Macquarie - Muted rally for metals prices by riteshbhansali


 LME cash price
                                                     Commodities Comment
                                       % change
                                      day on day     Muted rally for metals prices in Euros
 Aluminium                     96             0.4
 Copper                       375             0.2    Feature article
 Lead                         103             1.1
                                                      Across base metals, US dollar prices have been trending higher since the
 Nickel                       823             1.6
 Tin                          945             1.2      start of September, bolstered by further doses of QE. However, as the Euro
 Zinc                          95             0.1      has regained some of its strength over that period, moves in Euro terms have
 Cobalt                      1315             1.8      been much more subdued.
 Molybdenum                  1066             0.0
                                                     Latest news
 Other prices
                                                      Base metals recovered following Thursday‟s sell-off, gaining across the board
                                       % change
                                      day on day       on Friday. Nickel was the big mover, up 1.6% on the day to $18,136/t. Lead
 Gold (US$/oz)                1785            1.5      also rose 1.1%, and is now trading at a ~$200/t premium to zinc – something
 Silver (US$/oz)             34.69            1.3      we think the relative fundamentals justify. Precious metals were the big
 Platinum (US$/oz)            1642            1.4
                                                       gainers on Friday, all rising between 1.3% and 1.5% as the dollar faded.
 Palladium (US$/oz)            672            1.4
 Oil WTI                     92.81            1.0     Over the week as a whole, nickel and lead were again the outperformers,
 USD : EUR exchange rate     1.299            0.4      rising 2.2% and 0.8%, respectively, as the overall metals rally petered out.
 AUD : USD exchange rate     1.047            0.6
                                                       Having outperformed over the preceding week (despite terrible fundamentals),
 LME/COMEX stocks                                      aluminium dropped 4.2% WoW, while WTI oil dropped 6%
                           Tonnes         Change
                                                      LME copper inventories rose 1.1% WoW with 2.3kt net additions, but this was
 Aluminium              5,085,850           5,850
 LME copper               219,475            -875      dwarfed by a 10.4kt rise in SHFE inventories. With this, overall exchange
 Comex copper              45,507             278      held copper stocks rose 3.1%. Overall aluminium stocks gained 1.6%, while
 Lead                     283,625            -250      zinc rose 4.3% after big deliveries into the New Orleans queue. In contrast,
 Nickel                   120,852             -24
                                                       LME lead inventories dropped 3.3%.
 Tin                       11,990              35
 Zinc                     976,900          -3,150     The detailed breakdown of Chinese iron ore imports shows that August
                                                       imports from Australia totalled 31.78 million tonnes, an all-time record. This
 Source: LME, Comex, Nymex, SHFE, Metal                shows that, despite the falling price, all imported iron ore continues to find a
 Bulletin, Reuters, LBMA, Macquarie Research           home in China. Over the first 8 months of the year, Australian origin imports
 Articles of the week                                  totalled 223mt, up 20% YoY. In direct contrast, only 1.62mt of Indian ore was
  Steel still struggling                              received in the month, the lowest for over a decade. Jan-Aug Indian origin
    Aluminium: More money, more problems, more        imports totalled just 32mt, down 45% YoY. Overall Chinese import volumes
     downside                                          over Jan-Aug rose 8.7% YoY to 486 million tonnes. Meanwhile, the average
    Price forecast changes: Balancing growth
                                                       customs value of the ore received in August fell to the lowest level since May
                                                       2010, at $129.8/t. Given spot price moves, we would expect this to fall
                                                       dramatically in September.
    Chinese nickel pig iron now back in the money
                                                      McCloskey‟s has reported that Anglo American have started to settle their Q4
                                                       contract prices for the Foxleigh PCI brand at $125/t FOB Australia, a 23%
 Analyst(s)                                            drop on the $162/t agreed for Q3. However, given the hard coking coal
 Macquarie Capital (Europe) Limited
   Colin Hamilton                                      benchmark drop from $225/t to $170/t, this would actually take PCI to 73.5%
   +44 20 3037 4061       of the HCC price from 72% in the previous quarter. It also marks a decent
   Jim Lennon                                          premium to the current $103/t FOB spot assessment by Platts, and implies
   +44 20 3037 4271
   Ryan Belshaw                                        high ash PCI coals may be looking at a $110/t FOB Australia contract level.
   +44 20 3037 2732         With this, a semi-soft settlement of ~$115/t can be expected, taking it below
   Duncan Hobbs
   +44 20 3037 4497
                                                       the prevailing thermal coal contract and putting severe pressure on many
 Macquarie Capital Securities Limited                  Australian and US producers from a cost perspective.
   Graeme Train
   +86 21 2412 9035        The latest Mysteel survey of iron ore inventories held by small Chinese steel
 Macquarie Capital Securities (Singapore) Pte.         mills shows a stabilisation of levels over the past fortnight. Inventory now sits
                                                       at 17.3 days of consumption, rising slightly from the 17.0 days on September
   Bonnie Liu
   +65 6601 0144     7, thus representing the end of the three month destock. However, given that
                                                       the iron ore price has rebounded relatively ~$20/t over the past fortnight, it
 24 September 2012                                     also suggests the small mills were not active in driving this move.
Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our
Macquarie Research                                                                                                                                Commodities Comment

                 Currency shifts mean no surge of stainless orders (yet) on nickel rally
                  Across base metals, US dollar prices have been trending higher since the start of September,
                           bolstered by further doses of QE. However, as the Euro has regained some of its strength over
                           that period, moves in Euro terms have been much more subdued. As a result, the incremental
                           pick-up in European stainless steel orders which might have been expected has not taken place
                           yet. Meanwhile, ongoing A$ strength continues to hurt producer competitiveness in iron ore and
                           met coal.
                  Since the start of August, the LMEX index has risen by 14% in USD terms, with all metals
                           contributing, as ongoing weakness in industrial output was superseded by further central bank
                           easing. However, relative currency movements mean that the rally has been much more muted in
                           those currencies which have been appreciating over this period.
                  In particular, the Euro has moved from $1.23/€ to 1.30 over this time frame, as the probability of a
                           Euro zone collapse has diminished in the near term. As a result, the LMEX in Euro terms is up
                           just 6%. As such, metals buyers in Europe have been somewhat sheltered versus US peers.
                  One particular area where this effect certainly seems to have had an impact is European stainless
                           steel orders. Usually, a rally in nickel prices on the LME results in a surge of consumer orders into
                           stainless steel facilities, trying to lock in tonnages before the alloy surcharge increases. The
                           converse is also true – if consumers think nickel prices will fall they stay out the market as long as
                           they can, which in turn leads mills not to buy nickel. This is what causes the whiplash effect on
                           nickel from the stainless steel sector.
                  However, through the end of last week, the nickel price in Euro terms was more or less flat on the
                           start of August. Thus, the threat of an alloy surcharge rise (based on the Euro nickel price) was
                           small, and hence even with LME prices rallying through early September we understand there has
                           been no real order pick-up for stainless steel producers which might have been expected.
                  Indeed, it looks set to be outperformance of the nickel price as a whole which will drive the next
                           leg of orders. Over the 6 trading days, nickel has jumped 7% in Euro terms. Consumers will now
                           start getting concerned about the October alloy surcharge – the last time nickel traded at the
                           current price level, the surcharge was €200/t higher than at present. We would therefore expect
                           them to start booking additional tonnages imminently.
Fig 1 Copper prices have rallied over 10% in USD                                         Fig 2 In € terms, nickel prices have only just started
since the start of August, <5% in € terms                                                to rise – from this point stainless orders may pick up

                 Indexed copper prices, Aug 1 12 = 100                                                                Nickel prices in Euro
  115                                                                                      14,000
  110                                                                                      13,500

  105                                                                                      13,000

  100                                                                                      12,500

   95                                                                                      12,000
















Source: LME, Macrobond, Macquarie Research, September 2012                               Source: LME, Macrobond, Macquarie Research, September 2012

24 September 2012                                                                                                                                                               2
Macquarie Research                                                                                                                                                  Commodities Comment

                       One other currency which has been raising some eyebrows is the ongoing strength of the
                          Australian dollar given bulk commodity price weakness – still trading at 1.05 to the USD when
                          many expected a drop below parity. Indeed, as QE3 has come through it is again appreciating
                          against the USD. Thus, iron ore producers have taken the full brunt of the price drop, with no
                          currency benefit to offset. Meanwhile, the met coal price collapse has been amplified in AUD
                          terms when assessed against peer production countries such as Canada, hindering the Australian
                          competitive position.
                       One important factor over the coming period will be the behaviour of the RMB against the dollar,
                          given that the marginal producers across many metals and bulk commodities have costs
                          denominated in RMB. The RMB depreciation has reversed over the past couple of weeks, hand in
                          hand with a return of capital inflows into China funds – should this continue, it will push up USD
                          costs for Chinese enterprises. However, with manufacturing already starting to suffer from the
                          global trade slowdown and the leadership transition about to get underway, it would be a surprise
                          were it to move too fast.
Fig 3 The fall in commodity prices has not been                                                       Fig 4 …while met coal currency movements have
accompanied by a fall in the A$, which remains above                                                  seen Aus lose competitiveness vs. Canadian peers

                           Spot iron ore prices, 62% CFR China                                                                     Spot hard coking coal prices, FOB
  140                                                                                                  220

  130                                                                   AUD/t                          200                                                                  AUD/t
                                                                        USD/t                                                                                               CAD/t
  120                                                                                                  180



















Source: Platts, Macrobond, Macquarie Research, September 2012                                         Source: Platts, Macrobond, Macquarie Research, September 2012

24 September 2012                                                                                                                                                                                         3
Macquarie Research                                                                 Commodities Comment

            Summary of changes, week ended 21 September
            LME metal prices (%)                                      Cash       3-Month
            Aluminium                                                 -4.2%        -3.8%
            Aluminium Alloy                                           -4.3%        -4.3%
            NAASAC                                                    -3.7%        -3.7%
            Copper                                                    -1.0%        -1.2%
            Lead                                                       0.8%         1.0%
            Nickel                                                     2.2%         2.3%
            Tin                                                       -4.1%        -4.3%
            Zinc                                                       0.0%         0.0%
            Cobalt                                                     3.6%         3.6%
            Molybdenum                                                -2.1%        -2.1%

            Other prices (%)
            Gold                                                       0.5%
            Silver                                                    -0.1%
            Platinum                                                  -3.2%
            Palladium                                                 -4.3%
            Oil WTI                                                   -6.0%
            EUR : USD exchange rate                                   -0.9%
            AUD : USD exchange rate                                   -0.9%

            Exchange stocks                                         tonnes             %
            LME aluminium                                            76,875         1.5%
            Shanghai aluminium                                        9,299         2.4%
            Total aluminium                                          86,174         1.6%

            LME copper                                                2,300         1.1%
            Comex copper                                                127         0.3%
            Shanghai copper                                          10,428         6.7%
            Total copper                                             12,855         3.1%

            LME zinc                                                 52,700         5.7%
            Shanghai zinc                                               -75         0.0%
            Total zinc                                               52,625         4.3%

            LME lead                                                 -9,575        -3.3%
            Shanghai lead                                               480         2.7%
            Total lead                                               -9,095        -2.9%

            LME aluminium alloy                                      -2,120        -2.6%
            LME NAASAC                                                 -200        -0.1%
            LME nickel                                                  -24         0.0%
            LME tin                                                     115         1.0%

            Source: Comex, LBMA, LME, Nymex, Reuters, SHFE, Macquarie Research

24 September 2012                                                                                   4
Macquarie Research                                                                                                            Commodities Comment

                                                       Friday 21 September 2012

                                                            Commodities Prices
                                       Closing price *                Closing price *
                                   21-Sep-12    21-Sep-12            20-Sep-12    20-Sep-12               % ch. day    2012 YTD    Ave 2011
                                   US$/tonne        US¢/lb           US$/tonne        US¢/lb                on day    US$/tonne   US$/tonne
      LME Cash
      Aluminium                         2,108              96             2,098             95                  0.4       2,020        2,395
      Aluminium Alloy                   2,005              91             1,985             90                  1.0       1,925        2,262
      NAASAC                            2,063              94             2,063             94                  0.0       2,021        2,379
      Copper                            8,277             375             8,263            375                  0.2       7,945        8,811
      Lead                              2,280             103             2,256            102                  1.1       1,998        2,398
      Nickel                           18,136             823            17,855            810                  1.6      17,713       22,831
      Tin                              20,825             945            20,585            934                  1.2      20,921       26,021
      Zinc                              2,087              95             2,085             95                  0.1       1,938        2,191
      Cobalt                           29,000           1,315            28,500          1,293                  1.8      30,629       35,702
      Molybdenum                       23,500           1,066            23,500          1,066                  0.0      29,804       34,381
      LME 3 Month
      Aluminium                         2,116              96             2,110             96                  0.3       2,057        2,420
      Aluminium Alloy                   2,025              92             2,005             91                  1.0       1,952        2,259
      NAASAC                            2,100              95             2,100             95                  0.0       2,066        2,261
      Copper                            8,282             376             8,270            375                  0.1       7,934        8,825
      Lead                              2,288             104             2,265            103                  1.0       2,014        2,390
      Nickel                           18,175             824            17,895            812                  1.6      17,781       22,857
      Tin                              20,750             941            20,550            932                  1.0      20,947       26,036
      Zinc                              2,116              96             2,110             96                  0.3       1,949        2,210
      Cobalt                           29,000           1,315            28,500          1,293                  1.8      30,578       35,507
      Molybdenum                       23,500           1,066            23,500          1,066                  0.0      29,804       34,554
      * LME closing price - 1700 hrs London time. Year-to-date averages calculated from official fixes.

      Gold - London PM Fix (US$/oz)                     1,785                            1,759                  1.5       1,644        1,572
      Silver - London AM Fix (US$/oz)                   34.69                            34.25                  1.3       30.38        35.12
      Platinum - London PM Fix (US$/oz)                 1,642                            1,620                  1.4       1,522        1,720
      Palladium - London PM Fix (US$/oz)                  672                              663                  1.4         644          733
      Oil WTI - NYMEX latest (US$/bbl)                  92.81                            91.92                  1.0       96.36        94.65
      EUR : USD exchange rate - latest                  1.299                            1.294                  0.4       1.281        1.392
      AUD : USD exchange rate - latest                  1.047                            1.041                  0.6       1.035        1.032

                                                                Exchange Stocks
                                                                    Change since last report              Cancelled      End-11    Ch. since
      (tonnes)                     21-Sep-12      20-Sep-12            Volume       Percent                warrants      stocks      end-11
      LME Aluminium                5,085,850      5,080,000              5,850         0.1%               1,640,025   4,970,400     115,450
      Shanghai Aluminium             396,475        387,176              9,299         2.4%                       -     207,966     188,509
      Total Aluminium              5,482,325      5,467,176             15,149         0.3%                       -   5,178,366     303,959

      LME Copper                      219,475        220,350               -875          -0.4%               34,875     370,900     -151,425
      Comex Copper                     45,507         45,229                278           0.6%                    -      79,817      -34,310
      Shanghai Copper                 166,829        156,401             10,428           6.7%                    -      93,219       73,610
      Total Copper                    431,811        421,980              9,831           2.3%                    -     543,936     -112,125

      LME Zinc                        976,900        980,050              -3,150         -0.3%              362,375     821,700      155,200
      Shanghai Zinc                   302,325        302,400                 -75          0.0%                    -     364,186      -61,861
      Total Zinc                    1,279,225      1,282,450              -3,225         -0.3%                    -   1,185,886       93,339

      LME Lead                        283,625        283,875                -250         -0.1%               97,550     353,075      -69,450
      Shanghai Lead                    18,418         17,938                 480          2.7%                    -      30,586      -12,168
      Total Lead                      302,043        301,813                 230          0.1%                    -     383,661      -81,618

      Aluminium Alloy                  79,000         79,400                -400         -0.5%                1,740     142,880      -63,880
      NASAAC                          147,820        147,900                 -80         -0.1%                8,300     157,820      -10,000
      Nickel                          120,852        120,876                 -24          0.0%               12,648      90,048       30,804
      Tin                              11,990         11,955                  35          0.3%                7,420      12,190         -200

      Source: Comex, LBMA, LME, Nymex, Reuters, SHFE, Macquarie Research

24 September 2012                                                                                                                              5
Macquarie Research                                                                                                        Commodities Comment

             Articles of the Week
             August’s steel output figures reinforce effect of industrial slowdown
              Thursday saw the release of August data on global iron and steel production by worldsteel. This
               again highlighted the knock-on effect of slowing industrial output, with overall crude steel
               production down 1% YoY. August is traditionally a weak month for output, being the Northern
               Hemisphere summer; however, the dramatic sequential drop in Europe coupled with slowdown in
               China and Korea, accompanied by rapidly falling Asian steel prices, will do little to inspire
               confidence in the sector. With global capacity utilisation dropping back to the 75% mark, the
               structural overcapacity in steel output continues to weigh on margins.

     Fig 5 Key monthly steel production data
     Month                     Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12

     Crude steel production    Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12                        Jul-12 Aug-12
     World                     124,350 123,001 123,715 115,392 117,176 123,405 120,720 132,332 129,224 131,079 127,144 128,457 123,373
     World ex-China             65,598 66,301 69,042 65,509 65,012 66,672 64,837 70,751 68,649 69,845 66,931 66,764 64,670

     Crude steel production    Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12                        Jul-12 Aug-12
     (annualised mt)
     World                       1,464    1,497    1,457    1,404    1,380    1,453    1,519    1,558    1,572    1,543    1,547    1,512    1,453
     World ex-China                772      807      813      797      765      785      816      833      835      822      814      786      761

     YoY change                Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12                        Jul-12 Aug-12
     World                      9.4%   9.0%   5.8%   0.9%   1.7% -1.0%    1.8%   1.6%   1.5%   0.7% -0.9%                           0.7% -0.8%
     World ex-China             5.8%   3.4%   3.0%   1.8%   2.5% -2.9%    0.5% -0.4%    0.5% -0.7% -2.2%                           -2.3% -1.4%

     MoM change                Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12                        Jul-12 Aug-12
     World                      -2.6%  2.2% -2.7% -3.6% -1.7%      5.3%   4.6%   2.5%   0.9% -1.8%    0.2%                         -2.2% -4.0%
     World ex-China             -4.0%  4.4%   0.8% -2.0% -4.0%     2.6%   4.0%   2.1%   0.3% -1.5% -1.0%                           -3.5% -3.1%

     Pig Iron Production       Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12                        Jul-12 Aug-12
     World                      91,893   89,283   89,312   82,387   85,133   91,591   89,225   96,493   94,782   96,193   92,868   94,137   90,991
     World ex-China             37,947   37,199   38,309   36,496   37,124   37,326   35,809   38,982   38,006   38,852   37,153   37,816   37,247
     Iron ore importers         72,639   70,370   70,177   63,772   65,762   72,616   71,080   76,847   75,287   76,526   74,361   75,508   72,678
     Ore importers ex-China     18,693   18,286   19,174   17,881   17,753   18,351   17,664   19,336   18,511   19,185   18,646   19,187   18,934
     Met coal importers         29,678   30,368   31,669   31,652   31,435   28,908   28,243   30,121   29,511   30,248   29,578   30,138   29,747

     Pig Iron Production       Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12                        Jul-12 Aug-12
     (annualised mt)
     World                       1,082    1,086    1,052    1,002    1,002    1,078    1,123    1,136    1,153    1,133    1,130    1,108    1,071
     World ex-China                447      453      451      444      437      439      451      459      462      457      452      445      439
     Iron ore importers            855      856      826      776      774      855      895      905      916      901      905      889      856
     Ore importers ex-China        220      222      226      218      209      216      222      228      225      226      227      226      223
     Met coal importers            349      369      373      385      370      340      355      355      359      356      360      355      350

     YoY change                Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12                        Jul-12 Aug-12
     World                       9.2% 10.1%   8.0%   1.0%   2.3% -0.5% -1.3%     1.7%   1.9%   2.6% -0.1%                           0.4% -1.0%
     World ex-China              4.5%  3.0%   3.1%   2.0%   0.5% -4.6% -3.5% -1.3%      0.8% -0.9% -1.8%                           -2.4% -1.8%
     Iron ore importers         11.2% 12.6%   9.2%   0.1%   1.6% -0.1% -1.3%     2.6%   1.9%   3.1%   0.4%                          1.1%   0.1%
     Ore importers ex-China      6.9%  4.5%   2.6% -0.5% -3.9% -7.1% -5.9% -0.8% -0.5% -2.8% -1.5%                                 -2.1%   1.3%
     Met coal importers          0.4%  1.2%   1.7%   5.0% -3.1% -15.8%    3.4%   2.5%   1.5%   1.5% -2.5%                          -6.3%   0.2%

     MoM change                Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12                        Jul-12 Aug-12
     World                      -2.0%  0.4% -3.2% -4.7% -0.0%      7.6%   4.1%   1.2%   1.5% -1.8% -0.2%                           -1.9% -3.3%
     World ex-China             -2.0%  1.3% -0.3% -1.6% -1.6%      0.5%   2.6%   1.8%   0.7% -1.1% -1.2%                           -1.5% -1.5%
     Iron ore importers         -2.7%  0.1% -3.5% -6.1% -0.2% 10.4%       4.6%   1.1%   1.2% -1.6%    0.4%                         -1.7% -3.7%
     Ore importers ex-China     -4.6%  1.1%   1.5% -3.6% -3.9%     3.4%   2.9%   2.4% -1.1%    0.3%   0.4%                         -0.4% -1.3%
     Met coal importers         -7.7%  5.7%   0.9%   3.3% -3.9% -8.0%     4.4% -0.2%    1.2% -0.8%    1.0%                         -1.4% -1.3%
     Source: worldsteel, Macquarie Research, September 2012

24 September 2012                                                                                                                                    6
Macquarie Research                                                                                                                                                                                                      Commodities Comment

                                  When adjusting for countries not reported by worldsteel, we estimate global steel production fell
                                            45 MoM to 1,453mtpa in August. This is the lowest since December 2011, and 5% below the YTD
                                            average. While August is usually a weak month given the Northern Hemisphere summer, the 1%
                                            YoY drop will do little to cheer a global industry burdened by overcapacity. Both China and ex-
                                            China contributed to the fall, with ex-China steel output having now been in negative YoY territory
                                            since May.

Fig 6 August marked a large sequential fall in global                                                                                                     Fig 7 Ex-China production remains below 2011 levels
steel output – both China and ex-China contributed

                                 MoM changes in annualised crude steel output
                                                                                                                                                                                                      Ex-China steel output
         150                                                                                                                                                          860
                                                China                      ex-China

          50                                                                                                                                                          800

                                                                                                                                                           m tonnes


                                                                                                                                                                                                    2010         2011           2012
     -100                                                                                                                                                             700



















Source: worldsteel, Macquarie Research, September 2012                                                                                                                                        Apr
                                                                                                                                                          Source: worldsteel, Macquarie Research, September 2012

                                  The 14.5% fall in European Union steel output was the most conspicuous number, taking output to
                                            144mtpa, the lowest since December 2009. August is always a bad month for European output,
                                            but with Italian output halving (even without a huge effect from Ilva‟s Taranto plant yet) this level of
                                            weakness shows the disappointing underlying trend. Korean output also dropped 4.8% MoM as
                                            slowing global trade took effect, while Japan remained essentially flat on the month. The US
                                            bucked the trend, with production rising 2.8%; however, the high price arbitrage to Asian markets
                                            and the YoY fall in service center shipments recorded in August do raise some red flags for the
                                            call on production into year end.
                                  As previously published by NBS, Chinese output fell 4.8% MoM to 691mtpa. However, with
                                            finished steel inventory held by the mills building up during the month, in our view this production
                                            cut was both late and not severe enough. We would expect to see further cuts towards 660mtpa
                                            into October to clear the inventory chain. Worryingly, the CISA data for the first 10 days of
                                            October suggested a push back towards 700mtpa.

24 September 2012                                                                                                                                                                                                                                     7
Macquarie Research                                                                                                                                                                                                                                                                                                 Commodities Comment

Fig 8 August is always a bad month for EU output,                                                                                                                                           Fig 9 US service center steel shipments also dropped
but 2012 was even worse that 2010 or 2011                                                                                                                                                   YoY in August

                                                                                 EU crude steel output                                                                                                                YoY change in US Service Center steel shipments
                                  200                                                                                                                                                        35%
   million tonnes, annualised

                                  170                                                                                                                                                        25%


                                  130                                                                                                                                                        10%























Source: worldsteel, Macquarie Research, September 2012                                                                                                                                      Source: MSCI, Macquarie Research, September 2012

                                                           Global blast furnace output also fell 1% YoY and 3.3% MoM in August. However, this doesn‟t tell
                                                                the whole tale, with Japanese and Korean output rising MoM (despite the steel output drop). We
                                                                would expect to see pig iron output in these countries play catch-up in September.
                                                           One interesting point from the steel data this year is the implied drop in use of scrap. With pig iron
                                                                running much stronger than crude steel YTD, the implication is that scrap use is essentially flat
                                                                YoY, compared with the 9.7% rise in 2011. Partially, this is a function of lower prompt scrap from
                                                                industrial output, but it also implies the high prices of early 2011 pulled a decent amount of
                                                                material from the obsolete scrap pool. This helps to explain scrap‟s price outperformance this
                                                                year – while without this effect, demand for virgin raw materials such as iron ore and coal may
                                                                have been even lower!
Fig 10 Chinese production cust are underway, but not                                                                                                                                        Fig 11 Implied use of steel scrap is set to fall this
quickly enough                                                                                                                                                                              year

                                                          CISA 10 day production data - Total China estimate
                                  800                                                                                                                                                                                                      YoY change in implied use of scrap
  Crude steel production (mtpa)












                                  650                                                                                                                                                         6%




                                  600                                                                                                                                                         2%

                                  550                                                                                                                                                         -2%






































                                          Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12                                                                   Jul-12            Aug-12 S

Source: CISA, Macquarie Research, September 2012                                                                                                                                            Source: worldsteel, Macquarie Research, September 2012

24 September 2012                                                                                                                                                                                                                                                                                                                                                                       8
Macquarie Research                                                                                                                                                                                                                                                           Commodities Comment

                                         Aluminium: More money, more problems
                                Aluminium exchange prices have rallied almost 20% in the past month, and with “net prices”
                                         (which include global estimates of spot premiums) now cresting almost $2,450/t outside of China
                                         the gains will have serious implications for the S&D balance in the short and medium term.
                                Immediate impact…While there are negative implications for potential supply curtailments over
                                         the medium term, given the shift in the position of prices on the cost curve, the most immediate
                                         impact will be from the likely change in Chinese trade. Low prices ex-China have incentivised a
                                         200% YoY increase in their imports of refined aluminium, equivalent to almost 200kt though July
                                         (or almost 2% of ex-China demand!). Following the recent price gains this „additional‟ demand
                                         from Chinese importers is likely to end, and furthermore there is a high probability that the arb
                                         could release a flood of aluminium semi products from China.
                                Longer term….Our estimate of the net aluminium price of ~$2,440 prices leaves virtually all of the
                                         global production in a cash-positive position, reducing the likelihood of further capacity

Fig 12 LME prices even before considering record                                                                                                                        Fig 13 …with negative implications for Chinese
premiums are trading above prices in China…                                                                                                                             imports, which have totalled 200kt YTD

     600            Differential -                                                                                                                                       '000 t 80
                    SHFE minus                                                                                                                                                   70
     400            import price                                                                                                                                                 60
     200                                                                                                                                                                         50
      0                                                                                                                                                                          40                                                                                                       ~40kt per month
                                                                                                                                                                                                                                                                  ~3kt per month
    -400                                                                                                                                                                         10
    -800                                                                                                                                                                        -20
   -1000                                                                                                                                                                        -30









                                                                                                                                                                                                                                   Net refined ali imports

Source: LME, SHFE, Macquarie Research, September 2012                                                                                                                   Source: NBS, Macquarie Research, September 2012

                                China has scope to export more aluminium products – Production growth of 12% YTD has
                                         meant the Chinese aluminium market is still in surplus. Stocks of refined aluminium in SHFE and
                                         unregistered warehouses have risen by 360kt since January, while estimates for unreported
                                         stocks are upwards of 1.3Mt. Anecdotal evidence also suggests there is a significant stockpile of
                                         semi products in China.
                                We estimate the combined impact of falling imports of refined aluminium into China, and
                                         increasing exports of Chinese semi-products could have a net impact on the ex-China aluminium
                                         market of up to 95kt of aluminium per month. To put this in context, aluminium production ex-
                                         China is estimated to have fallen 1.5% in 2012, or 38kt per month. In short, Chinese trade will
                                         continue to act as a significant stabiliser for ex-China prices.

24 September 2012                                                                                                                                                                                                                                                                                                                      9
Macquarie Research                                                                                                                                     Commodities Comment

Fig 14 Semi exports from China have fallen 10% YTD,                                        Fig 15 …refined stocks in China have been rising
current prices are likely to drive a rebound in Q4…                                        YTD, with a similar surplus likely in semi products

Source: NBS, Macquarie Research, September 2012                                            Source: SHFE, SMM, Macquarie Research, September 2012

                             The shift in the position of prices on the global cost curve has been significant… In the past
                              month we estimate the rally in exchange prices alone has put upward of 10kt of smelter capacity
                              back into cash positive territory. Figures 16 and 17 show the cost curves for aluminium inclusive
                              of our estimate of physical spot premiums, and they illustrate that virtually all but the most
                              expensive operations are currently cash positive. It is worth noting that this is helpful as an
                              illustration but has shortcomings, especially given that not all smelters will be receiving >$200 spot

Fig 16                  Global aluminium cash costs vs prices                              Fig 17 Chinese aluminium cash costs vs prices

                             Aluminium cash costs and aluminium prices                                          2900

                2,650                                                                                           2700



                                                                                                $/t (inc VAT)

                                                             Cash Cost (C1) ($/t)
                                                             LME Cash price + estimated
                1,650                                        global premium
                                                             Current LME cash
                1,450                                                                                           1700

                        0       10          20          30             40             50
                                                                        cumulative Mt                                  0%   20%         40%          60%           80%   100%
                                                                                                                              SHFE price (inc VAT)     LME Price

Source: Woodmac, Macquarie Research, September 2012                                        Source: Clark and Marron, Macquarie Research, September 2012

                             The vertical ascent in premiums in the past three years has been astounding for a market
                              with ~5Mt of inventory in LME warehouses. While physical tightness and availability has
                              played a part in this rally, the largest driver is that the market is now applying a “discount” to the
                              LME aluminium contract. LME contracts, due to the delays in obtaining material from LME
                              warehouses, can effectively no longer be considered a physically settled contract – thus
                              consumers who would previously use the exchange prices to mitigate risk are now forced to buy

24 September 2012                                                                                                                                                               10
Macquarie Research                                                                                                                                    Commodities Comment

Fig 18 Aluminium premiums have been rising in                                      Fig 19 The LME contract is now discounted due to the
tandem with exchange prices – good news for                                        lack of effective physical settlement – driven by load
producers                                                                          out rates

                                   Aluminium ingot premiums                                                       How long would it take to draw down LME stocks at
                 300                                                                                                         minimum load out rates?
                                       Japan CIF
                 250                   US M.West del.                                                       700
                                       NW Eur DDP
                 200                                                                                                    523

                                                                                      No. of working days

                                                                                                            400                     362   358

                 100                                                                                        300
                                                                                                                                                243    234
                  50                                                                                                                                         118   111   108
                                   J 2008

                                               J 2009

                                                        J 2010

                                                                 J 2011

                                                                          J 2012
                       J 2007

Source: Fastmarkets, CRU, Macquarie Research, September 2012                       Source: LME, Macquarie Research, September 2012

                           There is no doubt that short covering by investors has played a role in the price strength.
                                Consumers are also likely to have run down stocks, faced with negative financial news and data,
                                which in part explains the weakness in European consumption. For these reasons prices may
                                overshoot in the short run as sentiment improves (and the dollar weakens!), but LME prices look
                                toppy from a fundamental perspective.

24 September 2012                                                                                                                                                              11
Macquarie Research                                                                                     Commodities Comment

           Commodity price forecast changes – Balancing different growth concerns
            In summary, the past quarter has seen a conspicuous slowdown in global growth, with the loss of
              momentum in the developed world spreading to emerging markets. This has certainly had
              an impact on commodity prices, with metals and bulk commodities all trading below levels seen
              early in 2012.
            A lack of supply growth and leverage to Chinese infrastructure means copper remains our
              favoured base metal exposure, while a return of investment flow should see gold regain upward
              momentum into 2013. We have reduced our expectations for future Chinese steel demand, which
              has pulled down expectations for iron ore and met coal prices.
            With leading indicators looking grim, the differing responses to growth concerns have been
              interesting. In the US, the Federal Reserve unleashed a third round of quantitative easing. While
              QE3 has not been assigned an aggregate monetary value in terms of the bonds it will purchase,
              the open-ended nature of has certainly been well received by markets and has bolstered business
              sentiment. In the short time since it has been announced, the „QE3 effect‟ on commodity market
              sentiment is clear to see. As growth concerns are put on the backburner for a while, there is
              increasing confidence that commodity markets can trade higher into early 2013. Whether
              this is just a growth-shifting bounce or more lasting boost for global growth now depends on
              emerging market reaction – the same medium-term challenges still persist.
            What has become evident is that China is actually quite comfortable with lower levels of
              growth. Growth for growth‟s sake is not the mantra in Beijing – the biggest driver of economic
              policy is social stability, perhaps best measured by looking at levels of employment and household
              income. Both of these indicators suggest that despite lower levels of growth, labour markets
              remain tight and income growth has been at a peak.
            Core to current concerns in China is the impact of overcapacity in the manufacturing sector.
              Relatively subdued demand growth has seen this weigh heavily on corporate profitability, which is
              now at levels not seen since the last global crisis reached its crescendo. The result is a relative
              lack of corporate investment, leaving a gap in Chinese growth plans that is increasingly
              being filled by a pick-up in infrastructure spending. To be clear, this is not a stimulus; the vast
              majority of these projects have previously been in the longer-term plan, but approvals are being
              given impetus and a relative lack of spend compared to budget in H1 2012 permits a sequential
              pick-up. Moreover, a lack of cash flow has hampered the ability to fund working capital at the
              same time as demand weakness has seen finished goods inventories rise. The resulting
              destocking cycle is serving to pull down apparent demand for many commodities.

24 September 2012                                                                                                      12
Macquarie Research                                                                                                                   Commodities Comment

              Macro Outlook: Responding to slowing global activity in different ways
               In the past month and a half, the global economy has experienced a noticeable slowing in the
                 pace of economic activity. For Asia, this loss of momentum has been highlighted by concerns
                 about the trajectory of China's growth and a concerning decline in the rate of growth of global
                 trade volumes. In the US, the economy's lacklustre performance in 2Q12 has resulted in further
                 substantive stimulus package from the US Federal Reserve, while in the Euro region
                 confirmation of a mild contraction in 2Q12 obscured the vast divergence in economic outcomes
                 throughout the region.
               Global industrial output has continued to slow: The slowing pace of industrial output growth
                 evident in developed economics during Q2 has now spread to emerging markets, which have lost
                 their early year momentum. Activity in the core of Europe is now suffering, and the drop in trade
                 flows is also hurting East Asia, while China‟s manufacturing sector – while still outperforming – is
                 feeling pressure from falling profitability. The US remains the area where output feels most solid,
                 aided by the shale gas effect. As a result of the coordinated drop, we have reduced our full year
                 global industrial production forecast to 2.9% from 3.25% previously. This is by no means a
                 catastrophe, but does take the edge off sequential commodities demand.
               The latest round of purchasing managers‟ indices (PMIs) also make rather grim reading on the
                 short-term outlook for the global economy. China‟s PMI fell to a nine-month low, Japan‟s PMI fell
                 to its lowest level since the fallout from the Tohoku earthquake last April, and although the
                 Eurozone PMI ticked up for the first time in six months, the indices for all of these economies were
                 below the 50-point threshold that demarcates expansion from contraction in activity.

Fig 20 Growth in global trade flows has continued to
slow through 2012                                                  Fig 21 The balance of economic risks in 2012-13
                                                                    Liquidity driven surges in activity                         Flat-lining with deflation
                                                                     Divergent and volatile growth in the major               Low sub-trend growth
                                                                                                                               Stagnant to weaker asset markets
                                                                     Fragile business and consumer confidence
                                                                                                                               Depressed business and consumer
                                                                     Volatile asset markets with high turnover                 confidence
                                                                     Low official interest rates                              Low interest rates and bond yields
                                                                     Unstable commodity prices              25%               Deflating commodity prices

                                                                             Balance of Risk                  10%
                                                                           Probability weighting

                                                                                                                  Global financial crisis mark II

Source: Macquarie Global Container Database, September 2012        Source: Macquarie Research , September 2012

               The Fed unleash their next wave of response: After a year of waiting, concerns over sluggish
                 growth has seen the US Federal Reserve unleash a third round of quantitative easing (QE). And
                 while QE3 has not been assigned an aggregate monetary value in terms of the bonds it will
                 purchase (QE1 US$1.5t, QE2 US$0.6t), the open-ended nature of QE3 has certainly been well
                 received by markets and has both substantially reduced certain economic risks and bolstered
                 business sentiment.

24 September 2012                                                                                                                                                    13
Macquarie Research                                                                                                 Commodities Comment

Fig 22 Emerging market economies have faced                              Fig 23 We have pulled down our industrial output
industrial production headwinds in mid-2012                              forecast to 2.9% – the growth slowdown is not severe

                            Emerging Economies
                                                                            Summary of Macquarie Global IP Forecasts
   6 - month                Asia
                                                                            % Change Y-o-Y       2008     2009    2010    2011   2012f
                                                           6 - month
   ann. chg                 Eastern Euro                                    Western Europe      -2.1%    -9.4%    4.1%    1.1%   -1.7%
                                                           ann. chg
                            Africa and Middle East                          Eastern Europe      -1.3%    -7.3%   10.9%    3.2%    1.9%
  20%                       Latin America                          20%      Total Europe        -1.9%    -8.9%    5.7%    1.6%   -0.8%

  15%                                                              15%      Japan               -3.4%   -21.8%   16.6%   -2.3%   2.6%
                                                                            China               12.7%    12.3%   14.3%   13.8%   9.8%
  10%                                                              10%      Other Asia           5.2%    -1.2%   10.6%    4.9%   1.8%
                                                                            Total Asia           7.2%     1.5%   13.6%    7.8%   5.7%
    5%                                                             5%
                                                                            USA                 -3.5%   -11.4%    5.4%    4.0%   3.0%
                                                                            Total NAFTA         -3.1%   -10.3%    5.2%    3.8%   3.0%
    0%                                                             0%
                                                                            Latin America        1.0%    -5.8%   10.5%    2.7%   0.4%
   -5%                                                             -5%
         Jan   May   Sep    Jan    May    Sep        Jan     May            OECD                -2.0%   -11.9%    8.0%    3.1%   1.2%
          10   10     10    11     11      11        12      12
                                                                            Total World          1.4%    -5.2%    8.8%    4.7%   2.9%

Source: Macrobond, Macquarie Research, September 2012                    Source: Macrobond, Macquarie Research, September 2012

                Medium-term global growth headwinds still remain: However, this does not necessarily mean
                 that the global growth outlook has commensurately improved. In Europe, although the recorded
                 contraction in the Euro region economy in 2Q12 was a mild 0.2 percent, this obscured the still
                 large divergences in economic outcomes across the region. Moreover, in the past two months,
                 further evidence has emerged that suggests the Euro core is now suffering from the spill over
                 effects of ongoing sovereign debt pressures in the periphery. While the ECB‟s Outright Monetary
                 Transactions provide a safety valve for Spain or Italy should they run into trouble, they do not
                 lessen the need for aggressive fiscal austerity, which is one of the main drags on growth.
                Furthermore, it has become increasingly apparent that the Chinese government is comfortable
                 with a slower rate of growth and still has concerns over inflation potential (mainly housing and food
                 driven) into the forthcoming leadership transition. We discuss this further in the subsequent
                 section; however, more variable rates of growth within China will perhaps be a more permanent
                 feature of the macroeconomic backdrop. With inflation now more structurally a challenge for
                 policymakers over the medium term, it seems unlikely that China can have all sectors firing at
                 once without creating the risk of overheating. This does not mean that growth won‟t be strong
                 enough to create tightness in commodity markets, but it is unlikely to be as strong across the
                 board as in the past.
                In the US, the economy certainly appears to have taken a summer vacation with the overall tempo
                 of activity slipping further. In the near term, we are still expecting ~2.25% seasonally-adjusted
                 GDP growth in the US in 2H, driven by consumer spending resulting from ongoing elevated
                 mortgage refinance activity and residential investment due to the ongoing gradual housing market
                 recovery. The improvement in housing starts we saw in the first half of this year should provide a
                 boost to activity in the back end of 2012.
                QE positive for sentiment, impact unclear: As noted by Macquarie‟s FIC Strategy team in their
                 recent “Ben‟s Bazooka” report, the Fed policy decision will undoubtedly be positive for sentiment
                 in the short-term given a) the extension of the rates guidance to keep rates at exceptionally low
                 level to mid-2015; b) that USD40bn per month additional bonds will be purchased on top of the
                 USD45bn purchases already planned in the ongoing Operation Twist, which runs to the end of the
                 year; and c) that the purchases are linked to the jobs market.
                However, there are couple of reasons not to expect as prolonged a risk-on rally of the likes we
                 saw post QEI and QEII. Firstly, unlike the periods of previous US QE, central banks of growth
                 currencies will not be tightening policy, for example, the RBA and BoK will likely be cutting rates,
                 giving a more muted dollar impact. Secondly, China is not running an aggressive stimulus or
                 aggressively easing policy as it did post the GFC.

24 September 2012                                                                                                                        14
Macquarie Research                                                                                                                                                                                                          Commodities Comment

                                             Furthermore, open-ended QE cuts both ways. While it leaves potentially large upside in terms of
                                                     the size of asset purchases, better US data would also curtail such upside. The difficult part of this
                                                     is the lack of clarity on the parameters for QE3. Indeed, given that there is no stated fixed
                                                     minimum initial allotment to the bond buying apart from the USD40bn per month purchase target,
                                                     QE3 will constantly come under pressure from the band of hawks that remains on the FOMC to try
                                                     to end the purchases as soon as job creation improves. For example, what unemployment rate is
                                                     low enough for the Fed to suspend asset purchases and what level of scrutiny will QE3 face at
                                                     each policy meeting? Both of these factors leave a cloud over the longevity of the any QE3 impact
                                                     and therefore market rally. Furthermore, it is likely to increase commodity price volatility around
                                                     Fed announcements.

Fig 24 The potential impact of QE3 is unclear, other                                                                                                                              Fig 25 The US$ has depreciated during previous QE
than extending the Fed’s balance sheet                                                                                                                                            bouts – we expect the same but to a lesser extent

                                                                                                                                                                                   Index                  US Trade Weighted Index            Index
                   3.30                                                                                                                                                    5000
                                                                                                                                                                                   115                                                          115
   USD Trillions

                   2.80                                                          "QE2"                                                                                                                           Massive global
                                                                                                                                                                           4000    110                           policy response                110
                   2.30                                                                                                                                                    3500
                                                                                                                                                                                               Lehman                               Euro
                                                                                                                                                                                   105                                              bond        105
                   1.80                                                                                                                                                    3000                                                 QE2 panic
                                                                                                                                                                                   100                                                          100
                   1.30                                                                                                                                                                                      Euro
                                                                                                                                                                           2000                              strains/US
                   0.80                                                                                                                                                    1500      95                      growth slows                       95
                          Jan 08
                                   Apr 08
                                            Jul 08
                                                     Oct 08
                                                              Jan 09
                                                              Apr 09
                                                                        Jul 09
                                                                                 Oct 09
                                                                                          Jan 10
                                                                                          Apr 10
                                                                                                   Jul 10
                                                                                                            Oct 10
                                                                                                                     Jan 11
                                                                                                                     Apr 11
                                                                                                                              Jul 11
                                                                                                                                       Oct 11
                                                                                                                                                Jan 12
                                                                                                                                                         Apr 12
                                                                                                                                                                  Jul 12

                                                                                                                                                                                     90                                                         90
                                                                       Fed Balance Sheet                                  LMEX                                                        Jan 07     Apr 08     Jul 09     Oct 10       Jan 12
Source: Macrobond, Macquarie Research, September 2012                                                                                                                             Source: Macrobond, Macquarie Research, September 2012

                                             Pressure shifts to emerging market central banks: What is crucial, in our view, is an
                                                     understanding of how QE3 will support US growth. While the Fed argues that QE works like
                                                     normal monetary policy (that is by cutting interest rates which then boosts growth), in our view, the
                                                     main advantage of QE3 is by weakening the US$ and providing a competitive kick to US exporters
                                                     and import-competing firms. Thus, from a global perspective, QE is initially a growth shifting
                                                     policy, rather than a growth boosting policy. That is, stronger US growth comes at the expense of
                                                     those economies against which the US$ is depreciating, consistent with the "currency wars" that
                                                     some policymakers have spoken about.
                                             However, those economies which are experiencing currency appreciation – be they in Latin
                                                     America or Asia – can try to offset the negative growth effects by cutting their own interest rates or
                                                     easing fiscal policy. If they do this, then QE does become a global growth boosting
                                                     policy. Effectively what QE does is forces those economies that can ease policy further to ease
                                                     policy further. This means that the ball is now in the court of other policymakers, such as the
                                                     emerging market central banks. And whether they like it or not, we think it‟s inevitable that they will
                                                     be compelled to respond to the changed circumstances. Thus the actions of the Fed and ECB
                                                     may not be the final chapter on policy easing; they could just be the start of another round – a
                                                     situation which would prove more positive for commodity markets into 2013 and beyond.

24 September 2012                                                                                                                                                                                                                                    15
Macquarie Research                                                                                                                                                                                                                                    Commodities Comment

                                    China outlook: More comfortable than expected with slower rates of
                                     Economic activity in China has certainly felt sluggish over 2012. Our economics team recently
                                           downgraded GDP growth expectations for the year to 7.7%, compared to the 9.2% reported
                                           growth in 2011. On these numbers, 2012 has seen the second sharpest YoY decline in GDP
                                           growth rates of at least the last 15 years (the greatest decline being 2008). This follows on from
                                           what was already a substantial slowing of the growth rate in 2011. Meanwhile, manufacturing
                                           activity indicators have steadily softened, falling to some of the lowest levels seen outside of the

Fig 26 GDP growth rates expected to see the second                                                                                                                          Fig 27 Still plenty of potential for an infrastructure
sharpest drop in recent history this year                                                                                                                                   pick-up within existing 2012 budget

                                                                                                                                                                                                                        Chinese infrastructure investment
                      16                 GDP growth (LHS)                                                                                20
                                         Change in GDP growth rate (RHS)                                                                                                                                 1600
                                                                                                                                         15                                                                      2010   2011     2012 Target   1H12
                                                                                                                                         10                                                              1400
                                                                                                                                               Change in GDP growth, %YoY
                      12                                                                                                                 5                                                               1200
   GDP growth, %YoY

                                                                                                                                                                                Rmb billion investment
                      10                                                                                                                 0
                                                                                                                                         -10                                                              800

                      6                                                                                                                  -15                                                              600

                      4                                                                                                                  -20
                      2                                                                                                                                                                                   200
                      0                                                                                                                  -35                                                                0

                                                                                                                                                                                                                Power grid           Rail          Water       FAI: road &
                                                                                                                                                                                                                               infrastructure infrastructure    waterway

Source: NBS, Macquarie Research, September 2012                                                                                                                             Source: NBS, Macquarie Research, September 2012

                                     Government has focused on fine-tuning rather than stimulus: While markets have been
                                           watching these indicators as a potential trigger for government stimulus, Beijing has not delivered
                                           anything of any size, with most policy action being monetary rather fiscal (recent infrastructure
                                           approvals were mostly for longer-dated projects with more medium-term than near-term impact).
                                     What has become evident is that China is actually quite comfortable with lower levels of growth.
                                           Growth for growth‟s sake is not the mantra in Beijing – the biggest driver of economic policy is
                                           social stability, perhaps best measured by looking at levels of employment and household income.
                                           Both of these indicators suggest that despite lower levels of growth, labour markets remain tight
                                           and income growth has been at a peak.
                                     This marks an important structural change in the Chinese economy. The idea that China needed
                                           growth of 8%+ stemmed from the mid-90s when Beijing was allowing failing SOEs to go bust and
                                           divest non-core assets. Coupled with an increasing pace of rural to urban migration, the labour
                                           force was growing rapidly and a fast pace of economic activity was required to ensure
                                           employment opportunities were available. With the labour market now in deficit, rapid growth is no
                                           longer required, nor would it be beneficial – without the available labour inputs, faster growth
                                           would prove highly inflationary.

24 September 2012                                                                                                                                                                                                                                                            16
Macquarie Research                                                                                                                                                                                                        Commodities Comment

Fig 28 Labour markets have remained in deficit                                                                                                   Fig 29 Household income growth, while softening, is
despite slower economic growth                                                                                                                   running at high levels

                                                                          Labour market demand/supply balance                                                                                      Household income growth - nominal

                                             1.20                                                             Increasing labour market deficit


                                                                                                                                                    YoY growth in household income
 Ratio of jobs available to job applicants


                                             1.00                                                                                                                                    15%



                                             0.70                                                                                                                                          Urban
                                                                                                             Increasing labour market surplus

                                             0.60                                                                                                                                    0%












Source: MOHRSS, Macquarie Research, September 2012                                                                                               Source: NBS, Macquarie Research, September 2012

                                                              A mixture of cyclical and structural elements behind lower growth: We would also note that
                                                                  the imminent leadership transition in China is likely to be accompanied by a lack of dramatic policy
                                                                  changes, and only minor monetary and fiscal policy adjustments should be expected over the
                                                                  coming six months. This lack of „guidance‟ is secondary to the lack of corporate profitability at the
                                                                  present time, but does have an effect on Chinese sentiment, which in itself is increasingly
                                                                  important for near-term commodity price moves.
                                                              While we still expect to see some improvements in headline figures in 4Q, which could last into
                                                                  next year, the overall picture doesn‟t look as optimistic as it did at the beginning of 2012.
                                                                  Economic policies may also become less expansive later next year when both growth and price
                                                                  pressure pick up. Thus, our China Economics team have downgraded our China GDP forecast for
                                                                  2012 from 8.1% to 7.7%, and from 8.1% to 7.5% for 2013.
                                                              Moreover, without pinning down exact growth numbers for years beyond 2013, we have the
                                                                  general feeling that they could also be marked with economic difficulties. So a better reference
                                                                  point for the current situation may be the hard period of 1998-2002 (albeit deflation back then)
                                                                  instead of the sharp deterioration of 2008. One feature of the former period, and potentially of the
                                                                  current period as well, is prolonged weak corporate performance, and efforts in capacity
                                                                  expansion are likely to be diverted more to margin improvements.
                                                              Overcapacity is starting to weigh in downstream sectors: Key to the concerns over the
                                                                  manufacturing sector has been the impact of overcapacity. Over recent years, downstream
                                                                  industries in China have by and large over-invested given a low capital barrier to entry and
                                                                  supportive rates of finance. This approach was fine when demand growth remained above trend;
                                                                  however the global slowdown has seen this capacity weigh heavily on corporate profitability, which
                                                                  is now at levels not seen since the last global crisis reached its crescendo.
                                                              This is where the interest rate cuts seen so far have helped, in terms of servicing existing debt.
                                                                  However, given the uncertain growth outlook across many sectors, corporate investment has
                                                                  slowed markedly. Moreover, a lack of cash flow has hampered the ability to fund working capital
                                                                  at the same time as demand weakness has seen finished goods inventories rise. The resulting
                                                                  destocking cycle is likely to persist to the remainder of 2012 (at least), depending on the rate of
                                                                  production cuts relative to demand, and is servicing to pull down apparent demand for
                                                                  commodities. China‟s corporate sector is still going through the adjustment process to cope with
                                                                  lower trend growth rates.

24 September 2012                                                                                                                                                                                                                         17
Macquarie Research                                                                                                                                                                                                                                                                                                                                        Commodities Comment

Fig 30 The dramatic buildout of capacity in recent                                                                                                                                                                   Fig 31 Output of manufactured goods remains weak
years is now taking a toll on corporate profitability                                                                                                                                                                in many cases
                                                                                                                                                                                                                                                                         Production and sales of excavators - YoY
                                                              Corporate profitability has slumped in 2012
  Aggregated net profit margin - industrial sector

                                                                                                                                                                                                                         300%                         production



                                                     5.5%                                                                                                                                                                100%

                                                     4.0%                                                                                                                                                                     0%

















Source: MOHRSS, Macquarie Research, September 2012                                                                                                                                                                   Source: CEIC, Macquarie Research, September 2012

                                                                        Infrastructure filling the corporate investment void: A relative lack of corporate investment
                                                                              leaves a gap in Chinese growth plans which is increasingly being filled by a pick-up in
                                                                              infrastructure spending. To be clear, this is not a stimulus; the vast majority of these projects have
                                                                              previously been in the longer-term plan, but approvals are being given impetus and a relative lack
                                                                              of spend compared to budget in H1 2012 permits a sequential pick-up. Infrastructure is now
                                                                              positioned as a balancing force in the economy with projects able to be sped up or slowed down
                                                                              (with the availability of finance as the key tool) depending on the government‟s outlook. In our
                                                                              view, there will be suitable infrastructure spend to offset the weakness in corporate investment,
                                                                              but not to fuel a strong growth uptick. However, this does have implications for the 2013
                                                                              commodities outlook, particularly those levered to infrastructure (such as copper).
                                                                        One interesting area in the coming months will likely be the behaviour of Chinese banks in tough
                                                                              market conditions. There appears to have been a shift from a profitability focus when determining
                                                                              lending criteria to a balance sheet focus, and over-the-cycle stability. However, this naturally favours
                                                                              SOEs over the private sector, which is only likely to receive very low loan to value ratios. This is
                                                                              likely to further hinder „flexible‟ investment in the Chinese economy, though could see a degree of
                                                                              restructuring providing employment does not become a bigger issue.
                                                                        In terms of the large infrastructure projects being progressed, banks will again have a key role. In
                                                                              general, fiscal funds only serve as start-up capital for these projects, and hence bank loans are
                                                                              also required to provide the bulk of project financing. However, banks have become more cautious
                                                                              in committing to long term lending, and the focus will be on the policy banks to support these
                                                                              projects. As Dragonomics eloquently put this process, the large infrastructure spend in opening
                                                                              up capacity will likely prove an economic disaster for standalone financial projects, but will give a
                                                                              large „social‟ benefit which is difficult to quantify.
                                                                        Consumption does not act as a policy lever in itself: It may be a core element of the economic
                                                                              rebalancing strategy, but it is proving hard for consumption to break out from its usual pattern set
                                                                              in the past decades. During 1H12 consumption‟s contribution to GDP growth turned out to be a
                                                                              resilient 4.5% vs. a 10-year average of 4.4%. On the flip side, there are no clear catalysts for
                                                                              further gains – the scale of measures initiated in 1H12 failed to provide any boost; moreover, the
                                                                              declining wealth-effect due to lower asset-prices as well as rising concerns on unemployment may
                                                                              limit the near-term growth prospects. Income tax cuts may be the next thing to stimulate
                                                                              consumption but again we think it falls into a long-term strategy, not a near-term fix.
                                                                        Despite the headline construction indicators looking weak, the real estate sector has been resilient
                                                                              over 2012. Demand for construction steels (rebar and wire rod) are up 4% YoY YTD,
                                                                              outperforming the broader market. Strength appears to have come primarily from the non-
                                                                              commodity construction sector – residential and non-residential projects driven by governments
                                                                              and corporates rather than developers selling into the market.

24 September 2012                                                                                                                                                                                                                                                                                                                                                                                                                 18
Macquarie Research                                                                                                                                                                                                                                                            Commodities Comment

                                       The commodity (or developer driven) side of the market looks set for a rebound into the end of
                                               2012 and 2013. Sales activity across tier 1 and tier 2 cities picked up dramatically from the start of
                                               this year and more recently we have started to see evidence of this spreading to the broader
                                               market, following the interest rate cuts. We expect this to lead to improving construction activity
                                               into next year.

Fig 32                      Real estate indicators appear to be improving…                                                                                                    Fig 33                          …while manufacturing indicators soften

                                                                          Construction indicators                                                                                                                                               PMI and IP growth
     100%                                                                                                                                                                                              54                                                                                                16%
                                     Floor area sold
                                     Floor area under construction                                                                                                                                     53

                                                                                                                                                                                                                                                                                                               Industrial production, YoY
                                                                                                                                                                                                       51                                                                                                12%

                                                                                                                                                                                PMI, >50 = expansion
 YoY, 3mma

             20%                                                                                                                                                                                       49

                                                                                                                                                                                                       48                                                                                                8%
                                                                                                                                                                                                       46               PMI (LHS)
                                                                                                                                                                                                                        Industrial Production (RHS)
       -40%                                                                                                                                                                                            45                                                                                                4%
























Source: NBS, Macquarie Research, September 2012                                                                                                                               Source: NBS, Macquarie Research, September 2012

                                       Inflation fears remain, limiting potential response: Overall, despite the fall in PPI over recent
                                               months, the government still seems concerned about the prospect of inflation given the recent rise
                                               in real estate prices– a feeling likely to have been reinforced by QE3. Moreover, the slight pick-up
                                               in housing prices is also likely to have concerned policymakers. Thus, while labour markets
                                               remain tight, a slew of further interest rate cuts are unlikely – China has never cut official rates in a
                                               rising CPI cycle. Thus, we are essentially forecasting the government would try hard to maintain a
                                               balance between growth (supporting asset values) and potential price pressure, and policy targets
                                               for next year will remain complicated. This is obviously not an easy job, particularly given that
                                               inflation seems to have grown more sensitive to changes in growth, as pointed out by the PBC.
                                       The risk is that the struggling manufacturing sector continues to deteriorate, perhaps coming
                                               under further pressure from falling export demand. This then has the potential to lead to problems
                                               with unemployment – generally a lagging indicator of corporate profitability – as businesses fail
                                               and consumer confidence gets hit again. Given that the property market is driven by consumer
                                               sentiment, sales would likely fall and construction activity with it.

24 September 2012                                                                                                                                                                                                                                                                                                                           19
Macquarie Research                                                                                            Commodities Comment

              Executive Summary: Looking better for demand into 2013, Chinese supply
              response remains key
               After a year which began with a degree of optimism for commodity prices as fears over global
                 growth receded, the return and escalation of familiar macroeconomic problems coupled with the
                 lack of a cyclical recovery in China meant Q1 gains faded to memory. With the vast majority of
                 prices down on the majority of comparison metrics, 2012 is unlikely to be fondly remembered by
                 commodity market producers on the whole.
               With the immediate demand environment still looking relatively subdued, prior to QE prices had
                 been bedding down within cost curves in an effort to push high cost supply offline. With supply
                 now reacting, the downside risk to many metals and bulk commodities from current levels is
                 limited. However, moving past the nadir in the growth cycle coupled with improved business
                 confidence offers 2013 upside, particularly for those commodities where supply either remains
                 constrained or had reacted quickly to price prompts, such as copper, iron ore and the PGMs.

Fig 34 Since our previous forecast, we have pulled down our 2013 price averages across the spectrum of
metals and bulk commodities

                     Change in average 2013 price estimates from our previous forecast
            Iron Ore    Platinum      Met        Steel    Aluminium      Zinc       Gold      Thermal     Copper      Nickel

                                                                                     -6%        -6%         -6%
   -15%                              -14%        -14%        -13%


   -25%       -23%

Source: Macquarie Research, September 2012

               In general, we have marked to market base metals for 2012 and pulled prices down by 5-15%
                 through 2013 as slower industrial output is factored in. Copper remains our favoured base metal
                 exposure, both due to the demand benefit from China‟s infrastructure push and ongoing lack of
                 supply growth. QE is likely to provide a near-term boost for all metals, but in our view aluminium
                 remains burdened with overcapacity, while the prospects for a zinc price spike above $2,500/t
                 have diminished given the increase in Chinese mine capacity, thus further upside to average price
                 in 2013 is minimal. The only outlier in our price changes is nickel, where we have made only
                 limited changes with a slight upgrade to 2013 given supply disappointments.
               Bulk commodities are the area where we have pushed through the largest downgrades.
                 However, from the current oversold position they also offer best upside in terms of average price
                 in 2013 from today‟s spot levels. The reduction of Chinese steel demand to 2-3%pa into the
                 medium term has a major effect on our raw material forecasts, with iron ore prices pulled back to
                 $130/t average for 2013, tailing off to $100/t beyond that point. The medium term met coal profile
                 has been brought closer to $200/t for HCC material. We have reduced the 2013 thermal coal
                 contract slightly, but still feel spot prices have upside from current levels into Q4 as Chinese hydro
                 output seasonally weakens. Steel prices have also been dropped by 10-15% through the curve,
                 keeping the margin to raw materials essentially unchanged. We would reiterate that the global
                 steel industry is in desperate need of a restructure and permanent capacity closures.

24 September 2012                                                                                                              20
Macquarie Research                                                                                                                                                                             Commodities Comment

                                         The lack of conviction in precious metals has surprised us this year, and we have dropped our
                                           near term forecasts given the 2012 base. However, conviction is starting to return, boosted by QE
                                           for gold and silver and South African production risk in PGMs. Palladium remains our preferred
                                           exposure into the medium term given its leverage to emerging market auto production, while the
                                           confirmation of low 2015 interest rates has seen us push up the back end of the gold curve.
                                           Meanwhile, renewed focus on Us Fed meetings means volatility is back in vogue again.

Fig 35 We see strong upside in 2013 from current bulk commodity price levels as the destocking cycle ends.
The post QE rally means upside has already been reflected in base metals

                                                                       2013 forecast compared to current spot price levels



                         5%                                                                                                                 0%           0%                 0%

                         -5%                                                                                                                                                               -1%     -3%
                                         Met            Iron Ore               Thermal               Gold            Platinum         Nickel             Zinc           Steel           Aluminium Copper
Source: LME, Platts, globalCoal, Macquarie Research, September 2012

                                         A record year for demand, if not prices: Many of the core themes running through metals and
                                           bulk commodity markets over the past few years remain very much in place. Long run prices
                                           continue to move higher rather than lower. Meanwhile growth rates have generally been slower,
                                           demand is on track for another record year in 2012, with the importance of China meaning even a
                                           slower pace of growth results in the absolute demand delta in commodity markets being well
                                           above the long term norm. In addition, urbanisation and industrialisation of emerging markets
                                           continues at an above trend pace, and the longer term potential of commodity markets remains
                                           intact, even if the medium-term risk profile has stepped up another notch. In addition, the classical
                                           counter-cyclicality between China and ex-China demand still holds for the base metals, though
                                           both look to have sequentially dipped through Q3.
Fig 36 The China to ex-China countercyclicality                                                                               Fig 37 Global steel demand is still set for a record
continues to hold in base metals                                                                                              year, though growth rates have conspicuously slowed

                                           Change in base metals apparent demand                                                                                  Global crude steel output, annualised
   % change yoy - 3MMA

                                                                                                                                 m tonnes

                          -30%                                                                                                                                                                  2009              2010












                                                                                                                                                                                                2011              2012









                                                              China           World Ex-China

Source: IAI, ICSG, ILZSG, INSG, Macquarie Research, September 2012                                                            Source: worldsteel, Macquarie Research , September 2012

24 September 2012                                                                                                                                                                                                              21
Macquarie Research                                                                                                                                                                                                                                                                                                        Commodities Comment

                   Don’t underestimate the impact of cyclical supply: The story on the supply side continues to be
                            the relative outperformance of Chinese (and other) cyclical supply growth relative to international
                            peers. This output, whether from mine or smelter, generally operates a low capex, high opex model
                            and tends to be the balancing factor in metals markets. Such production typically has a degree of
                            flexibility, depending on the amount of private sector involvement, and reacts to price prompts. To
                            invoke a response, prices must trade to a level at which cash flow either incentivises additional
                            output or pushes output offline, depending on the direction of the demand cycle.

                  Fig 38 Chinese commodity supply growth has massively outperformed
                  international peers in relative terms over the past decade

                                                  Change in Chinese commodity output - 2011 vs. 2001















                                                               (crude ore)

                                                                                                                                                                                                                                               (62% Basis)




                                                                                          Crude steel
                                                                 Iron ore

                                                                                                                                                                                                                                                 Iron ore


                  Source: NBS, CNIA, Macquarie Research, August 2012

                   So far in 2012, we have seen Chinese nickel, thermal coal and iron ore supply exit the market
                            relatively quickly as prices traded down into the cost curve. However, commodities such as zinc
                            and aluminium did not see the same supply response even though economics suggested they
                            should. Such inefficiency is set to prolong the surplus in both markets.
Fig 39 Many commodities are trading into the cost                                                                                                                 Fig 40 Metals price moves have tended to be reflected
curve at the presently, limiting sustainable downside                                                                                                             with a lag in China’s PPI

 100%           Current spot price premium over cost of marginal producer                                                                                                                                                    YoY changes, LMEX and Chinese PPI
                                                                                                                                                                    120%                                                                                                                                                                                                                 15%
                                                                                                                                                                                                                                                                                                                                        LMEX (LHS)
                                                                                                                                                                    100%                                                                                                                                                                PPI (RHS)

  60%                                                                                                                                                               80%                                                                                                                                                                                                                  10%

                                                                                                                                                                    40%                                                                                                                                                                                                                  5%

  20%                                                                                                                                                               20%

                                                                                                                                                                     0%                                                                                                                                                                                                                  0%

 -20%                                                                                                                                                               -40%                                                                                                                                                                                                                 -5%
                                                               Thermal Coal


                                                                                                                                                                    -80%                                                                                                                                                                                                                 -10%


                                                                                                                                                Iron Ore


                                                                               Met Coal





















Source: Metal Bulletin, LME, Platts, Macquarie Research, September 2012                                                                                           Source: LME, NBS, Macquarie Research, September 2012

24 September 2012                                                                                                                                                                                                                                                                                                                                                                         22
Macquarie Research                                                                                         Commodities Comment

            With adequate volumes of flexible supply available across metals markets, and demand growth
              cycling around a lower trend, classical commodity economics have regained their prevalence.
              Through Q3, many commodity prices have been trading into cost curves in order to drive supply
              rationale. The difference in the new commodity environment is that demand swings are generally
              driven by China, and it is Chinese supply which reacts to balance the market. In our view, the
              importance of cyclical supply is underappreciated, and it is this area which now defines many
              commodity markets – until it is completely displaced commodity prices will continue to trade above
              long run equilibrium levels.
            Thus, in a demand growth scenario which is not aggressive, this cyclical supply can serve to
              balance the market quickly. Dramatic price moves (either up or down) of the like seen from highly
              supply-constrained environments are less likely in the coming years. That is not to say prices will
              not be volatile, as prices do have to overshoot to bring about the necessary supply response.
              Rather, a „normalised‟ price for most markets again involves consideration of how much cyclical
              supply is required to balance any given market, and where this comes on the cost curve. Given
              the relatively high opex for much of the cyclical supply in the markets, this is likely to remain above
              long run marginal costs in the medium term, keeping commodity prices elevated above historical
            A drop to a long run commodity price environment will only come when enough cyclical supply is
              displaced by now, lower cost material to force structural supply to react to demand swings. This is
              a function of two things: the rate of demand growth and the execution of new supply.
            This change in market structure also has implications for market modelling. For as long as metals
              have been around, traditional commodity analysis of supply vs. demand and a resulting surplus or
              deficit has been used to categorise market dynamics. In our view, the new evolution means the
              conventional technique‟s universal application has become outdated in certain instances. We
              review alternative supply and demand techniques we apply to analysis in our Macquarie
              Commodities Comment “Redefining supply-demand balances” – 11th June 2012.
            The great destock has pushed down apparent demand for commodities: Over and above the
              slowdown in industrial output, the rebalancing of downstream sectors has seen an amplified effect
              on apparent commodities demand through a destocking cycle. With production being slow to cut
              in many cases when demand fell, the resulting inventory build tied up a lot of working capital. With
              cash flows under pressure, the result has been a destock of raw materials – ex-China destocked
              during Q4 2011 and hasn‟t recovered, while the China PMI raw materials inventory sub-index has
              shown stock draw since mid-2011. Such a destock cannot last forever, and even a slowdown in
              the rate will boost apparent demand; however, it is likely that while overcapacity is crimping
              margins, levels of commodity inventory will remain sustainably lower. This process will only be
              enhanced by rising real interest rates across markets as a whole, making raw materials inventory
              a headwind rather than an asset to profit from.
            Perhaps the best example of this in practice comes from the steel market. Our Macquarie China
              Steel Sector Survey showed a dramatic rise in finished steel inventories during July and August.
              As a result, mills destocked raw materials to keep working capital in balance, with the result that,
              in our estimations, Chinese mills were destocking iron ore at the rate of 200mtpa in August. This
              is the main reason we consider iron ore fundamentally oversold.

24 September 2012                                                                                                          23
Macquarie Research                                                                                                                                                                                                                        Commodities Comment

                                                                                                                                                     Fig 42 …forcing an aggressive destock of raw
Fig 41 In general, a build up of finished inventories in                                                                                             materials as per the Chinese PMI raw materials
China has sucked up working capital…                                                                                                                 inventory subindex

                                  What level of steel inventory are you currently holding?
               13                                                                                                                                                                                                                                  Increasing stockbuild

               12                                                                                                                                                              52

                                                                                                                                                        PMI (50 = no change)
   Days of sales


                   9                                                                                                                                                           48
                   5                                                                                                                                                                                                                         Increasing stock draw
                   4                                                                                                                                                           42

                                                                                                                                                                                    J 2011

                                                                                                                                                                                                               J 2011

                                                                                                                                                                                                                        S 2011

                                                                                                                                                                                                                                 N 2011

                                                                                                                                                                                                                                          J 2012

                                                                                                                                                                                                                                                                         J 2012
                                                                                                                                                                                             M 2011

                                                                                                                                                                                                      M 2011

                                                                                                                                                                                                                                                       M 2012

                                                                                                                                                                                                                                                                M 2012










Source Macquarie China Steel Sector Survey, September 2012                                                                                           Source: CFLP, NBS, Macquarie Research, September 2012

                                      With price fall comes even greater likelihood of supply growth underperforming
                                         expectations: Pressure for reductions in capital spend in the metals and mining sector is a hot
                                         topic at present, with lower commodity prices, escalating capital costs and uncertainty over growth
                                         all playing into a need to conserve cash flow. While the high output base and depletion of existing
                                         assets means capex as a whole is set to remain above trend (and long run commodity price on an
                                         upward trajectory), and projects are likely to be phased or deferred rather than cancelled, it seems
                                         inevitable that certain areas will feel the pressure, particularly in regions with little in the way of
                                         existing assets.
                                      Pressure on producers to pull back capex after a period of above-trend growth is by no means a
                                         new phenomenon. Indeed, it is highly typical of the third year of a cycle where cash flows are
                                         strong – governments want more money, employees want more money and shareholders want
                                         more money. This, coupled with a pullback in near-term commodity prices, has made higher
                                         capex allocation extremely difficult to justify. However, many metals still need substantial
                                         additional and replacement supply in absolute terms in the coming years, making balancing
                                         growth against return more difficult than ever. In general terms, it is likely that sustaining capital
                                         spending will be hit first in the cycle for major miners (particularly maintenance and mining
                                         services), while smaller producers may have to pull allocation from the growth budget. It is
                                         unlikely projects will disappear, but the likelihood of cyclical, phased capital spend may well see
                                         delays relative to current plans.
                                      It should be noted that in some metals, there is very little growth capex already. In particular,
                                         outside of China there are very few projects in downstream sectors such as carbon steel, stainless
                                         steel and aluminium. This is essentially down to the fact that new operations in these areas do not
                                         return their capital presently, with margins very low which in turn makes banks less willing to lend.
                                         Thus, ex-China capacity additions in the coming years are set to be few and far between, despite
                                         a much lower ramp-up in capital intensity than seen on the mining side.
                                      In contrast, we do not expect to see any pullback in copper capex spend, despite the fact that
                                         capital intensity of copper mines has increased at 22% per annum on average over the past seven
                                         years. The lack of mine output growth over the same period, and the high rate of depletion,
                                         means copper investments continue to find backing. In contrast, unfinanced, infrastructure heavy
                                         bulk commodity project spend is likely to be at the sharp end of any capex pullback.
                                      QE3 getting financial market involved again: In the short time since it has been announced,
                                         the „QE3 effect‟ on commodity market sentiment is clear to see. Exchange traded commodities
                                         are up 5-10% as short positions are covered and length is added in the risk-on rally. Meanwhile,
                                         the positive sentiment has also flowed into physical markets, with iron ore up over 10% since the
                                         announcement. Meanwhile, Figure 43 below highlights that the usual correlation between base
                                         metals and G3 PMI broke down markedly during QE2, with metals strongly outperforming.

24 September 2012                                                                                                                                                                                                                                                                 24
Macquarie Research                                                                                                                                                                                                                                                                   Commodities Comment

                          As a result, as growth concerns are put on the backburner for a while, there is increasing
                                  confidence that commodity markets can trade higher into early 2013. Financial market backing is
                                  returning, and base metals are already starting to push out the cost curve, with $9,000/t copper
                                  potentially back on the agenda. However, there are two areas where QE3 is likely to have further
                                  metals market impact, notwithstanding any wider impact on the global economy. The first is the
                                  return of conviction to precious metals markets, and increased ETF inflows. This could well push
                                  gold to new highs in 2013, with silver also outperforming. Secondly, the fact that rates will stay
                                  low through 2015 makes the reallocation of capital away from metals financing less likely. This is
                                  set to keep large quantities of aluminium, zinc and nickel unavailable the market into the medium
                                  term, enhancing the impression of physical tightness.

Fig 43      PMIs and base metals prices have tended to move in tandem … except in the event of QE2

                                                                                                                                     LHS: LMEX index                                       RHS: G3 PMI
        4,500                                                                                                                                                                                                                                                                                                                     60

        4,000                                                                                                                                                                                                                                                                                                                     55

        3,500                                                                                                                                                                                                                                                                                                                     50

        3,000                                                                                                                                                                                                                                                                                                                     45

        2,500                                                                                                                                                                                                                                                                                                                     40

        2,000                                                                                                                                                                                                                                                                                                                     35

        1,500                                                                                                                                                                                                                                                                                                                     30
                J 2007

                                           J 2007

                                                             N 2007
                                                                      J 2008

                                                                                                 J 2008

                                                                                                                   N 2008
                                                                                                                            J 2009

                                                                                                                                                       J 2009

                                                                                                                                                                         N 2009
                                                                                                                                                                                  J 2010

                                                                                                                                                                                                             J 2010

                                                                                                                                                                                                                               N 2010

                                                                                                                                                                                                                                        J 2011

                                                                                                                                                                                                                                                                   J 2011

                                                                                                                                                                                                                                                                                     N 2011
                                                                                                                                                                                                                                                                                              J 2012

                                                                                                                                                                                                                                                                                                                         J 2012
                                                    S 2007

                                                                                                          S 2008

                                                                                                                                                                S 2009

                                                                                                                                                                                                                      S 2010

                                                                                                                                                                                                                                                                            S 2011
                         M 2007
                                  M 2007

                                                                               M 2008

                                                                                        M 2008

                                                                                                                                     M 2009

                                                                                                                                              M 2009

                                                                                                                                                                                           M 2010
                                                                                                                                                                                                    M 2010

                                                                                                                                                                                                                                                 M 2011
                                                                                                                                                                                                                                                          M 2011

                                                                                                                                                                                                                                                                                                       M 2012
                                                                                                                                                                                                                                                                                                                M 2012
Note: all data are month averages. LMEX is a weighted index of LME aluminium, copper, lead, nickel, tin and zinc prices. G3 – Japan, USA and Eurozone
Source: ISM, LME, Markit, Macquarie Research, September 2012

                          Seasonality will only bring benefit in 2013: With China acting more and more like a typical
                                  Northern Hemisphere economy in terms of demand shifts through the year, seasonality is
                                  becoming increasingly important in metals markets. Historically, metals-related demand data
                                  tends to be down in the third quarter of each year before rebounding in the fourth quarter, as
                                  manufacturing pulls out the summer lull. However, with leading indicators falling, the remainder of
                                  2012 looks challenging for underlying global demand. Rather, the potential for a tailwind from the
                                  typical mid-Q1 boost in 2013, bolstered by looser monetary policy, is perhaps more pertinent for
                                  metals markets.
                          China’s infrastructure push favours copper: The infrastructure spend now coming through
                                  from the Chinese government to replace corporate investment is set to have differing effects on
                                  commodities demand. For steel, infrastructure makes up a relatively small portion of overall
                                  demand, with real estate much more influential. Thus, while the Ministry of Rail‟s efforts to meet
                                  2012 budget will bring benefit, it is only partially offsetting manufacturing weakness. In contrast,
                                  copper demand is highly levered to infrastructure, which makes up over 40% of Chinese
                                  consumption via the State Grid and industrial power. As a result, we expect a positive influence to
                                  feed through to copper demand in late 2012-early 2013.

24 September 2012                                                                                                                                                                                                                                                                                                                       25
Macquarie Research                                                                                            Commodities Comment

Fig 44    Copper is much more levered to a push in Chinese infrastructure spend than steel

          Copper demand by sector - 42% infrastructure                 Steel demand by sector - 14% infrastructure
         Automotive                                                                       16%      Infrastructure
             5%                           Infrastructure -
                                                                    Shipbuilding                        14%
                                            Power grid
                  Consumer                     Infrastructure -
                  Appliance                                                   Appliances
                                              Industrial power
                    16%                                                          7%                      Construction


Note: Antaike, CISA, Macquarie Research, September 2012

               China‟s recent inflation numbers have shown a decent slowdown in CPI and PPI inflation. While
                 the impact of food prices, particularly pork, receives much of the headlines, metals prices have
                 certainly played their part. Indeed, metals prices have generally been a stabilising influence on
                 China‟s inflation through the growth cycle. In RMB terms, current prices for steel, stainless steel
                 and aluminium are below those seen in January 2005. In these sectors, raw material prices have
                 pushed higher however the ability and will to add capacity in China has driven deflationary
                 pressures as excess capacity battles for market share, at the expense of profitability – much the
                 same as is happening in downstream manufacturing today. The exception is copper, where such
                 a Chinese response could not be invoked at the mining level. Moves in the LMEX index have
                 historically been reflected with a slight lag in China‟s PPI, albeit in a less amplified manner. Thus,
                 further YoY negative PPI in the coming months should not be a surprise, and gives the
                 government a bit more leeway to push metals-intensive infrastructure spend.

24 September 2012                                                                                                             26
Macquarie Research                                                                                                                        Commodities Comment

              Base metals
               In general, we have marked to market base metals for 2012 and pulled prices down by 5-15%
                through 2013 as slower industrial output is factored in.
Fig 45    Base metals forecasts
                                              2010     2011     2012     2012      2012      2012     2012      2013     2014       2015       2016       2017
                                      Unit     CY       CY       Q1       Q2        Q3        Q4       CY        CY       CY         CY         CY         CY     LT $2012
 Copper                   New     $/tonne     7,539    8,811    8,310    7,869     7,700     8,200    8,020     8,063    7,675      7,550      7,500      7,500      6,504
                          Old                 7,539    8,811    8,310    7,869     8,850     8,300    8,332     8,538    7,675      7,550      7,500      7,500      6,504
                          %chg                  -        -        -        -     -13.0%     -1.2%    -3.8%     -5.6%       -          -          -          -         -
 Aluminium                New     $/tonne     2,173    2,395    2,177    1,978     1,900     2,000    2,014     2,138    2,300      2,500      2,500      2,600      2,425
                          Old                 2,173    2,395    2,177    1,978     2,200     2,300    2,164     2,463    2,750      2,900      2,900      3,000      2,425
                          %chg                  -        -        -      0.0%    -13.6%    -13.0%      -6.9%   -13.2%   -16.4%     -13.8%     -13.8%     -13.3%            -
 Zinc                     New     $/tonne     2,159    2,191    2,025    1,932     1,875     1,925    1,939     2,056    2,200      2,300      2,300      2,250      1,875
                          Old                 2,159    2,191    2,025    1,928     2,150     2,200    2,076     2,288    2,575      2,475      2,475      2,300      1,875
                          %chg                  -        -        -      0.2%    -12.8%    -12.5%      -6.6%   -10.1%   -14.6%       -7.1%      -7.1%      -2.2%           -
 Nickel                   New     $/tonne    21,809   22,831   19,651   17,146   15,950    17,000    17,437    18,250   21,125     24,251     26,455     28,660     24,251
                          Old                21,809   22,831   19,651   17,146   17,250    18,000    18,012    18,188   21,125     24,251     26,455     28,660     24,251
                          %chg                  -        -        -        -      -7.5%     -5.6%      -3.2%     0.3%          -          -          -          -          -
 Lead                     New     $/tonne     2,148    2,398    2,093    1,974     1,925     1,975    1,992     2,088    2,250      2,300      2,250      2,200      1,875
                          Old                 2,148    2,398    2,093    1,974     2,250     2,300    2,154     2,388    2,500      2,375      2,250      2,200      1,875
                          %chg                  -        -        -        -     -14.4%    -14.1%      -7.5%   -12.6%   -10.0%       -3.2%           -          -          -
 Tin                      New     $/tonne    20,453   26,021   22,941   20,565   19,000    20,000    20,626    21,500   22,500     25,000     23,500     23,500     20,000
                          Old                20,453   26,021   22,941   20,565   24,000    24,000    22,876    25,250   23,500     22,500     23,500     23,500     20,000
                          %chg                  -        -        -        -     -20.8%    -16.7%      -9.8%   -14.9%     -4.3%     11.1%            -          -          -

Source: LME, Macquarie Research, September 2012

               Copper still has the best fundamentals of the base metals. This is due to the fact that for the third
                consecutive year, copper supply has lagged behind demand, leaving global stocks at just over
                four weeks of supply. While subdued demand in 2012 has cushioned the impact a copper
                shortage has had on prices, the steps governments and central banks globally have taken to
                address sluggish growth suggests there is upside risk to our consumption forecast for 2013. Low
                availability of copper along the supply chain, especially outside of China, leaves copper best
                positioned in the base metal group to benefit from a recovery.
               Aluminium production continues to set new records as new capacity ramps up output in China,
                overwhelming modest reduction in output elsewhere due to financial pressure from the downward
                trend in prices since 2Q 2011. While aluminium production is ample and stocks are near record
                levels, availability to consumers continues to be limited by hoarding of stocks, funded by forward
                price spreads and facilitated by de facto limits on load out rates from LME warehouses. This has
                lifted aluminium premiums to record levels worldwide, with LME-deliverable products, such as
                ingot, outperforming non-deliverable products, such as billet. We think the "carry trades" will
                continue to shape the aluminium market for some time, supporting premiums and encouraging
                surplus production. While the outlook for aluminium demand is positive – it has outperformed all
                other metals market over the last decade – there is more than enough capacity to meet any
                reasonably anticipated level of consumption.
               Zinc demand had been robust through the first half of this year but has been more subdued over
                the last quarter, in line with typical seasonal patterns related to galvanised steel production. At the
                same time, zinc mine and metal output has also been strong with the result that the market
                remains firmly in surplus, although some of that surplus has shifted from metal to concentrates as
                Chinese zinc smelters have moderately reduced operating rates, and zinc metal stocks remain
                very high. Looking ahead we expect the zinc market to remain well supplied. While a number of
                significant zinc mines known to be nearing exhaustion closure dates have pushed out and there
                already appear to be enough projects in the pipeline to offset these closures when they come that
                have been brought forward even at the price levels zinc traded over the last couple of years.
               Lead demand-related data readings have been broadly constructive in recent months and lead
                demand typically increases towards the end of the calendar year for seasonal reasons related to
                lead use in replacement battery production. While lead demand looks positive, there has been no
                shortage of supply, especially from China, although the scale of the increase in output there is
                probably overstated. That said, lead output is up sufficiently to maintain a moderate surplus in the
                global market and, in the short term, appears set to rise further with some smelter capacity due to
                restart. Looking further ahead, however, the lead market balance may become tighter. It remains
                an open question whether China can maintain higher lead mine output and production from the
                major mines elsewhere in the world will probably be no more than flat at best.

24 September 2012                                                                                                                                                        27
Macquarie Research                                                                                                                                                    Commodities Comment

                    Nickel production is likely to exceed supply at least out to 2014 due to the ramp up of Chinese
                     nickel pig iron production and a number of large Greenfield projects. Prices have recently
                     bounced off cost-support and are likely to trade in a relatively narrow range out to 2014 driven by
                     the marginal cost of Chinese nickel pig iron (which is rising). By mid-decade, the market will need
                     new high-cost capacity and prices should rise sharply.
                    Molybdenum supply is being constrained in the short run and there is some upside for
                     prices. However, in the medium term, a large expansion in new supply outside China appears
                     possible. Prices are supported by Chinese cost support and as Chinese costs rise so prices
                     should edge higher.

                   Steel and bulk commodities
                    Bulk commodities are the area where we have pushed through the largest downgrades. However,
                     from the current oversold position they also offer best upside in terms of average price in 2013
                     from today‟s spot levels. Moves in Chinese steel output continue to be crucial to this sector. We
                     have recently downgraded our Chinese steel forecasts, which feed through to lower medium-term
                     raw material demand.
                    Longer-term, the same themes still exist in the iron ore market; execution on supply projects
                     continues to disappoint, more Chinese high-cost ore than expected is required to balance the
                     market, and Chinese domestic material is quick to exit and enter the market when prices dictate.
                     However, as we pull down our Chinese steel demand growth profile, this naturally feeds through to
                     an impact on iron ore fundamentals and price, and we have pulled down our price outlook to the
                     $100-130/t range CFR China through 2017.

Fig 46      Bulk commodity price forecasts
                                                      2010        2011        2012        2012     2012        2012        2012       2013     2014        2015       2016       2017    LT $2012
                                            Unit       CY          CY          Q1          Q2       Q3          Q4          CY         CY       CY          CY         CY         CY    Long term
Iron ore - Australian fines      New c/mtu fob          183         249         217         214      168         173         193        196      186         170         161        144      110
                                 Previous               183         249         217         214      244         244         230        256      243         228         226        174      110
                                 % change               -           -           -           -     -31.2%      -29.2%      -16.0%     -23.7%   -23.4%      -25.7%      -28.7%     -17.5%          -
Iron ore - Australian fines      New c/mtu fob          210         272         229         224      179         183         204        208      201         185         176        159      130
                                 Previous               210         272         229         224      255         262         243        276      263         248         246        194      135
                                 % change               -           -           -           -     -29.9%      -30.3%      -16.0%     -24.9%   -23.5%      -25.6%      -28.4%     -18.3%
Spot 62% Fe iron ore China       New      $/t cfr       147         169         144         141      112         115         128        130      125         115         110        100       80
                                 Previous               147         169         144         141      160         160         151        169      161         153         151        120       80
                                 % change               -           -           -           -     -30.0%      -28.1%      -15.4%     -23.0%   -22.5%      -24.6%      -27.3%     -16.7%          -

Thermal coal - Australian Spot   New        $/t fob     99         122         114          97         91          98       100         100     100          95           94         91        85
                                 Previous               99         122         114          97         90         108       102         106     100          95           94         91        85
                                 % change                     -           -           -         -   0.6%        -9.3%      -2.3%      -6.1%           -           -          -            -         -
Thermal coal - S.African Spot    New        $/t fob     91         117         105           90        88          95         95         97      91          90           89         88        80
                                 Previous               25         117         105           90        87         105         97        101      91          90           88         88        80
                                 % change                                 -    -           -      1.1%         -9.5%       -2.3%      -4.2%           -           -     1.7%              -         -
Thermal coal - JFY contract      New        $/t fob     98         130         130         115       115          115       115         104     105         100           95         96        85
                                 Previous               98         130         130         115       115          115       115         115     105         100           95         96        85
                                 % change                  -              -           -         -         -           -          -    -9.6%          -      -                -            -         -
Hard coking coal                 New        $/t fob    191         289         235         210       225          170       210         201      206    215              205       200        155
                                 Previous                191       289         235         210       225          225       224         234      225    215              205       200        155
                                 % change                  -              -    -           -         -        -24.4%       -6.1%     -13.9%    -8.3%        -                -          -           -
Semi-soft coking coal            New        $/t fob    141         211         148         147       145          118       140         131      134    140              133        130       105
                                 Previous              141         211         148         147       145          148       147         156      150    145              144        140       105
                                 % change                  -              -    -           -         -        -20.3%       -5.1%     -16.3%   -10.6%   -3.6%           -7.1%      -7.1%             -
LV PCI coal                      New        $/t fob    149         223         171         154       162          130       154         145      149    155              148        145       120
                                 Previous              149         223         171         154       162          160       162         174      182    176              170        166       120
                                 % change                  -              -    -           -         -        -18.8%       -4.6%     -16.5%   -18.2% -12.2%           -12.9%     -12.7%           -
Coke - China export spot         New        $/t fob    453         491         458         452       405          350       416         318      340    348              340        330       340
                                 Previous                453       491         458         452       420          420       438         428      438    423              410        410        340
                                 % change              -           -           -           -      -3.6%       -16.7%       -4.9%     -25.7%   -22.3% -17.8%           -17.1%     -19.5%           -

Source: TEX Report, McCloskey, Platts, globalCOAL, Macquarie Research, September 2012

                    Metallurgical coal prices are now trading at levels not seen since the annual benchmark broke
                     down, and have fallen furthest of all the commodities we cover in this compendium. The heady
                     days of the $330/t supply shock contract price are long forgotten, and the cost curve is very much
                     back in play again. This is despite an ongoing lack of supply growth in the seaborne market –
                     something only likely to get worse with closures at existing operations and pullbacks in growth
                     projects. We consider the current prices unsustainable, but upside requires the return of the
                     Chinese „market of last resort‟. The medium term met coal profile has been brought closer to
                     $200/t for HCC material.

24 September 2012                                                                                                                                                                                28
Macquarie Research                                                                                                                                 Commodities Comment

                 Steel prices have also been dropped by 10-15% through the curve, keeping the margin to raw
                      materials essentially unchanged. We would reiterate that the global steel industry is in desperate
                      need of a restructure and permanent capacity closures. Global steel production looks set to post
                      the lowest level of growth since 2009 this year, as on going global economic malaise has put
                      pressure on industrial production and construction activity in most major markets. Even China,
                      where demand frequently runs against the cycles of the rest of world, has seen growth rates
                      stalling - output is up just 2.3% YoY over the first eight months of the year, driven primarily by
                      exports and inventory build. Outside China, steel production has grown just 0.6%YoY for the year
                      to date.
                 In many ways, thermal coal acted as a foretaste of what would happen to wider commodity
                      markets later in 2012. Q2 saw a combination of sluggish Chinese demand growth and plentiful
                      supply available in the seaborne market, dragging prices down into the cost curve. There is little
                      doubt the same fundamental factors which pulled prices down remain in place, with the market
                      looking adequately supplied into the medium term. However, with Chinese supply having adjusted
                      with falling prices, further downside from current levels seems unlikely, though any uplift is more
                      likely to be driven by seasonal than fundamental factors, in particular the Q4 drop in Chinese
                      hydro generation and Q1 drop in seaborne supply. We have reduced the 2013 JFY thermal coal
                      contract expectations slightly to $104/t FOB Australia.
Fig 47    Steel and alloy forecasts
                                                   2010     2011     2012     2012       2012       2012      2012     2013      2014        2015        2016       2017 LT $2012
                                            Unit    CY       CY       Q1       Q2         Q3         Q4      CY        CY        CY          CY         CY         CY
Manganese ore                  New c/mtu CIF            7      5.5      4.6      5.0        5.1        5.0     4.9       5.6       6.0         6.5         6.0       6.0      5.0
                               Previous               7.3      5.5      4.6      4.9        5.1        5.5     5.0      6.0        6.5         6.0         6.0                5.0
                               % change              -        -        -      2.0%         -       -9.1%     -2.0%    -7.3%     -7.7%        8.3%              -                  -
FeCr (EU contract)             New          c/lb     125      125      115      135        125        112     122       123       120         130         135       135      115
                               Previous              125      125      115      135        135        130     129       128       120         130         135                115
                               % change              -        -        -        -       -7.4%     -13.8%     -5.4%    -3.9%            -           -           -                  -
Steel - Average HRC            New      $/tonne      653      754      696      681        630        614     655       641       660         648         634       634      590
                               Previous              653      754      696      681        710        710     699       745       763         738         744                590
                               % change              -        -        -        -      -11.3%     -13.6%     -6.3%   -13.9%    -13.4%      -12.2%      -14.8%                     -
Steel Scrap - average #1HMS    New      $/tonne      356      438      416      393        360        313     371       346       338         333         313       293      262
                               Previous              356      438      416      393        420        413     411       431       412         393         391                262
                               % change              -        -        -        -      -14.3%     -24.2%     -9.7%   -19.7%    -17.8%      -15.3%      -19.8%                     -

Source: CRU, Platts, Macquarie Research, September 2012

                 Ferrochrome contract prices appear set to fall again in 4Q 2012, following a reduction of 10¢/lb to
                      a headline level (before discounts) of 125¢/lb DDP Europe in 3Q 2012 agreed in late June, since
                      when spot prices have continued to drop. This had prompted some debate about risks to
                      production as a result of financial pressure on high cost producers. However, chrome ore prices
                      have also been falling, reducing costs for non-integrated alloys producers, notably in China, which
                      is the world's second largest ferrochrome producer and imports most of its chrome ore. A more
                      immediate positive for ferrochrome prices comes from the recent rebound in nickel prices, since
                      the two tend to trade in tandem as a function of sharing a common customer base, but is probably
                      too late to avoid a fall in contract prices for the next quarter. Looking further ahead, capacity
                      expansions are likely to keep ferrochrome prices under pressure for the next couple of years at

24 September 2012                                                                                                                                                               29
Macquarie Research                                                                                                                        Commodities Comment

                Precious metals
                 The lack of conviction in precious metals has surprised us this year, and we have dropped our
                  near term forecasts given the 2012 base. However, conviction is starting to return, boosted by QE
                  for gold and silver and South African production risk in PGMs.

Fig 48       Precious metals forecasts
                                      Unit    2010       2011     2012     2012       2012       2012       2012    2013    2014     2015     2016       2017 LT $2012
                                                  CY         CY    Q1       Q2         Q3         Q4           CY      CY       CY      CY       CY         CY Long term
 Gold                      New        $/oz   1,225      1,570     1,691    1,610      1,643      1,780     1,681   1,876   1,713   1,394    1,300      1,275        950
                           Old        $/oz    1225       1570     1,691    1,610      1,750      1,900      1738    2000    1713     1394     1188       1188        950
                           % change            -          -         -        -       -6.1%      -6.3%     -3.3%   -6.2%      -       -      9.5%       7.4%             -
 Silver                    New        $/oz       20         35        33       29         30        36        32       38      32      20       19         19        14
                           Old        $/oz        20         35       33       29         32        36         33       38      32      20       17         17        14
                           % change            -          -         -        -       -5.0%      -1.4%     -1.6%      -       -     2.5%    11.8%       8.8%             -
 Platinum                  New        $/oz   1,605      1,719     1,607    1,484      1,500      1,600     1,548   1,750   1,850   1,900    1,950      1,950      1,800
                           Old        $/oz    1605       1719     1,607    1,484      1,650      1,950      1673    2038    1850     1900     1950       1950      1800
                           % change            -          -         -        -       -9.1%     -17.9%     -7.5% -14.1%       -       -        -          -              -
 Palladium                 New        $/oz     524        734       682      643        612        675       653     790     830     850      875        900        800
                           Old        $/oz       524        734     682      643        750        875        738   1019       950     900      950        950       800
                           % change            -          -         -        -      -18.4%     -22.9%    -11.5% -22.5% -12.6% -5.6%        -7.9%      -5.3%             -
 Uranium spot              New        $/lb       46         56        52       52         51        49        51       50      60      65       69         70        50
                           Old        $/lb        46         56       52       52         51        52         52       50      60      65       67         67        50
                           % change                 -     -         -        -          -       -5.8%     -2.4%      -       -       -      2.7%       4.8%             -

Source: LME, Metal Bulletin, Macquarie Research, September 2012

                 Thus far, 2012 has been the year in which gold lost its way. After outperformance through 2009
                  and 2010, momentum had faded as the 2012 price models broke down – yet again, models for
                  gold worked until they suddenly didn‟t. With this, net length in futures positions pulled back as
                  conviction waned. However, with the Federal Reserve taking yet more action, the old conviction is
                  returning and gold‟s push towards new highs in 2013 looks to have been reinvigorated.
                  Meanwhile, a kick-start of investment demand is likely to see silver push back towards $40/oz.
                 In our opinion, the combination of a robust demand outlook, supply disruption risk and the
                  increased cost of both existing and new supply make the PGMs extremely strong from a
                  fundamental standpoint. Overall platinum demand is somewhat mixed and not enough to drive
                  prices higher without the backing of investment flows. Supply, however, is unequivocally poor.
                  With risk of in excess of 500k/oz of mine supply being lost in South Africa alone this year, we now
                  expect a global fall of ~14%YoY in 2012. The safety net from destocking of metal in the pipeline
                  last year now appears to have been used, while a combination of political and cost pressures
                  makes maintaining existing South African supply, never mind growth, a challenge. Palladium looks
                  extremely levered to a risk-on rally given mine supply is also going backwards and demand
                  prospects for gasoline vehicles remains reasonable. In the near term, the non-commercial net
                  long position in palladium sits at only 52% of the record high, while short positions have been at
                  all-time highs. Thus, while palladium is less levered to South African supply, more importantly it is
                  faced with less positioning headwinds than its sister metal, and is likely to outperform in a QE
                  environment just as it did in previous episodes.

24 September 2012                                                                                                                                                     30
Macquarie Research                                                                                                                                                                                                                                                                                                                          Commodities Comment

                                        Chinese nickel pig iron – uncertainties remain as costs fall and then
                                        prices rise again!
                                         On September 6, we wrote that the nickel market was returning to balance and the risks to prices
                                                           had returned to the upside (Nickel returning to balance – Commodities 6-Sept 2012). Since then
                                                           prices have risen almost 12% and prices are around 18% higher than their mid-August lows. Our
                                                           rationale from a turning point was severe production cuts in Chinese nickel pig iron production
                                                           since March 2012 (see Figure 49) and mounting supply disruptions from non-Chinese producers.
                                                           Obviously, the announcement of QE3 in the USA helped!
                                         We have updated our assessment of Chinese nickel pig iron production and costs to reflect recent
                                                           pricing developments in raw materials and also the sudden recovery in nickel prices over the past
                                                           two weeks. Costs have fallen sharply since March 2012 as a result of falling nickel ore, coal and
                                                           coke prices but until recently prices had fallen faster, which has caused the producers of nickel pig
                                                           iron from older electric furnaces to incur losses (these producers accounted for around 60% of
                                                           2011 nickel pig iron production – see Figure 51).

                                        Fig 49 LME nickel prices turn suddenly upwards



                                              LME stocks: tonnes






















                                                                                                                                                                                                LME price                           90th percentile of cash costs

                                        Source: LME, Wood Mackenzie, Macquarie Research, September 2012

Fig 50 Estimated Chinese monthly nickel pig iron                                                                                                                                                                                        Fig 51 Estimated Chinese annual nickel pig iron
production                                                                                                                                                                                                                              production by main process

                      400                                                                                                                                                                                                                               300                                                                                            273   275    300
                      350                                                                                                                                                                                                                               250                                                                                                         250
                      300                                                                                                                                                                                                                               200                                                                                                         200
   '000t annualised

                                                                                                                                                                                                                                             '000t Ni

                                                                                                                                                                                                                                                        150                                                                                                         150
                      225                                                                                                                                                                                                                                                                                     89
                                                                                                                                                                                                                                                        100                                        71                                                               100
                                                                                                                                                                                                                                                        50                           20                                                                             50
                                                                                                                                                                                                                                                         0                                                                                                          0
                                                                                                                                                                                                                                                                  2005         2006                2007       2008        2009              2010       2011 2012f











                                                                                                                                                                                                                                                                  0.5-2% Ni blast furnace                                       4-8% Ni blast furnace
                                                                                                                                                                                                                                                                  9-15% Ni electric arc furnace                                 9-15% Ni RKEF

Source: Industry data, Macquarie Research, September 2012                                                                                                                                                                               Source: Industry data, Macquarie Research, September 2012

                                         The fall in prices had not led to loss-making by blast furnace producers (especially for 1.7% NPI
                                                           producers, who continue to receive a significant iron credit in their sales price) and from newer
                                                           rotary kiln electric arc furnace (RKEF) producers who have 30-50% less energy use per tonne of
                                                           nickel produced than the older electric furnace producers.

24 September 2012                                                                                                                                                                                                                                                                                                                                                       31
Macquarie Research                                                                                                                                                                                                                                                                                                                                                                                                                         Commodities Comment

                                      The recent rise in LME nickel prices may soon feed through into a rise in Chinese domestic prices
                                                         for nickel pig iron, taking prices above costs again (see Figure 52, where we have inputted the
                                                         nickel price average for the past five days for our September prices and compared them with our
                                                         estimates of costs). In addition there are plans over the next 18 months to bring on stream
                                                         well over 100ktpa of low-cost RKEF (rotary kiln electric furnace) of production capacity. The
                                                         supply response from the existing NPI producers to the new higher prices may well be delayed by
                                                         1-2 months but inventories of nickel ore are high. In the short run, there is also some evidence of
                                                         a rise in nickel orders from the stainless industry over the past week – nickel accounts for around
                                                         50% of the price of stainless steel and stainless steel buyers are speculatively restocking. Prices
                                                         may overshoot in the short run, but now look toppy from a fundamental perspective.

                                     Fig 52 Estimated “average” Chinese nickel production costs and prices by main
                                     process by month since January 2011

                                                          11                                                                                                                                                                                                                           11
                                                          10                                                                                                                                                                                                                           10
                                           $/lb ex-VAt

                                                          10                                                                                                                                                                                                                                  9

                                                                                                                                                                                                                                                                               $/lb ex-VAT
                                                           9                                                                                                                                                                                                                                  8
                                                           8                                                                                                                                                                                                                                  7
                                                                                                        Price: 8-13% NPI
                                                           7                                                                                                                                                                                                                                                                                                           Price: 8-13% NPI
                                                                                                        Costs: 10% Ni - Coastal EAF                                                                                                                                                           6                                                                        Costs: 12% Ni - Conventional EAF
                                                           7                                            Costs: 10% Ni - Inner Mongolia EAF                                                                                                                                                                                                                             Costs: 12% Ni - RKEF
                                                           6                                                                                                                                                                                                                                  5

















                                                          10.0                                                                                                                                                                                                                                15

                                                             9.5                                                                                                                                                                                                                              14
                                                                                                                                                                                                                                                                                $/lb ex-VAT
                                            $/lb ex-VAT

                                                             7.5                                                                Price: 4-6% NPI                                                                                                                                                                                                                          Price: 1.5-2% NPI

                                                             7.0                                                                Costs: 6% Ni in blast furnace                                                                                                                                 10                                                                         Costs: 1.7% Ni in blast furnace

                                                             6.5                                                                                                                                                                                                                                  9














                                     Source: SMM (China), Chinese trade data, Mysteel (for coke prices), Macquarie Research, September 2012

Fig 53 Chinese nickel ore prices fall despite                                                                                                                                                                                                                                    Fig 54 Chinese nickel port stocks – sufficient for six
Indonesian restrictions (quotas plus 20% export tax)                                                                                                                                                                                                                             months production (and more stocks at the NPI plants)

                   150                                                                                                                                                                                                                   28000
                                                                                                                                                                                                                                                                                                  Nickel ore inventory at the ports '000tonnes

                   130                                                                                                                                                                                                                                                                                                                                                 Stocks rise but their book value is
                                                                                                                                                                                                                                                         LME nickel: $/tonne

                                                                                                                                                                                                                                         24000                                                                                                   16000
                                                                                                                                                                                                                                                                                                                                                                       higher than the current price – it
 Ni ore: $/t cif

                   110                                                                                                                                                                                                                   22000
                                                                                                                                                                                                                                                                                                                                                                       may not be “available”.
                                                                                                                                                                                                                                         20000                                                                                                   14000
                   70                                                                                                                                                                                                                    16000                                                                                                   12000

                   50                                                                                                                                                                                                                                                                                                                            10000
                   30                                                                                                                                                                                                                    10000






























                                       0.9-1.1% Ni                                                          1.4-1.6% Ni                                                                     1.9-2.0% Ni
                                       2.0-2.1% Ni                                                          LME Ni price

Source: SMM, LME, Macquarie Research, September 2012                                                                                                                                                                                                                             Source: SMM, CRU, Macquarie Research, September 2012

24 September 2012                                                                                                                                                                                                                                                                                                                                                                                                                                                     32
Macquarie Research                                                                                                                              Commodities Comment
Important disclosures:
 Recommendation definitions                                  Volatility index definition*                            Financial definitions
 Macquarie - Australia/New Zealand                           This is calculated from the volatility of historical    All "Adjusted" data items have had the following
 Outperform – return >3% in excess of benchmark return       price movements.                                        adjustments made:
 Neutral – return within 3% of benchmark return                                                                      Added back: goodwill amortisation, provision for
 Underperform – return >3% below benchmark return            Very high–highest risk – Stock should be                catastrophe reserves, IFRS derivatives & hedging,
                                                             expected to move up or down 60–100% in a year           IFRS impairments & IFRS interest expense
 Benchmark return is determined by long term nominal         – investors should be aware this stock is highly        Excluded: non recurring items, asset revals, property
 GDP growth plus 12 month forward market dividend            speculative.                                            revals, appraisal value uplift, preference dividends &
 yield                                                                                                               minority interests
 Macquarie – Asia/Europe                                     High – stock should be expected to move up or
 Outperform – expected return >+10%                          down at least 40–60% in a year – investors should       EPS = adjusted net profit / efpowa*
 Neutral – expected return from -10% to +10%                 be aware this stock could be speculative.               ROA = adjusted ebit / average total assets
 Underperform – expected return <-10%                                                                                ROA Banks/Insurance = adjusted net profit /average
                                                             Medium – stock should be expected to move up            total assets
 Macquarie First South - South Africa                        or down at least 30–40% in a year.                      ROE = adjusted net profit / average shareholders funds
 Outperform – expected return >+10%                                                                                  Gross cashflow = adjusted net profit + depreciation
 Neutral – expected return from -10% to +10%                 Low–medium – stock should be expected to                *equivalent fully paid ordinary weighted average
 Underperform – expected return <-10%                        move up or down at least 25–30% in a year.              number of shares
 Macquarie - Canada
 Outperform – return >5% in excess of benchmark return       Low – stock should be expected to move up or            All Reported numbers for Australian/NZ listed stocks
 Neutral – return within 5% of benchmark return              down at least 15–25% in a year.                         are modelled under IFRS (International Financial
 Underperform – return >5% below benchmark return            * Applicable to Australian/NZ/Canada stocks only        Reporting Standards).
 Macquarie - USA                                             Recommendations – 12 months
 Outperform (Buy) – return >5% in excess of Russell          Note: Quant recommendations may differ from
 3000 index return                                           Fundamental Analyst recommendations
 Neutral (Hold) – return within 5% of Russell 3000 index
 Underperform (Sell)– return >5% below Russell 3000
 index return

 Recommendation proportions – For quarter ending 30 June 2012
                      AU/NZ         Asia      RSA            USA       CA           EUR
 Outperform           55.67%      61.00%     53.43%        42.58%    69.23%       46.60% (for US coverage by MCUSA, 9.05% of stocks followed are investment banking clients)
 Neutral              30.50%      22.11%     36.99%        52.41%    28.02%       33.69% (for US coverage by MCUSA, 8.14% of stocks followed are investment banking clients)
 Underperform         13.83%      16.89%     9.59%         5.01%     2.75%        19.71% (for US coverage by MCUSA, 0.45% of stocks covered are investment banking clients)

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