very high inflation through the duration of the sec-
                                                                                                            ond boom provided further dissimilarity from the first
                                                                                                            commodity boom. Not only did the period record very
                                                                                                            strong price rises, irrespectively how measured, for raw
                                                                                                            materials as well as for manufactures.
                                                                                                            The years were also characterized by chaotic changes in
                                                                                                            the parities between major currencies, all of which were
                                                                                                            freely floating after the dollar anchor had been removed
                                                                                                            and the dollar itself was made non-convertible to gold
The second commodity boom (1968-1980)                                                                       in 1971. Measured by CPI, inflation totalled no less than
                                                                                                            305% over the 12-year period, a sharp contrast to the
The second boom was much stronger than the first. It was also much more pervasive in
                                                                                                            first commodity boom.
that the prices of all commodity groups rose sharply. Similar to what happened in the
first boom, a very strong macroeconomic performance during 1972 and 1973 constituted                        Rampant inflation brings on negative real rates
an important trigger to the rising commodity prices. But there were three additional trig-                  The rampant inflation which had resulted in negative
gers. First trigger was that the boom had been preceded by two consecutive years of                         real interest rates for long periods, the chaos in cur-
widespread crop failures, on which a dramatic cut in Peruvian fishery was superimposed.                     rency markets and the poor performance on the stock
Peru’s anchovy catch declined from 12.6 million tons in 1990 to 2.3 million in 1973.                        exchanges in the early 1970s led many investors to
The scarcity of food led to substitution in land use, e.g. from cotton to grains, which re-                 move out of bonds and shares and into real estate, art,
sulted in falling agricultural raw materials supply. The year 1973, therefore, saw deficient                commodities, and gold.
inventories both for food and agricultural raw materials.                                                   The speculative demand for commodity inventories as a
For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                    6
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Commodity supercycle ending? China isn’t all that matters, Part 2
                                                                                                            commodities, but by early 1974 the energy prices had
                                                                                                            risen by much more than any other commodity group.
                                                                                                            And despite fluctuations in the constant prices,
                                                                                                            prompted mainly by inflation, they remained 150–
                                                                                                            200% above the base year (1970). The machinations
                                                                                                            of the OPEC oil cartel explain the difference. Oil domi-
                                                                                                            nates the energy price index, and members of OPEC
                                                                                                            adjusted (decreased) supply to the falling demand in
                                                                                                            1974 and 1975, caused by the combination of deep-
                                                                                                            ening recession and the price shock.
                                                                                                            The cartel’s success in defending its desired price is
                                                                                                            clearly seen in the relative stability of nominal crude
                                                                                                            prices from the beginning of 1974, and was followed
                                                                                                            by another run-up in commodity/gold prices until
                                                                                                            1980, when prices fell over the next six years, effec-
                                                                                                            tively killing the 1970s era of high inflation (thanks to
                                                                                                            then Fed Chairman Volker's jacking up of short-term
                                                                                                            interest rates). Thereafter, commodity prices were



 ‘‘safe’’ store of value was a further contributory factor to the commodity and gold
 boom. The aggregate commodity price index in nominal dollar rose sharply in 1973,
 and remained above a 250 average through 1974 and 1975 -- the energy index was at
 about 330, all the other commodity indices around 150. In the course of 1974, under
 the weight of the recession prompted by the oil crisis, the constant dollar metals and
 agricultural raw materials indices fell back sharply, to end the year at 100. They re-
 mained at that level through 1975, when the recession deepened. The metal prices
 were additionally depressed by large sales between mid-1973 and mid-1974 from the
 US government’s strategic stockpiles, and in late 1974 from excessive commercial
 stocks in Japan that had been built up in the preceding year.
 Rising crude oil prices did most of the damage
 Energy prices rose significantly at the end of 1973, slightly later than the prices of other
For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                       7
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Commodity supercycle ending? China isn’t all that matters, Part 2
                                                                                                       India) into the global economic horserace triggered a massive
                                                                                                       run-up in commodities.
                                                                                                       In 2004, the year when commodity prices rose substantially, the
                                                                                                       economic growth in the OECD accelerated strongly, and attained
                                                                                                       a historical high of 3.3% for GDP and 4.1% for industrial output.
                                                                                                       But a similar acceleration in developing Asia was probably of
                                                                                                       greater significance for commodity markets. For although the
                                                                                                       latter area accounted for 27% of global GDP in 2005, compared
                                                                                                       with OECD’s 52%, the two Asian giants China and India were
                                                                                                       passing through a development stage that is much more inten-
                                                                                                       sive in primary materials use than the dematerializing mature
                                                                                                       OECD economies (M. Radetzki, 2006).
                                                                                                       China specially stands out in this respect. The country’s share of
                                                                                                       global demand growth for petroleum between 2000 and 2005,
                                                                                                       at 28% was almost double its share of global GDP in 2005
                                                                                                       (15.4% in PPP terms). In some metal markets, China’s domi-
                                                                                                       nance had become unsustainably extreme. Its share of global
                                                                                                       demand growth between 2000 and 2005 was more than 50%
                                                                                                       for aluminium, 84% for steel and 95% for copper.
                                                                                                       Producers caught unaware by China, India demand
more or less stable and quiet (excepting minor run-ups every now and then) un- Raw material producers were caught unaware, and with the
til late 2001, when China made a dramatic entrance to the world stage, courtesy contemporary habit of just-in-time inventories in many produc-
of the World Trade Organization.                                                tion chains at that time, and little spare production capacity,
The third commodity boom (2002-present)                                         prices in many markets moved up strongly. There was also an-
                                                                                other factor that amplified the importance of China and India in
The third commodity boom started in late 2001 and it may not have run its the commodities race -- a dollar added to the GDP in developing
course yet. Like the preceding booms, it was importantly triggered by a demand Asia absorbs more than twice the quantity of commodities as
shock. As in earlier commodity booms, the demand shock was importantly a re- does a corresponding dollar’s growth in the OECD countries.
sult of fast macroeconomic expansion. Furthermore, it was likewise abetted by
then Fed Chairman Greenspan's decision to hold short-term rates low far longer Therefore, the two countries would contribute about equally to
than necessary after the dot-com collapse in 2000 and the subsequent growth commodity demand growth if their economies expanded at the
recession. The ensuing demand from a rapid economic reflation of the Western same rates. But since developing Asia’s economies expanded at
economies after the 2000 contraction, and the entry of China (and subsequently more than twice the OECD rate, it would follow that their
For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                       8
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Commodity supercycle ending? China isn’t all that matters, Part 2
                                                                                                           to the upward price push, as did the storm damage to
                                                                                                           production installations in the autumn of that year
                                                                                                           (Hurricane Katrina in the U.S.). Oil prices remained at very
                                                                                                           high levels late in 2005 and early 2006, despite virtually
                                                                                                           full capacity utilization by OPEC. Metals and minerals
                                                                                                           prices rose as fast as energy until early 2005, then fell and
                                                                                                           stagnated for a while. By early 2007, a rapid rise in energy
                                                                                                           prices left all commodity sectors behind, culminating in a
                                                                                                           top spot price of $147.30/bbl by July, and subsequently
                                                                                                           helping trigger the Great Recession of 2007-2008.
                                                                                                           Crude and commodity prices will rise further
                                                                                          Last week, we asked: "Is the commodity supercycle end-
                                                                                          ing?" We answered: "Not if the Fed runs true to form" Part
                                                                                          1 (Diapason Capital Markets Report, April 19, 2012). The
                                                                                          primary premise leading to that belief was that "the Fed's
                                                                                          reaction function almost guarantees that interest rates will
                                                                                          stay too long, reigniting inflation". The chart on the left
                                                                                          tells us that the Fed is in the process of repeating past er-
                                                                                          rors, since they almost always react very late to develop-
                                                                                          ments in the economy rather than being proactive. In
                                                                                          short, the Fed is way too easy today, and this portends
contribution to commodity demand growth overwhelmed that of the OECD (as can be higher inflation in the future.
gleaned from the data on the previous page).                                              And if we think through the implications of a repeat of
The inflation record across the third boom is a bit unusual, as was that of the first those errors (especially in a 1970s context), then we will
boom (at least in its early stages). While national statistics have recorded an extremely come to the conclusion that commodities will continue to
low inflation in all important countries, the CPI Index increased from 1.6% in 2002 and rise higher in coming years. Given the context of a “Long
4.75% in 2005. The inflation recorded by the index in the 2 years is almost entirely Wave” dynamics still likely operative in commodity prices,
due to a sizable decline by some 30% in the US dollar parity versus the Euro.             we may still have a series of booms/busts with an up-
                                                                                          wards bias for a few more years, possibly until 2022-2026.
As in the second boom, the energy index, reaching almost 200 at its initial peak in
2005, recorded the strongest price increase. Oil, of course dominates this index. The No, we don’t think the “Commodity Supercycle” is going to
small inventories resulting from OPEC production restrictions in the years preceding end sometime very soon, if the Fed's reaction function
the boom, along with a further short output cut by the cartel early in 2005 contributed runs true to form (as is almost always the case).
For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                      9
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  Research Team                                                               _______________

  Sean Corrigan                                        Robert Balan                                        Alessandro Gelli                           Marion Megel
  Chief Investment Strategist                          Sr. Market Strategist                               Fundamental Research                       Fundamental Research
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  The Diapason Capital Markets Report is published and edited by Robert Balan, Senior Market Strategist
 Robert Balan has more than 3 decades of experience in the financial markets. Education in mining engineering, computer science, and training in economics led to a commodity analysis career
 during the commodity boom of the early 1970s. Robert made a switch to global macro focus in the early 1980 when the commodity bull market waned, with specialization in foreign exchange.
 Robert wrote a very high profile daily FX analysis while Geneva-based in the mid-1980s (the first FX commentary with a real global readership, "most accessed" in the Reuters and Telerate net-
 works from 1988 to 1994). He worked for Swiss Bank Corp and Union Bank of Switzerland (precursors of today’s new UBS) as head of technical research and proprietary trader in various major
 finance centers (London, New York, and Toronto) from late 1980s to mid-1990s. A stint at Bank of America as head of global technical research (London, New York) followed in late 1990s to early
 2000s. He returned to Switzerland in 2004 as head of technical research and strategy, and FX market analyst for Swiss Life Asset Management in Zurich. He joined Diapason Commodities Man-
 agement in 2008 as senior market strategist utilizing macro-economic drivers, structural/technical data in modeling asset price and sector movements. Robert wrote a book on the Elliott Wave Prin-
 ciple in 1988, hailed by the London Society of Technical Analysts as best book ever written on the subject. Robert is a member of the National Association for Business Economics (NABE), USA.

 Diapason Commodities Management SA 2012
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                                                                                                     The Diapason Capital Markets Report
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 they are deemed to understand and accept the terms, conditions and risks associated therewith and are deemed to act for their own account, to have made their own independent decision and
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Any third party product based on or in relation to the Indexes may only be issued upon the prior written approval of their respective owners and upon execution of a licensing agreement between
those parties and the party intending to launch a product.
For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                                                   11
                                                                                                     The Diapason Capital Markets Report
  DISCLAIMER
 Trademarks (continued)
 The Index Owners and their affiliates disclaim any liability to any party for any inaccuracy in the data on which their respective Index are based, for any mistakes, errors, omissions or inter-
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 © Diapason Commodities Management SA 2012
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 Last update on 13 February 2012                                                          Compliance approved: April 30, 2012




For important Disclaimers and Disclosures, please refer to the last two pages of this publication                                                                                                     12

				
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