17 May 2012 Economics Research http://www.credit-suisse.com/researchandanalytics Commodities Advantage: China – How Worried Should We Be? Commodities Research Research Analysts Navigating the Three Speed Global Economy Ric Deverell +44 20 7883 2523 The flow of economic data over the past week was on balance more positive email@example.com than many feared, with US IP for April and European and Japanese Q1 GDP all Joachim Azria surprising to the upside. Indeed, if one were to just look at the economic data, +1 212 325 4556 and not focus on the large and ever present risks emanating from Greece, it is firstname.lastname@example.org clear that growth in the G7 has continued to rebound from last year‟s swoon. Cilline Bain Unfortunately, life post Lehman is never that simple, with the Chinese data +44 20 7888 7174 release last week raising fears of a hard landing in the Middle Kingdom, while email@example.com events in Europe remind us that the economic data is backward looking – we Marcus Garvey note that growth in Europe was a relatively strong 0.7% in Q1 last year, but +44 207 883 4787 gave way to a 0.3% Q4 contraction as the “panic” took hold. firstname.lastname@example.org Given that events in Europe remain by their nature hard to predict, in this Tom Kendall week‟s note we do a deep dive into the current state of the Chinese +44 20 7883 2432 email@example.com economy. While the risks have clearly risen, we find that after a period where final demand was weaker than industrial production in H2 last year (resulting in Stefan Revielle an inventory build), over recent months this situation has reversed, with demand +1 212 538 6802 firstname.lastname@example.org stronger than production (inventories have been falling). This suggests that IP growth should bottom soon, and that unless demand takes another down leg Andrew Shaw (Europe remains the big risk), Chinese growth should improve in H2. +65 6212 4244 email@example.com All in all, this suggests to us that while the risks in the next month or two remain Jan Stuart to the downside, the most likely outcome (absent a European +1 212 325 1013 catastrophe…) is that the current three-speed economy transforms into a firstname.lastname@example.org synchronized recovery in H2. While it‟s hard to see it now, we believe this Ivan Szpakowski would most likely result in a rebound in most commodity prices with the likely + 65 6212 3534 falls in the next few weeks providing an attractive entry point. email@example.com Martin Yu + 44 20 7883 2150 Focus – The Land Down Under firstname.lastname@example.org Last week we met with a wide range of investors in Australia. Notably, despite the ongoing “mining boom” most of the focus in that producing nation is currently on supply side issues, whether they be taxation (resource nationalism), cost escalation (both currency, labor and capital) or the continued struggle to get qualified labor. The key message was that the risks to the wall of supply that many have been expecting have increased further, with Australian production of base metals in particular likely to have peaked unless prices move materially higher over coming years. It also suggests that while commodity prices are likely to remain relatively high, equity margins will likely remain under pressure. ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX. FOR OTHER IMPORTANT DISCLOSURES, PLEASE REFER TO https://firesearchdisclosure.credit-suisse.com. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 17 May 2012 In this Issue Macro View – A Three Way Tug of War…. 3 China: Lies, Damn Lies, and Statistics – Recovery Still In Sight ................. 3 Thank God For America – The US Stands Alone ...................................... 10 Europe: Backward Looking Data Improving, But The Great Tail Risk Remains Front and Centre ........................................................................ 11 Japan on the Improve ................................................................................ 12 Focus – The Land Down Under 14 Cost Escalation is the Word…. .................................................................. 14 Storm clouds gathering…or just a temporary hiccup? ............................... 14 Peak Aus Metal Production? ..................................................................... 17 Gold – Multi Year Opportunity? Or the Beginning of the End? 20 Trade Recommendation ............................................................................ 20 Bulk Commodities 21 Thermal Coal – Drowning in a sea of supply ............................................. 21 Iron Ore – Macro Fears Again Infect Physical Markets ............................ 24 Petroleum 25 Natural Gas 26 US supply moving in the right direction ..................................................... 26 Agriculture – Bearish bias continues 27 Technical Analysis 29 WTI Crude Oil‟s correction set to persist lower to $83.34 .......................... 29 Trade Recommendations 30 Commodities Advantage: China – How Worried Should We Be? 2 17 May 2012 Macro View – A Three-Way Tug of War…. The flow of economic data over the past week was on balance more positive than many feared, with US IP for April and European and Japanese Q1 GDP both surprising to the upside. Indeed, if one were to just look at the economic data, and not focus on the large and ever present risks emanating from Greece, it is clear that growth in the North Atlantic and Japan is continuing to rebound from last year‟s swoon. Unfortunately, life post Lehman is never that simple, with the Chinese data release last week raising fears of a Chinese hard landing, while events in Europe remind us that the economic data is backward looking – we note that growth in Europe was a relatively strong 0.7% in Q1 last year, but that that momentum quickly gave way to a 0.3% Q4 contraction as the “panic” took hold. While the risks have clearly risen, we continue to think that the most likely scenario is a more synchronized rebound in H2 this year (see a detailed analysis below). Of course the fly in the ointment remains developments in Europe, with the risk that another bout of panic results in another dip in activity – with the risk of full blown crisis in Europe („serious people‟ are now actively discussing the possibility that Greece may leave the eurozone) remaining uncomfortably high. In this world, while we continue to expect a rebound in many industrial commodity prices in H2, the near-term risk remain clearly to the downside. We would not recommend establishing a long side bias until the European panic begins to subside, which looks unlikely until at least late June, assuming new Greek elections help clarify the situation. China: Recovery Still In Sight The weakness in the Chinese IP growth and monetary aggregates in the month of April was a genuine surprise last week, with the dip in IP suggesting that the strong March data may have been a head fake, and that underlying momentum remains soft. It was notable that the weakness in April IP was in line with that observed in the NBS PMI (as seasonally adjusted by Credit Suisse) the week before (see Chinese Growth Disappoints), as well as the moderation in growth of monetary aggregates. Exhibit 1: Chinese IP Remains Soft Mom trend sa change in Chinese IP, Average of HSBC and NBS PMI New Orders (NBS sa by Credit Suisse) 65.0 Average PMI New Orders Chinese IP ann mom trend sa, rhs 30% 25% 60.0 20% 55.0 15% 10% 50.0 5% 45.0 0% 40.0 -5% Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: the BLOOMBERG PROFESSIONAL™ service While the initial print was a shock to the market, over the past week we have been digging through the a range of Chinese data in an effort to get a better feel for where we stand, and for what happens next. Commodities Advantage: China – How Worried Should We Be? 3 17 May 2012 Somewhat surprisingly (at least to us), our broad conclusion remains that growth troughed in Q1 and is likely to rebound modestly in H2. The primary modification to our view is that the recovery out of the Q1 trough may be slower than expected, with Q2 only modestly stronger than the low point in Q1. As we have often stated, basic material demand in China is driven primarily by a combination of fixed asset investment and industrial production, with industrial production ultimately driven by final demand, which in broad terms can be captured by data for retail sales, fixed asset investment and exports. In large part, we feel that part of the weak consensus view has been driven by observing the economy in nominal terms (FAI, retail sales and exports are all released as nominal yoy changes by the NBS). However, it is very clear that the rate of inflation has moderated substantially over the past year, with this disinflation providing a substantial drag on nominal variables. When the nominal series are adjusted for inflation, the supposed weakness appears far less scary. Fixed Asset Investment As we have noted on numerous occasions, when viewed in real level terms, aggregate fixed asset investment has been far steadier than suggested by much of the market commentary. Most of the variation in recent years has been nominal effects and monthly volatility. In level terms, FAI jumped on the back of the stimulus in late 2008 and 2009, and since has seen relatively stable growth of 17%, down from the pre-crisis 25% growth rate. Taken literally, the pace of growth in FAI dipped a little in Q4 last year (but really it was just a weak December, which to us is more about statistical volatility than signal), but growth has rebounded so far this year, with the level back on trend. Exhibit 2: Fixed asset investment remains robust Exhibit 3: If anything, growth has rebounded in 2012 Level of real FAI, deflated by PPI, logs (RMB Billions) Real trend mom, seasonally adjusted Chinese fixed asset investment, real ann trend mom sa 80.0% 30.0% Chinese IP ann mom trend sa, rhs 70.0% 25.0% 60.0% 20.0% 50.0% 40.0% 15.0% 30.0% 10.0% 20.0% 5.0% 10.0% 0.0% 0.0% -10.0% -5.0% Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: NBS, Credit Suisse Source: NBS, Credit Suisse We also note that despite falling prices, and weakness in sales and new starts, total construction in the housing sector (as measured by FAI housing – again we deflate the series to iron out pricing effects) has remained resilient, with developers continuing to work through the backlog of orders, as we had anticipated in Chinese Housing and Commodity Demand: Healthy Growth Despite Private Dip, with the link between sales and actual construction much weaker than many had feared. Some of our China analysts have also noted that developers are not moving to rapidly deplete inventories, but are rather moving new starts in line with sales. Commodities Advantage: China – How Worried Should We Be? 4 17 May 2012 It also worth noting that the government‟s housing policy is targeted at controlling prices in response to social pressures in major cities, but that commodity demand is related to actual construction activity and not prices or even sales volumes. Exhibit 4: Real estate construction (FAI) remains Exhibit 5: Again, if anything, growth has picked up strong this year Level of real FAI, deflated by PPI, logs Real trend mom change in FAI Real Estate Construction, seasonally adjusted Source: NBS, Credit Suisse Source: NBS, Credit Suisse Finally, after slow growth in 2011, there is early evidence that infrastructure spending has begun to rebound in recent months, as the government moves to ensure that growth does not slump further. Note that despite all the talk of the rebalancing of growth, infrastructure spending is an area where the government can quickly and directly stimulate activity in the face of weakness in other sectors, and as such tends to reflect the Government‟s policy stance of the day. Exhibit 6: Infrastructure spending – Rebound? Exhibit 7: Has the new stimulus started? Level of real FAI, deflated by PPI, logs Real trend mom, seasonally adjusted Source: NBS, Credit Suisse Source: NBS, Credit Suisse Retail Sales Despite the clear objective to rebalance the economy, real retail sales growth has remained remarkably stable, with the average pace since early 2010 around the same 10% as seen pre crisis. In broad terms this suggests that much of the observed weakness has been driven by falling prices and base effects. Commodities Advantage: China – How Worried Should We Be? 5 17 May 2012 Notably, while sales growth dipped late last year, it has since rebounded, with activity back on the trend apparent over recent years. Exhibit 8: Chinese underlying real retail sales Exhibit 9: With the dip late last year being unwound growth has returned to pre stimulus 10ish% Level and real trend mom, seasonally adjusted Real trend mom, seasonally adjusted 7.3 China retail sales, real ann trend mom SA annualized 30.0% 30.0% Chinese IP ann mom trend sa, rhs growth = 9.8% 7.1 25.0% 25.0% post-stimulus annualized growth 6.9 growth = 17.2% 20.0% 20.0% 6.7 annualized stimulus growth = 15.0% 15.0% 6.5 10.0% 10.0% 10.0% 6.3 6.1 5.0% 5.0% 2005 2006 2007 2008 2009 2010 2011 2012 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: Markit Economics, NBS, Credit Suisse Source: Credit Suisse Exports While neither FAI nor retail sales growth has seen any significant shifts in real terms, it has become increasingly clear that weak growth in the North Atlantic economies has resulted in a marked slowdown in the underlying pace of export growth. After growing at around 20% per year pre-crisis, export growth since mid-2008 has slowed to an average 6%, with growth of only a little above 3% annualized since late 2010. However, as with both FAI and retail sales, the dip in activity seen at the turn of the year has now been effectively unwound, with growth momentum bouncing back so far this year in line with the modest recovery in the US, and to a lesser extent Europe. Exhibit 10: Structural export growth has slowed, Exhibit 11: …Or to a very weak 3ish%? but is it to 6ish%... Level and real trend mom, seasonally adjusted Real trend mom, seasonally adjusted 14.2 14.2 14.0 14.0 slow annualized 13.8 annualized 13.8 growth = 3.3% growth = 6.3% 13.6 13.6 Global recession & Global recession 13.4 13.4 rebound with 43% annualized annualized annualized growth growth = 20.1% growth = 20.1% 13.2 13.2 13.0 13.0 2005 2007 2009 2011 2005 2007 2009 2011 Source: Markit Economics, NBS, Credit Suisse Source: Credit Suisse Commodities Advantage: China – How Worried Should We Be? 6 17 May 2012 Exhibit 12: Short-term momentum has recovered, but structural growth likely to remain subdued … Europe remains a big concern Index and trend mom change, seasonally adjusted 63 US & Euro Manf PMI New Orders average 6.0% Chinese real exports, trend mom sa, rhs 61 5.0% 59 4.0% 57 3.0% 55 2.0% 53 1.0% 51 0.0% 49 47 -1.0% 45 -2.0% Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Source: the BLOOMBERG PROFESSIONAL™ service Proxy For Chinese Demand Combining the three measures (FAI, retail sales and exports) as a simple proxy for Chinese demand, it is notable that despite all the talk of weakness, Chinese demand in real terms remains consistent with the longer run trend. Nevertheless, it is also clear that the impact of the post-crisis stimulus has faded, with growth since early 2010 modestly weaker (14.6% annualized) than the roughly 18% growth seen pre crisis. In large part, this is due to weaker structural export growth (external demand) rather than any change in the domestic economy. Exhibit 13: Our demand proxy is back on long-run Exhibit 14: But the pace of growth looks to have trend slowed a little, with exports the key drag Average of real FAI, Retail Sales and Exports Log Level Average of real FAI, Retail Sales and Exports Log Level 5.9 5.9 5.7 5.7 5.5 5.5 annualized growth = 14.6% Stimulus 5.3 5.3 annualized 5.1 5.1 growth = 28.2% 4.9 4.9 annualized growth = 18.5% 4.7 4.7 4.5 4.5 2006 2007 2008 2009 2010 2011 2012 2006 2007 2008 2009 2010 2011 2012 Source: the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse From a cyclical perspective, after a period where demand had slowed more than IP last year (a period of inventory build), IP growth has continued to slow so far this year, while final demand has substantially recovered from the weakness in late 2011. This suggests to us that after a period of building inventory in late 2011, manufacturers have been running down inventories so far this year. Commodities Advantage: China – How Worried Should We Be? 7 17 May 2012 If final demand remains solid (Europe is an obvious concern), this suggests that production is most likely to begin to recover over coming months, although continued weak exports suggests that a return to the 15% average growth seen pre crisis is unlikely. Exhibit 15: Rebound in final demand suggests that IP also set to recover Chinese IP growth mom sa trend versus average of real FAI, real retail sales and real export growth mom sa trend Average of Retail Sales, FAI, Exports, real ann trend mom 35.0% 30.0% Chinese IP ann mom trend sa, rhs 30.0% 25.0% 25.0% 20.0% 20.0% 15.0% 15.0% 10.0% 10.0% 5.0% 5.0% 0.0% 0.0% -5.0% Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: NBS, Credit Suisse Monetary Data & Policy Outside of industrial production, the lack of indications of monetary stimulus represented our biggest disappointment in China‟s April macroeconomic data release. The PBoC‟s Q1 monetary policy statement released at the end of March announced a shift from “selective adjustment” to “appropriate increase” of money and credit supply, and March monetary data seemed to confirm a shift to more full-fledged easing. However, this momentum did not carry over into April, with the PBoC reacting by cutting the RRR. New RMB bank loans failed to maintain the strong pace set in March, dropping back into line with volumes seen in 2010 & 2011. The PBoC‟s social financing data (the central bank‟s most comprehensive measure of credit throughout the entire economy) was even more disappointing. Most notably, growth in bank acceptances/letters of credit was soft (RMB 28 billion) following the strong increase in March (RMB 277 billion). This sector had been under pressure since last August when banks were instructed to begin holding reserves against money pledged for such financing, but had appeared to be recovering following the full implementation of this regulation in February. The normalization of such credit would be a huge boon, particularly to beleaguered industrial and trading firms. While the flow of credit remains a risk, we continue to expect lending to pick up in coming months, as we would need to see lending 6%-20% higher than 2011 levels for the remainder of the year to hit the government-implicit target of RMB 8-8.5 billion for the year as a whole. Commodities Advantage: China – How Worried Should We Be? 8 17 May 2012 Exhibit 16: Bank lending did not maintain March momentum, but should be stronger over coming Exhibit 17: Recovery of letters of credit (green in months chart) would provide an important stimulus RMB billions RMB billions 2,000 2,000 1,750 Other 1,500 Corporate 2012 Bonds 1,500 2011 Bank 1,250 Acceptances 2010 Trust Loans 2009 1,000 2003-2007 average Entrusted 1,000 750 Loans Foreign 500 Currency Loans RMB Loans 500 250 0 -250 0 Jan- Feb- Mar- Apr- Jan- Feb- Mar- Apr- Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011 2011 2011 2011 2012 2012 2012 2012 Source: CEIC, PBoC, Credit Suisse Source: PBoC, Credit Suisse Policy Outlook We expect a renewed focus from policymakers to ensure that growth does not slow further – GDP growth in Q1 was 7.4% saar, at the lower end of the authorities‟ likely tolerance. While we do not expect a 2009-style aggressive policy response, we expect modest additional stimulatory measures. However, as is often the case in China, it is unlikely that there will be any major announcement; rather, identifying China‟s policy stance will remain a case of watch what I do rather than what I say. We expect a combination of: Renewed efforts from the party to ensure that banks (which are fundamentally agents of the government‟s fiscal policy) achieve RMB 8-8.5 trillion in new loans for the year. Note that while there may well be additional RRR cuts, they are only effective at directly stimulating credit if banks are constrained with respect to funds available for lending – something for which there is not currently a clear case. Interest rate cuts would also be difficult given the weakness in deposits, leaving quantitative rationing as the primary monetary policy tool. Further moderate fiscal expansion. The apparent rebound in infrastructure spending is encouraging, with further emphasis on the social housing rollout likely over coming months. China‟s State Council also unveiled RMB 36 billion in consumer subsidies this week (principally for energy efficient appliances), representing the most substantial new subsidies yet this year. While not as large as those rolled out in the wake of the financial crisis, they reflect the government‟s willingness to provide support via fiscal measures. The Commerce Ministry has also been aggressively pushing to support for exporters, and while keeping the RMB from appreciating has been the only major concession it has won so far, additional supportive policies are likely. Selective easing of restrictions on home purchases in individual cities, as well as improved mortgage availability, pricing, and relaxation of down payment requirements for first home buyers. Commodities Advantage: China – How Worried Should We Be? 9 17 May 2012 Thanks For America – The US Stands Alone Somewhat remarkably, despite the weakness elsewhere, the gradual recovery in the US continues to build, with the slowdown scare in the process of being relegated to history. This week industrial production growth for the month of April printed at 1.1%, well above the consensus expectation of 0.5%, while US housing starts also continued to improve. Exhibit 18: USIP continues to recover Percent and index 17% US IP ann 3mma US Manf IP ann 3mma ISM Manf New Orders 75 70 12% 65 60 7% 55 2% 50 45 -3% 40 -8% 35 2005 2006 2007 2008 2009 2010 2011 2012 Source: the BLOOMBERG PROFESSIONAL™ service To us the excellent work undertaken by our US equity housing research team (Housing Starts and Permits - Single-Family Activity Improving Through Selling Season as Buyers Gain Confidence) provides quite compelling evidence that the major blockage to the US recovery (the housing sector) is gradually beginning to thaw, suggesting considerable upside to growth and commodity demand over the remainder of the year. Exhibit 19: Buyer traffic and home sales Exhibit 20: Home prices and price index Index against trend monthly changes (existing and new home sales) Index and monthly changes, seasonally adjusted 70.0 Buyer Traffic Index 6% 80.0 Home Price Index 2.0% Total Home Sales Trend MoM, rhs Case-Shiller Home Price MoM SA, rhs 70.0 1.5% 60.0 4% 1.0% 60.0 50.0 2% 0.5% 50.0 40.0 0.0% 0% 40.0 30.0 -0.5% 30.0 -2% -1.0% 20.0 20.0 -1.5% -4% 10.0 10.0 -2.0% 0.0 -6% 0.0 -2.5% 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Advantage: China – How Worried Should We Be? 10 17 May 2012 Europe: Backward Looking Data Improving, But The Great Tail Risk Remains Front and Centre Over the past week Europe has continued to dominate market pricing. Perversely, while all of the focus remains on the Greece related risks, the actual economic data continues to suggest that after slumping heavily late last year, economic activity began to stabiles in early 2012, with GDP flat (after falling 0.3% in Q4), while in trend terms euro area IP growth has returned to around zero, following a substantial contraction in Q4. Exhibit 21: The European recovery has commenced: Exhibit 22: And IP Momentum is turning positive, GDP has stopped contracting with the PMI once again a poor guide… Real quarterly change Percent 1.5% Euro PMI New Orders 65.0 15% Hundreds Euro IP Ex Construction MoM SA,ann trend mom rhs 1.0% 60.0 10% 0.5% 55.0 5% 0.0% 50.0 0% -0.5% 45.0 -5% -1.0% -1.5% 40.0 -10% 2005 2006 2007 2008 2009 2010 2011 2012 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Source: the BLOOMBERG PROFESSIONAL™ service, Eurostat, Credit Suisse Source: : the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Of course, this economic data is backward looking, with the real issue in Europe related to the size of the Greek exit tail risk, and in derivative form, the degree to which the renewed panic will see economic growth dip again. We note that as the panic commenced in Q2 last year growth had substantially more momentum than at present. In Q1 2012 GDP grew by 0.7%, much more than the flat outcome in Q1 this year. It is also notable that the disparities in growth have also increased with Germany growing in Q1, while the rate of contraction in the periphery has increased. In terms of the assessment of the probability of a Greek exit, or a related major growth shock, any assessment is by nature subjective. We suspect the Greek government is looking at the Argentinian experience very closely. They would currently be weighing the certainty of a long lasting depression, with the very large cost of leaving the euro, which nonetheless holds the possibility of some recovery. We note that the real difference, however, is that when Argentina defaulted and broke the hard peg, it did so in isolation (although the bond holders wouldn‟t agree with this analysis). The challenge for Europe is to contain such an event to Greece – it‟s always really been about the other peripheral countries. So what might be in Greece‟s interest may not be great for others…. Even given this, however, it is clear that „serious people‟ think that a break is inevitable. The choice for the core (and for the US China etc) is between the likelihood of a market panic every six months or so, or the possibility of a sharp (and hopefully relatively short) shock. At the moment they on balance continue to think that living with the volatility is the best outcome. But they are also aware that the pesky thing about these situations is that the people (they are democracies after all) often have other ideas. It‟s not great secret that government officials in Berlin etc are doing the math on whether they can contain the fallout of a Greek departure. Commodities Advantage: China – How Worried Should We Be? 11 17 May 2012 This all suggests to us that the probability of a departure is greater than many think. And that while the very large cost of Greece leaving the euro suggests that it remains in both Greece‟s and the core‟s interest to push on with the current plan, it would be risky indeed to establish substantial long positions in risk assets until the current panic in Europe subsides. Exhibit 23: But the great risk is that the renewed financial panic results in a further dip in activity – with the risk of a Greek exit too large for comfort Percent 7.5 Spain Italy 7 6.5 6 5.5 5 4.5 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Source: the BLOOMBERG PROFESSIONAL™ service Japan on the Improve Mostly ignored in the rush to focus on downside risks in Europe, the Japanese national accounts for Q1 confirmed that after a rugged year that begin with the tragic tsunami, the Japanese economy is finally beginning to climb off the mat. While it is unlikely that the rebound pace of growth in Q1 (GDP increased by 4% saar) will be sustained, it does highlight the fact that Japanese commodity consumption, as the reconstruction commences, will be a positive this year, whereas last year it was a large drag, particularly on basic materials. Exhibit 24: Japanese GDP on the move…. 8 Rebounding? 6 4 2 0 -2 -4 -6 Earthquake -8 -10 -12 2005 2006 2007 2008 2009 2010 2011 2012 Source: the BLOOMBERG PROFESSIONAL™ service Commodities Advantage: China – How Worried Should We Be? 12 17 May 2012 Commodity Performance Commodities continued to fall with other risk assets over the past week, with palladium, WTI crude oil and corn the biggest losers. Only US natural gas ended the week higher as injections remained below average for this time of the year. In year-to-date terms, soybean remained the top performer, followed by RBOB gasoline. Exhibit 25: Commodity Performances (as of close of May 10, 2012) Weekly returns, active contract Year to date returns, front month Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Advantage: China – How Worried Should We Be? 13 17 May 2012 Focus – The Land Down Under Cost Escalation is the Word…. “Can‟t you hear, can‟t you hear the thunder? You better run, you better take cover” – Men at Work, „Down Under‟ Any trip to Australia brings a certain amount of bellicose about everything from the government to „Aussie Rules‟ football or cricket. The latter is usually considered far more important to the people on the street than the price of copper, but public interest in taxation policies affecting the mining industry, environmental impact, and even the behavior of prominent mining magnates, as examples, have attracted a high degree of public attention. Coming in the midst of the government‟s budget roll-out, last week‟s travels by Credit Suisse‟s commodities team to see producers and investors in all corners of the vast continent revealed a heightened degree of anxiety about the path forward, not just in 2012, but for many years to come. Storm clouds gathering…or just a temporary hiccup? On this visit, there was a much deeper feeling that storm clouds were gathering on the horizon, although there was a wider belief that emerging market demand patterns would remain relatively strong, in contrast to the more pessimistic perception of China in Europe and, especially, the USA. With miners and energy companies chasing plans to develop projects sometimes of Titanic proportions (literally), statements from a number of major players about investment prudence and tightened portfolio management are a clear indicator that some industry captains are preparing thoroughly for more uncertain times. This is exemplified by BHP Billiton‟s CEO, Marius Kloppers, who commented at an investment conference this week: "Clearly what we've seen over the last 12 months or so is that our projected rate of cash generation has changed. So, on balance, while we still want to invest throughout the cycle, it just means that our ability to do those projects will change as the cash-flow generation has changed." When he was asked whether the company would still spend a planned US$80 billion over the next five years the answer was a very simple, “no”. This does not mean growth in Australia‟s commodity supply is at an end, but it is illustrative of a more refreshed understanding of the opportunity cost of capital by major miners, predominantly dictated by a riskier global macro and commodity price environment. The question is where else does the money flow? The answer for some of the investors we addressed was emerging markets to Australia‟s north. There are two things certain in life…one of them is taxes Of course, more broadly, producers have not shied away from beating their own drum, but many complain more about the loss of investor confidence in decisions that change. For example, whatever the merit, the poor handling of the Henry Tax initiative by the government continues to be the source of prickly debate. The most recent bout of price weakness has accentuated fears that Australia‟s long boom has moved into a distinctly different, and more challenging, phase and that the easiest fruits have been plucked without optimum distribution of „economic rent‟. Naturally, a question of perspective. On the one hand is a government worried about balancing the books for years to come, and increasingly aware that the opportunity to cash in on windfall years may have largely passed. On the other, investors are becoming much more risk averse in the sector, especially in the face of rising capital intensity, and mine developers/promoters keen to retain rewards subject to fiercer claims by other stakeholders. Commodities Advantage: China – How Worried Should We Be? 14 17 May 2012 Tension between resources companies and other key stakeholders – not least the state – is nothing new. However, the establishment of consistent and transparent frameworks agreed by all interest groups appears to be a long way off. Very recent examples of this include the decision by BHP Billiton to close its marginal Norwich Park metallurgical coal mine, on the grounds of weak profitability, but almost certainly influenced by protracted labor disputes afflicting the group‟s met coal mines. Similarly, Rio Tinto and the Queensland and federal governments have been embroiled in debate about plans to develop a new bauxite mine, with the sticking point being different interpretations of the environmental assessment. The result is project delay, with cost consequences. We take the view that an extended era of relatively strong demand growth for industrial and energy commodities lies ahead, but that general cost escalation and, in some cases, the sapping effects of resource depletion, are likely to chip away at margins, at least for those operators not blessed with very low-cost production bases. In essence, this is how we regard the second half of the so-called „long boom‟. This is a view shared by a number of Australia‟s major resource companies which have signaled reining back ambitious investment spending over the next few years. This is a clear signal of the shifting return dynamics. There is a clear trend among investors of a firmer re-orientation towards selective emerging market exposure and re-balancing of Australian positioning. Cost escalation – causing a rethink? Virtually all producers we met expressed serious concerns about cost inflation, both capital and operating, and problems in controlling this. For the major producers this is mirrored in statements that demonstrate a renewed strategic focus on cost control, and operational performance improvement, as well as disciplined development, where the general industry track record is one of under-performance on meeting both budget targets and schedules. For example: Today‟s gold prices are putting a strain on marginal sources of supply. Base metals producers too complain about a growing squeeze on margins. Both sectors face constraints on lifting production; our quarterly forecasts reflect this, with gold, silver, zinc, lead and nickel close to peak levels in 2012-13; current market conditions are likely to bring forward, rather than defer, this „peaking‟. In thermal coal too, we have heard protestations that current prices, should they persist, would undo the attractiveness of expanding output. Likewise, we have seen a squeeze on marginal suppliers of coking coal in the recent price downturn. In contrast, expansion is the name of the game in iron ore and LNG, but, even here, rising capital intensity and an uncertain price outlook are stacking the risks towards under-delivery. At the time of our latest quarterly forecast, we re-iterated a view that iron ore supply might take longer to overwhelm demand than many forecasters had expected. This remains a prominent risk to these forecasts in the face of current price retreats. The same is true of LNG, but the risks here for Australia‟s suppliers lies with a steady shift in emphasis to shale gas (noticeable in some producer presentations), and the likelihood, eventually, that cheaper US gas will find its way into seaborne markets, as well as the potential impact of opening up shale gas opportunities elsewhere over time. Cost dynamics about to change again In a booming market, with prices rising, costs always rise too – the „inputs‟ are markets too, subject to the laws of supply and demand. This week‟s slide in the Australian dollar to fractionally less than parity with the US dollar for the first time in almost five months, emphasizes the “risk-off” effects of the current commodity market gyrations. Currency appreciation has been a major factor behind Australia‟s outpacing many other regions in terms of cost escalation, but these movements are not permanently in one direction. Commodities Advantage: China – How Worried Should We Be? 15 17 May 2012 Here we should remind readers that when markets slip, they often slide – much further than expected. This is not our central assumption, but cost curves provide little material support if sentiment is in the wrong direction (mines often do not shut down quickly as, in the very short run, many of their costs are fixed). Prices typically overshoot, both on the way up, and on the way down. A sharper plunge in key commodity prices in the next few weeks or months would almost certainly be accompanied by a similar slide in the Australian dollar – this in turn chases costs down, and triggers further falls. Remember, US$3,000/t copper in late 2008/early 2009 went hand-in-hand with 63 cents to the US dollar. Exhibit 26: Copper prices and the Australian dollar in late 2008 and early 2009 US$/t, AU$/US$ $10,000 $1.10 LME Copper 3M AUD/USD (rhs) $9,000 $1.00 $8,000 Fell hand-in-hand $0.90 $7,000 $6,000 $0.80 $5,000 $0.70 $4,000 $0.60 $3,000 $2,000 $0.50 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Exhibit 27: Long term Australian dollar trend Exhibit 28: Australian terms of trade A$/US$ Index $1.60 140 130 $1.40 120 $1.20 110 100 $1.00 90 $0.80 80 $0.60 70 60 $0.40 50 $0.20 40 1975 1980 1985 1990 1995 2000 2005 2010 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: the BLOOMBERG PROFESSIONAL™ service Source: the BLOOMBERG PROFESSIONAL™ service Rising labor charges are a major element behind this pattern of increasing costs, across the board. The Australian National Resources Sector Employment Taskforce estimated a shortage of 36,000 trades workers by 2015. So too, delays and costs of sourcing capital equipment and inflated costs of consumables have adversely impacted mining and project development. Commodities Advantage: China – How Worried Should We Be? 16 17 May 2012 Presentations by Rio Tinto and Xstrata highlight that lead times for procuring heavy equipment (draglines, locomotives, large haul trucks, re-claimers etc.) still stand at two years or more (the same as in 2007), double „normal‟ lead times. These same presentations point to the impact of changing regulations, community issues and environmentalist opposition as being the major causes in project deferrals and delays. Xstrata more broadly highlights the cost dilemma. The Australian-based miner estimates that capital intensity of copper mines potentially to be developed in the next eight years is generally more than double the US$7,700/t average (in real 2011 US dollar terms) for projects brought on line in 1985-2011. Operators and developers indicated to us that cost escalation in Australia has been more onerous than in many other geographies. Peak Australia Metal Production? Australia‟s base metals and gold miners are facing high rates of depletion – resulting in grade declines and pressure on fundamental costs of unit extraction. This is in contrast to iron ore where mine production has grown by an order of magnitude since the 1990s: Exhibit 29: Australia’s mined production of industrial commodities Metal content in „000t or raw iron ore in Mt 1995 2000 2005 2010 2011 2012 2013 2014 2015 Copper 402 830 914 861 947 989 1014 1016 995 Zinc 910 1386 1346 1481 1490 1516 1634 1643 1294 Lead 440 661 733 648 576 613 717 708 675 Nickel 101 168 200 181 192 205 206 205 202 Iron Ore 130 157 239 402 439 479 558 650 733 Source: Credit Suisse forecast, Brook Hunt (Wood Mackenzie), World Steel Association Australia went into the 2000s at a copper mine production rate of 830 kt/y, but output in 2012 is expected to still fall short of the 1 Mt/y mark. With the exception of Olympic Dam, which is some years away from adding to Australia‟s copper supply substantially, new projects will likely struggle to compensate the effects of depletion, with copper mine supply expected to peak at about 1 Mt/y, relying on Olympic Dam‟s expansion to counter this trend. BHP Billiton has stated it will make a decision on this South Australian mega-project this year, but many analysts consider initial designs may be more modest. Zinc mine production stood at 1.4 Mt/y in 200, but was just 100 kt/y higher by 2011. The closure of Century in Queensland in 2014 and a number of other mines will see zinc mine production likely peak at little more than 1.6 Mt/y in the next 2-3 years. Lead mine output has already slipped back from a peak 727 kt/y in 2001 to less than 600 kt/y. Expansions at Magellan and Rasp are expected to temporarily stem this decline, but lead mining in Australia too will have likely passed a peak by 2013-14. The restart at Ravensthorpe in Western Australia (to an eventual 40 kt/y Ni) – which appears to be on track – will potentially bring Australia‟s nickel mine production back up to the 200 kt/y mark, a level reached in the second half of the 2000s. Once again, though, the effects of depletion in WA‟s sulphide resources, slowed by successful additions by smaller companies, will begin to show up in more dramatic fashion beyond 2015. The scope for further growth in bauxite and alumina production exists, with rises beyond 2012‟s expected 20.8 Mt achievable over the next few years. However, regulatory approval will play a big hand in this outcome. A moot point. Commodities Advantage: China – How Worried Should We Be? 17 17 May 2012 Exhibit 30: Australia’s copper, zinc, lead and nickel mine supply in 1995-2015 Index: 1995=100 Source: Credit Suisse, Brook Hunt (Wood Mackenzie), World Steel Association Some explorers and developers have opted to shift their primary focus offshore, especially in light of perceived higher exploration success, and lower risk of „deal breakers‟. However, going offshore is no panacea for success either, with myriad factors – many common to Australian operators – from infrastructure costs, to skills shortages, securing quality contractors, capital equipment lead times, to locational and community risks, making guarantee of high returns a major challenge. Not to mention political risks. In summary: The ingredients for an eventual acceleration of capital outflows in the resources space are building. How rapidly this pattern evolves will be down not only to the serendipity of commodity markets, but also to the vision, or otherwise, of policymakers. The scorecard here is still lacking. There is general dissatisfaction at government stewardship of Australia‟s resources industry; equally, industrial relations and public sentiment towards resources companies show plenty of room for improvement. Australia remains an important contributor to growth for a number of major industrial and energy commodities, but the forces of depletion and cost escalation mean that windfall profitability for many operators outside of iron ore may be a thing of the past. For base metals and gold, supply is likely to be at, or close to, a peak – deeper-than- expected cyclical price weakness would serve to bring forward and accentuate this peaking, potentially sowing the seeds for a subsequently sharper price upswing. Iron ore supply looks set to continue its growth, but the long-awaited „wall‟ of new supply may be pushed back in time. However, if new projects at an advanced stage do meet their targets, the prospects of fiercer supply competition point to potential for price corrections in years to come. The coal industry faces challenges in timely supply growth at economic value, both on the basis of costs and in the face of generally poor industrial relations. In the longer run, growth in supply of gas from unconventional sources points to the gradual emergence of coalescing globally-priced gas markets. This may take many years to come, but risks impacting the economics of LNG projects may be growing, although the massive investment stream looks assured for the next few years given the large lags in the projects. Commodities Advantage: China – How Worried Should We Be? 18 17 May 2012 Investors and producers retain a belief that demand prospects in emerging markets will remain relatively strong, but that this does not guarantee easy returns. All round, the easy pickings for Australia‟s resources industry would appear to have gone, something that both investors and the federal government appear to be recognizing. Meanwhile, participants with strong existing asset positions may have the opportunity to reap a harvest for many years to come. Exhibit 31: Spot iron ore in Australian dollars Exhibit 32: LME copper in Australian dollars Spot, A$/t Three month contract, A$/t $210 $12,000 $11,000 $190 $10,000 $170 $9,000 $150 $8,000 $130 $7,000 $6,000 $110 $5,000 $90 $4,000 $70 $3,000 $50 $2,000 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Source: the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse Exhibit 33: LME Aluminum in Australian dollars Exhibit 34: Comex gold in Australian dollars Three month contract, A$/t Front month, A$/t $4,500 $2,000 $1,800 $4,000 $1,600 $3,500 $1,400 $3,000 $1,200 $1,000 $2,500 $800 $2,000 $600 $1,500 $400 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Source: the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse Commodities Advantage: China – How Worried Should We Be? 19 17 May 2012 Gold – Multi-Year Opportunity? Or the Beginning of the End? Gold has moved into dangerous territory over the past week, with the long-term trend now under threat. Notwithstanding the volatility of most asset prices over recent years, gold has moved in a really tight trend for the past decade, increasing at a consistent 16% per year. Every time the price has moved three standard deviations above the trend it has corrected, while every time it has fallen three standard deviations below it has resumed the upward trend. Indeed, every time it has moved to the top of the range it has then in the subsequent year moved to the bottom of the range, before resuming the up trend At the current price of $1546 we are well below the trend, with the lower three standard deviation band at $1518. The last time gold had a correction of this magnitude was between March and October 2008 – the bottom was 23 October (hopefully there are no parallels with forthcoming events in other markets…). History suggests that we either bounce from here, or that the correction accelerates, with the chances of an outright route a possibility. While we expect gold to peak sometime next year, on balance we expect the uptrend to resume over coming weeks, with the current level providing a rare entry opportunity. We note that we are yet to break the 3 standard deviation band that held in 2008. For a more detailed discussion see - Gold Watch Exhibit 35: Breaking out or bouncing back? US$ $2,000 Gold Price $1,750 Expected Value Upper 3 Std Dev. $1,500 Low er 3 Std Dev. $1,250 $1,000 $750 $500 $250 2006 2007 2008 2009 2010 2011 2012 Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service Trade Recommendation Given that on balance we expect the decade long up trend to resume, we recommend increasing exposures to gold at current levels through the purchase of a short-dated (2week to 1 month) call with strike of $1625. The risk is the premium paid. Commodities Advantage: China – How Worried Should We Be? 20 17 May 2012 Bulk Commodities Thermal Coal – Drowning in a sea of supply With many of the world‟s coal market participants gathering in Nice earlier this week, it provided a good opportunity to test people‟s current sentiment. Given the continuing slide in thermal coal prices (Exhibit 36), the mood was decidedly bearish with the million dollar questions being “how long will this last” and “how low can we go”? Exhibit 36: Thermal prices continue to slide Exhibit 37: Short positioning has clearly paid off US$/t, spot US$/t, front calendar contract 150 135 Newc API #4 API#2 140 130 130 125 120 120 110 115 100 90 110 80 105 70 100 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Source: Credit Suisse, McCloskey Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service In the near term, short positioning means the paper market (Exhibit 37) could be susceptible to a short-covering rally but the current physical market dynamics mean any paper rally would likely meet good selling and be more flash in the pan than full-blown recovery. As illustrated by the below (Exhibits 38 39), the well documented net change in US exports has been dramatic and the shift in domestic energy markets engendered by shale gas means we expect this to remain a structural rather than cyclical dynamic (as outlined in The Pause That Refreshes). Exhibit 38: US thermal coal exports Exhibit 39: US thermal coal imports Mt, SA Mt, SA 6 3.5 3.0 5 2.5 4 2.0 3 1.5 2 1.0 1 0.5 0 0.0 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Source: Credit Suisse, Customs Data Source: Credit Suisse, Customs Data Commodities Advantage: China – How Worried Should We Be? 21 17 May 2012 Further out, with our forecast for China and India to import more than 200Mt and 150Mt respectively in 2014, we see this US glut as much less of a dampener on the market but that provides little solace for those selling coal in the coming months. The current situation thus remains one of robust demand overwhelmed by more than ample supply. Exhibit 40: Seaborne arb for Chinese thermal coal imports US$/t (lhs), Percent (rhs) Impo rted Co al (So uth China CIF + VA T) 145 Do mestic Co al (QHD FOB + Freight) 10% Impo rted Co al Disco unt (rhs) 140 8% 135 130 6% 125 120 4% 115 2% 110 105 0% Jun-11 Sep-11 Dec-11 Mar-12 Source: Credit Suisse, McCloskey In terms of what can then turn things around, the marginal cost of production is clearly not a base for spot market prices as trades below $90/t already put most Russian production and many US suppliers out of the money on a DES ARA basis (see – Thermal Coal – In limbo; how low can it go?). Despite this, production cutbacks will take time to come as some of this material is still priced into the Pacific market (Exhibit 40) and because the combination of fixed costs and cash flow requirements will still see producers offering coal on which they are making a loss – particularly for tonnes that have already been mined. Consequently, a price recovery led by production cut backs would take some time to materialse, with price dynamics in the aftermath of this being heavily influenced by whether or not these tonnes return to the market or are replaced by new sources of production – at least one of which will be needed to meet ongoing Asian demand growth. A key issue to watch is thus any pushback or cancellation of capacity additions, as demonstrated by Rio Tinto‟s Mount Pleasant project in Australia. At current prices, many producers will be reassessing planned expansions and, we believe, coal demand in future years will mean prices at considerably higher levels as, without this, supply growth will be insufficient. In the meantime however, the focus is very much on cutbacks to current production rather than push backs of existing expansion plans Commodities Advantage: China – How Worried Should We Be? 22 17 May 2012 Turning to the demand side, whether or not an upside surprise from already high levels could clean up the market‟s surplus is something we see as relatively unlikely. The key reasons is that, while Chinese and Indian demand has been and, we believe, will continue to be strong, there are clear obstacles to their moving dramatically higher in the short term. Exhibit 41: Chinese thermal coal imports Exhibit 42: Indian thermal coal imports Mt, SA Mt, SA 18 10 15 8 12 6 9 4 6 3 2 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Source: Credit Suisse, Customs Data Source: Credit Suisse, Customs Data For Indian buyers, though they have been back in the market since November‟s decline on the back of a weakening rupee, the recent fall in the rupee again highlights the divergence between API #4 coal priced in USD versus INR. Given the much discussed political issues around domestic coal and electricity prices, Indian buyers remain extremely price sensitive and the recent move in USDINR – to record weakness above 54 – means import volumes now being negotiated could well come under pressure. Exhibit 43: Soft Chinese electricity generation Exhibit 44: Weak rupee threatens Indian imports TWh, SA API #4, spot, US$/t (lhs), INR/t (rhs) 430 200 9000 USD INR 180 8000 400 160 370 7000 140 340 6000 120 310 5000 100 280 4000 80 250 60 3000 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: Credit Suisse, China NBS Source: Credit Suisse, , the BLOOMBERG PROFESSIONAL™ service On the Chinese side, April‟s macro data represented a clear slowdown with electricity production, falling 5.1% month on month SA (Exhibit 43). From here we expect the economic backdrop to improve as the government provides some degree of stimulus but not for a rapid rebound as witnessed after the 2008/09 fall. In line with this and the price attractiveness of imported coal, we see import levels picking back up through the peak demand months of the summer and Q4 but not moving to highs capable of tightening the market dramatically this year (Exhibit 41). Moreover, the price sensitivity of Chinese buyers means any rally which closed the arb would likely see them step back from the market. Commodities Advantage: China – How Worried Should We Be? 23 17 May 2012 Outside of a European „blow up‟ taking everything down (not our base case scenario), prices are likely to remain subdued with the speed of any recovery dependent on how far we fall. The further we fall the faster producers will feel the pain that forces production closures – leading to a faster recovery in a tighter market and greater vulnerability to weather induced disruptions. If however prices continue to slowly slide lower, then the market faces more of a war of attrition – people will try to hold on in the hope of an improvement, giving us a longer period of depressed prices. Iron Ore – Macro fears again infect physical markets Spot iron ore prices continue to ease back, falling to US135/t on the TSI 62% Fe marker yesterday. Latest results from tenders suggest a further slip is likely to take place in the next day or so. Traders indicate that the mood continues to be one of distinct caution, with resistance in placing prompt cargoes as mills hold back. Moreover, the recent price retreat has left traders with uncomfortable positions to manage on their books. Beyond unsettling macro data, mills generally remain spooked by news-flow from Europe and broader moves in commodity prices. Exhibit 45: Iron Ore prices falling with macro fears US$/t 190 Spot Front Month Swap 180 170 160 150 140 130 120 110 100 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service Commodities Advantage: China – How Worried Should We Be? 24 17 May 2012 Petroleum The slide in Brent oil prices looked in April like a „mini-correction‟, then became in early May a bout of „spring doldrums‟ and now has graduated to a fully fledged rout. Of course, Brent is losing ground as part of a much broader risk off move. Nearby fundamentals continue to support (in a relative way). And our base case still has things improving materially in 2H. Nevertheless, on the month, prompt Brent futures are down 8.4%, the qtd average is $117/b and falling, and for the year we‟re at $118 and falling as well. Our average price target for 2012 of $125 Brent looks decidedly challenged. And as we said in the macro section “this is not yet the itme to scale into long positions” either. Near-term downside risk weigh heaviest. And aside from the worries around Euro-land other political clouds are drifting across the oil landscape as well: One, apparently there is a renewed push by consuming countries to agree to release strategic inventories. The effort is reportedly now on the G8 agenda on May 20-21 in Chicago. Two, the meeting in Baghdad on May 23 of the P5+1 and Iran negotiators has taken on added significance. European leaders apparently are considering to postpone full implementation of their sanctions on imports of Iranian oil – which is scheduled for July 1. Exhibit 46: LLS versus Brent Crude Exhibit 47: Brent Oil futures ($/bbl) (month1 vs month 6, $/bbl) Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: Credit Suisse Who‟s sitting pretty? US Gulf Coast refiners looking good A combination of factors has pulled the rug out from underneath crude oil prices on the US Gulf Coast. Local inventory has been built up to record highs – Breaking News: DOE-EIA Petroleum Statistics - 2012 Week 19. Extremely low natural gas prices mean processing costs are that much lower. Most refiners there are among the most complex (and thus flexible in terms of input and product slates) as well. They have thriving export markets from Latin America to West Africa and including Europe as well. And of late they‟ve been given an added source of supply with the coming on stream of the recently reversed Seaway pipeline, which can deliver cheap feedstock from the US Midcontinent to the Gulf. In the above chart, it‟s clear that import benchmark LLS has collapsed relative to global benchmark Brent. For a while at least, the US won‟t be importing much light-sweet feedstock. Put different, the surplus of US onshore crude that had been land-locked for more than two years already, is finally and literally making its way into the Atlantic Basin. Going forward, recent crude oil weakness on US the Gulf Coast would be exacerbated meaningfully with an SPR releaser. Without that, all markets will remain in the thralls of a macro environment that‟ll dictate whether our base-case trends play out constructively for the second half of 2012, or whether in the remainder of the year Brent markets will once again chop around inside a boring range around $110/b +/-$10. Commodities Advantage: China – How Worried Should We Be? 25 17 May 2012 Natural Gas US supply moving in the right direction US natural gas prices for June delivery continued to gain this week, adding another ~3.5% to the already ~30% price increase since troughing mid April. As noted in Commodities Advantage: Chinese Growth Disappoints, we think much of the perceived recent tightness in the market stems from a series of lower-than-normal storage injections, undercut from record gas power burn in much of the US. While we think these gains in power demand are near a tipping point, it is worth noting the shrinking gap in y-o-y dry gas production volumes. Exhibit 48: US natural gas futures curve Exhibit 49: US total dry gas production ($/Mmbtu) (Bcf/d) 65 63 61 59 57 55 53 51 49 47 45 Jan Mar May Jul Sep Nov 2012 2011 Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: Betnek Energy, Credit Suisse Exhibit 50: SE-TX production (interstate only) Exhibit 51: NW-ROX production (interstate only) (Bcf/d vs 5 year range) (Bcf/d vs 5-year range) 26 14.5 24 14 22 13.5 20 13 18 12.5 16 12 14 11.5 12 11 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov 2012 2011 2012 2011 Source: Bentek Energy, Credit Suisse Source: Bentek Energy, Credit Suisse Moving in the right direction, but not there yet. As noted in Exhibits Exhibit 49- 51, total US dry gas production is currently 2 Bcf/d above year-ago levels (down from 6 bcf/d y-o-y in Jan 2012) but still remains 4.3 Bcf/d above on YTD comparisons. Regional intrastate deliveries indicate much of the stagnation in production is resulting from below year-ago trends in the Southeast-Texas area as well as the Northwest-Rockies producing areas. Based on analysis published in US Natural Gas Reservoir - When will gas supply turn?, we expect production declines from January 2012 levels of 1.5 bcf/d by year end. This expectation captures announced producer curtailments, gains in associated production and recent trends in key producing gas basins. While promising, a likely normalization of coal to gas switching levels, loss of PRB switching at ~2.70 levels, coupled with still above year ago levels in supply place near term risks to the downside in our view. Commodities Advantage: China – How Worried Should We Be? 26 17 May 2012 Agriculture – Bearish bias continues Planting remains ahead of schedule Agriculture grain prices retreated this week with corn, wheat and soybean prices falling by 4.4%, 2.3% and 1.2% respectively. Although it is likely that the pullback in risk assets affected the agricultural market, we believe fundamentals continues to play a strong role in keeping prices on a downward trend. The bearish supply picture continues to dominate prices, even as reports continue to indicate robust demand from China. Earlier in the week, the China National Grain and Oil Information Center indicated that Chinese corn imports for 2011/12 will likely increase even further to 6 million tons (revising their previous estimate of 5.5 million tons). Further, Chinese soybean imports remain supported despite the moderation seen in other commodities (see China Commodity Trade Report – April 2012). The latest crop progress report released on May 14 indicated that the corn crop was 87% planted (compared to the five-year average of 66%), and the soybean crop was 46% planted (compared to the five-year average of 24%). We note that Dec-12 corn and Nov-12 soybean prices have reacted quite strongly to this data. Prices of both fell significantly following each report that showed that the level of planting in this year was remained higher or at a high level relative to the five-year average. Exhibits 52 and 53 below show the Dec-12 corn and Nov-12 soybean price moves following each report and the difference of the current planting progress relative to the five- year average. Exhibit 52: US corn against planting reports Exhibit 53: US soybean against planting reports Dec-12 corn in cents per bushel (lhs), difference in 2012 plantings relative to 5 Nov-12 soybeans in cents per bushel (lhs), difference in 2012 plantings relative year average in percentage (rhs) to 5 year average in percentage (rhs) 560 Planting progress significantly 30% 1410 Planting progress significantly 25% higher than average push prices higher than average push prices lower.. 1390 lower.. 550 25% 20% 1370 540 20% 1350 15% 530 15% 1330 10% 1310 520 10% 1290 5% 510 5% 1270 500 0% 1250 0% 02/04/2012 16/04/2012 30/04/2012 14/05/2012 02/04/2012 16/04/2012 30/04/2012 14/05/2012 Source: the BLOOMBERG PROFESSIONAL™ service, USDA, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, USDA, Credit Suisse Commodities Advantage: China – How Worried Should We Be? 27 17 May 2012 Exhibit 54: Commodities Forecast Table Units as indicated below, updated on April 13, 2012 (see The Pause That Refreshes) 2011 2012 2013 2014 2015 LT Avg '12 vs Yr Avg Q1 Q2 (f) Q3 (f) Q4 (f) Yr Avg (f) Q1 (f) Q2 (f) Q3 (f) Q4 (f) Yr Avg (f) Q1 (f) Q2 (f) Yr Avg (f) Yr Avg (f) (real) '11% Energy Brent (US$/bbl) 109.97 118.50 124.00 128.00 130.00 125.00 130.00 132.00 133.00 135.00 132.50 133.00 135.00 135.00 130.00 90.00 14% WTI (US$/bbl) 90.70 103.03 109.50 118.00 118.00 112.00 122.00 128.00 130.00 132.00 128.00 130.00 132.00 132.00 125.00 84.00 23% U.S. Natural Gas (US$/MMBtu) 4.07 2.77 2.20 2.50 3.10 2.64 3.60 3.40 3.80 4.00 3.70 4.40 4.20 4.29 4.50 4.50 -35% U.K. NBP (GBp/Therm) 56.40 57.45 62.00 62.00 72.00 63.40 72.00 62.00 62.00 72.00 67.00 73.00 63.00 68.00 66.00 50.60 12% Iron Ore Iron ore fines - 62% (China CFR) US$/t 168 142 150 160 160 153 160 160 155 155 158 135 135 135 120 90 -9% Iron ore fines - (China CFR) US¢/dmtu 271 229 242 258 258 247 258 258 250 250 254 218 218 218 194 145 -9% Iron ore lump - 63% (China CFR) US$/t 177 149 159 172 172 163 172 172 167 167 170 150 150 150 134 101 -8% Iron ore pellets - 66% (China CFR) US$/t 205 184 195 205 205 197 205 205 200 200 203 179 179 179 163 131 -4% Coking Coal Hard coking coal (US$/t) 289 235 210 225 235 226 245 240 235 235 239 235 235 235 235 170 -22% Semi hard coal (US$/t) 274 223 200 214 223 215 233 228 223 223 227 223 223 223 223 160 -22% Semi soft coal (US$/t) 212 157 141 151 157 151 164 161 157 157 160 157 157 157 157 132 -29% PCI coal (US$/t) 223 169 153 164 172 165 179 175 172 172 174 172 172 172 172 134 -26% Thermal Coal Thermal Coal (Newcastle FOB) US$/t 123 113 110 115 115 113 120 125 125 130 125 130 130 130 135 120 -8% Thermal Coal (API#2 CIF) US$/t 122 100 105 110 110 106 115 120 120 125 120 125 125 125 130 120 -13% Thermal Coal (API#4 FOB) US$/t 116 105 105 110 110 108 115 120 120 125 120 125 125 125 130 120 -7% Base Metals Copper (US$/MT) 8,887 8,329 8,900 9,200 9,500 8,980 9,300 9,000 8,800 8,500 8,900 8,500 8,500 8,500 7,000 5,500 1% Aluminium (US$/MT) 2,424 2,188 2,300 2,500 2,600 2,395 2,700 2,700 2,700 2,700 2,700 2,600 2,550 2,550 2,650 2,400 -1% Alumina spot (US$/MT) 389 317 330 350 370 342 370 380 380 390 380 400 400 400 415 400 -12% Nickel (US$/MT) 23,015 19,654 19,500 20,500 21,500 20,290 21,500 21,000 20,500 20,000 20,750 20,000 20,000 20,000 21,000 20,000 -12% Lead (US$/MT) 2,405 2,097 2,150 2,250 2,400 2,225 2,500 2,600 2,700 2,800 2,650 2,950 3,100 3,100 3,300 2,000 -7% Zinc (US$/MT) 2,220 2,031 2,050 2,100 2,150 2,085 2,250 2,300 2,400 2,500 2,363 2,650 2,800 2,800 3,000 1,900 -6% Tin (US$/MT) 26,191 22,937 23,000 24,000 25,000 23,735 26,000 26,000 26,000 26,000 26,000 26,000 26,000 26,000 26,000 20,000 -9% Precious Metals Gold (US$/oz) 1,571 1,690 1,720 1,810 1,840 1,765 1,920 1,860 1,740 1,660 1,795 1,500 1,450 1,450 1,350 1,300 12% Silver (US$/oz) 35.20 32.60 31.60 34.30 35.40 33.50 36.20 32.60 29.00 26.80 31.15 25.00 24.00 23.80 22.50 21.70 -5% Palladium (US$/oz) 730 685 735 785 825 760 850 890 930 950 905 965 980 980 1,010 900 4% Platinum(US$/oz) 1,720 1,610 1,680 1,700 1,750 1,685 1,800 1,820 1,840 1,900 1,840 1,900 1,900 1,900 1,925 1,900 -2% Rhodium (US$/oz) 2,010 1,430 1,500 1,550 1,600 1,520 1,900 2,200 2,250 2,350 2,175 2,600 2,950 3,000 3,200 3,200 -24% Minerals Zircon bulk (US$/t) 1,880 2500 2550 2625 2725 2,600 2850 2975 3075 3200 3,025 3,300 300 3,200 2,225 1,500 38% Rutile bulk (US$/t) 1,055 2400 2400 2700 2700 2,550 2800 2800 2900 2900 2,850 2,800 2,800 2,700 1,650 1,000 142% Synthetic Rutile (US$/t) 858 2050 2050 2350 2350 2,200 2450 2450 2550 2550 2,500 2,450 2,450 2,375 1,463 890 156% Ilmentite - sulphate 54% (US$/t) 209 325 325 350 350 338 350 350 350 350 350 325 325 300 250 200 62% Titanium Slag - SA Chlor 86% (US$/t) 798 1750 1750 2000 2000 1,875 2050 2050 2150 2150 2,100 2,050 2,050 1,988 1,256 760 135% Uranium spot (US$/t) 57 52 54 56 58 55 60 65 65 70 65 70 75 75 75 65 -4% Agriculture Wheat-CBOT (US¢/bu) 710 643 650 575 600 617 630 660 680 650 660 650 650 650 600 600 -13% Corn-CBOT (US¢/bu) 680 641 650 575 550 600 550 550 550 550 550 500 500 500 500 500 -12% Soybeans-CBOT (US¢/bu) 1,320 1,273 1,400 1,350 1,300 1,331 1,260 1,280 1,280 1,220 1,260 1,200 1,200 1,200 1,200 1,100 1% Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Advantage: China – How Worried Should We Be? 28 17 May 2012 Technical Analysis WTI Crude Oil‟s correction set to persist lower to $83.34 Cilline Bain +44 20 7888 7174 WTI Crude Oil (NYMEX Continuaiton) – Weekly email@example.com Source: CQG, Credit Suisse WTI Crude Oil (NYMEX Continuation) continues its downtrend lower, after breaking through its 200-day average at 96.51. This now acts as resistance to the upside and is expected to cap along with chart resistance located at 98.24/97.69. The recent prod below the 92.52 interim chart support level suggests further weakness lower to the 61.8% Fibonacci retracement support level placed at 88.55. With weekly slow stochastics steadily trending lower and showing no signs of reversal as well as having plenty of scope before they become oversold, the likelihood is for this decline to persist lower through 88.55 to the next major cluster of Fibonacci retracement support at 83.34/82.57. Here, at the latter support cluster, we envisage the downtrend to end and for a base to unfold – culminating in the beginning of WTI‟s next upward phase commencing for back to the 110.55/114.83 high. As an aside, it is important to note that the market‟s long-term upward trend off the 32.40 is still very much intact for now, and hence this current downward phase has to be treated as corrective in nature. Only above 96.51 and then 98.24 resistance hurdles signals an end to the current decline, with recovery risk then higher once again for back to 110.55/114.83 long term resistance. Commodities Advantage: China – How Worried Should We Be? 29 17 May 2012 Trade Recommendations Exhibit 55: Trade recommendations scorecard – (returns at end of day, May 16, 2012) Based on end of day prices or latest available price, recommendations in dark blue have been closed out, recommendations in green are initiated today Returns column: green means positive returns, and red means negative returns, black when zero. Commodity Position Publication Date Initiated Opening Current or Profit/(loss) Return (Closed) Price Close Price Gold Buy June Call, strike China – how 17 May 2012 of $1625 worried should we be? Platinum Buy Jul 12 platinum Platinum - ripe for a 26 Apr 2012 $10.3346 $0.7104 -$9.62 -93.1% 1650 / 1725 call bounce? spread at 2:3 ratio Henry Hub Buy Jun-12 $2.10 put, The Pause That 12 Apr 2012 $0.4475 $0.0261 -$0.3614 -93.3% Natural Gas and buy Jan-13 $4.00 Refreshes call in 2:1 ratio Aluminium Buy September 2,400 The Pause That 12 Apr 2012 $33.68 $10.32 -$23.36 -69.4% Calls Refreshes Palladium Buy Sept 12 Gold: taking the 14 Mar 2012 $26.2117 $1.0457 -$25.116 -96% Palladium Call short side of RV trades Iron Ore Buy Q4 2012 Iron ore Chinese Tide 01 Mar 2012 $131.50 $125.00 -$6.5 -4.9% swap Begins to Turn Aluminium Buy Q3 aluminium From Fear Flows 16 Jan 2012 $2,203.83 $2,035.33 -$168.5 -7.6% Opportunity Iron Ore Buy Cal-13 iron ore From Fear Flows 16 Jan 2012 $125.25 $121.00 -$4.25 -3.5% swaps Opportunity Brent crude Buy Dec 15 Brent, The Pause That 12 Apr 2012 $98.05 $94.71 -$3.34 -3.4% stop loss at $94.50 Refreshes (16 May 2012) Lead Buy June 12 LME Lead: This is the 29 Feb 2012 $2,169.50 $2,073.00 -$96.50 -4.5% lead Dip – Buy it (11 May 2012) Copper Buy Dec-12 copper From Fear Flows 16 Jan 2012 $8,110.00 $7,998.00 -$112.00 -1.4% Opportunity (11 May 2012) Copper Sell Sep 12 7250 put 2012 is NOT a 19 Apr 2012 -$6.15 $100.4388 $106.5888 1,732.9% and buy Sep 12 8400 Rerun of 2011 (03 May 2012) / 9500 call spread Lead and Buy Dec-12 lead, sell From Fear Flows 16 Jan 2012 $71.50 $102.50 $31.00 43.4% Zinc Dec-12 zinc Opportunity (03 May 2012) Thermal Coal Buy Newc Cal14 Sell The Pause That 12 April 2012 $2.81 $2.46 $0.35 12.46% API #2 Cal14 Refreshes (19 Apr 2012) Thermal Coal Buy CAL13 swaps on A Dangerous New 4 Oct 2011 $119.20 $114.24 -$5.75 -4.82% dips below $120 for Phase (15 Mar 2012) Newcastle coal RBOB Buy the June 12 Selective Easing 15 Feb 2012 $0.7804 $1.106 $0.326 41.72% Gasoline 330/340 call spread Offset by Greek (08 Mar 2012) and sell the June 12 Default Risk 340/350 call spread RBOB Buy the June 12 340 Selective Easing 15 Feb 2012 $8.2662 $11.4219 $3.16 38.18% Gasoline call Offset by Greek (08 Mar 2012) Default Risk ICE Gasoil Buy Jun-12, sell Apr- Mixed Blessings 09 Jan 2012 -$5.75 -$2.00 $3.75 65.22% 12 gasoil (08 Mar 2012) Thermal coal Buy API4 Coal, Sell The Relative States 15 Feb 2012 -$5.37 -$4.92 $0.45 8.4% API2 Coal of Different Coal (29 Feb 2012) Markers Heating Oil Buy Jun-12, sell Apr- Mixed Blessings 05 Jan 2012 -$2.47 -$0.15 $2.32 93.9% 12 heating oil (29 Feb 2012) WTI Crude Buy Dec-13 WTI calls Oil fundamentals: 10 Nov 2011 $3.6481 $4.2233 $0.5752 15.8% Oil Supply-side worries (01 Feb 2012) Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Information, opinions and estimates contained in this report reflect a judgment at the original date of publication by CS and are subject to change without notice. The price, value of and income from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities and financial instruments may be subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instruments. The P&L results shown do not include relevant costs, such as commissions, interest charges, or other applicable expenses. Source: Credit Suisse Locus Commodities Advantage: China – How Worried Should We Be? 30 GLOBAL COMMODITIES RESEARCH Ric Deverell, Managing Director Eric Miller, Managing Director Global Head of Commodities Research Global Head of Fixed Income and Economic Research +44 20 7883 2523 +1 212 538 6480 firstname.lastname@example.org email@example.com LONDON One Cabot Square, London E14 4QJ, United Kingdom Tom Kendall, Director Marcus Garvey, Analyst Martin Yu, Analyst Head of Precious Metals Research +44 20 7883 4787 +44 20 7883 2150 +44 20 7883 2432 firstname.lastname@example.org email@example.com firstname.lastname@example.org TECHNICAL ANALYSIS Cilline Bain, Associate +44 20 7888 7174 email@example.com NEW YORK 11 Madison Avenue, New York, NY 10010 Jan Stuart, Managing Director Joachim Azria, Associate Stefan Revielle, Associate Head of Energy Research +1 212 325 4556 +1 212 538 6802 +1 212 325 1013 firstname.lastname@example.org email@example.com firstname.lastname@example.org SINGAPORE One Raffles Link, Singapore 039393 Andrew Shaw, Director Ivan Szpakowski, Associate Head of Base Metals & Bulks Research +65 6212 3534 +65 6212 4244 email@example.com firstname.lastname@example.org Disclosure Appendix Analyst Certification Ric Deverell, Joachim Azria, Cilline Bain, Marcus Garvey, Tom Kendall, Stefan Revielle, Andrew Shaw, Jan Stuart, Ivan Szpakowski and Martin Yu each certify, with respect to the companies or securities that he or she analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. 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