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Scotiabank Commodity Price Index - Commodity Report - December 21


									                                 Best Wishes for the Holiday Season!
Global Economic Research                                                        December 21, 2010
                                                                                 November 16, 2007

Patricia Mohr (416) 866-4210

Scotiabank’s Commodity Price Index — Year-End Review & Outlook for 2011

     Top ‘picks’ for investors in 2011 — palladium, copper, potash and uranium.
     A ‘tsunami’ of investment capital from China is headed into Canada’s mining and oil & gas sectors.
     The agricultural environment for fertilizer application is one of the best ever seen.

S    cotiabank’s Commodity Price Index is ending 2010 on a strong
     note, up 3.0% m/m in November. The All Items Index has now
surpassed the near-term peak in April prior to a two-month correction
                                                                                                 Palladium — A Top Pick For 2011
                                                                                                 US$ per ounce,
                                                                                                 London Fixes
                                                                                                                       Record Fix:
                                                                                                                       US$1,090 Jan. 26, 2001

                                                                                   1,000                                                              50
last spring — triggered by the Euro-zone ‘debt crisis’ and another                                               Palladium
                                                                                                                                  Dec. 20, 2010
slowdown in the U.S. economy — and is up 36.2% from the April                        800          Record Silver Fix:                    US$747        40
2009 cyclical low. While remaining volatile, commodity prices should                              US$49.45 Jan. 18, 1980
                                                                                                  during Hunt Brothers'
strengthen further in 2011, after about a 12% gain in 2010 (from late                600          silver squeeze.                              US$
2009 through November), though the increase may moderate.                                                                                     29.21
                                                                                     400                                                              20
    Resource prices will receive a boost in 2011 primarily from the
ongoing strength of ‘emerging’ market demand. China should post                      200                                                              10
another year of favourable, though somewhat slower GDP growth (9.5%                                                                 Silver
compared with at least 10% in 2010). Judging from the stronger                          0                                                             0
                                                                                            78    82   86   90    94   98    02    06   10     14
Purchasing Manager Indices in October and November, a slight uptick in
industrial activity to 13.3% yr/yr in November and ongoing strength in                      Palladium: A 'precious' and an 'industrial' metal.
                                                                                            Precious metal prices have been boosted by high
retail sales (up 18.7% yr/yr), China’s economy has picked up in recent                      government deficits in the Euro zone and United
months, after slowing in the late summer. While China will move to a                        States, calling into question the integrity of paper
                                                                                            currencies. Scotia Mocatta is the permanent chair
more ‘prudent’ monetary policy to contain rising inflation (+5.1% yr/yr                     of the London Silver Fix.
in November), China is likely to achieve a ‘soft-landing’ for its economy,
shifting from an export-driven to a more consumer-based expansion (with                          Commodity Price ‘Sweepstakes’
strong intra-Asian trade also underpinning growth). The details of this shift            Top Five Performing             Top Five Performing
will be unveiled in China’s 12th Five-Year Plan next spring.                                Commodities
                                                                                               In 2010
                                                                                                                               In 2011
    Secondly, QE2 (an additional round of ‘quantitative’ easing —                            (% price increase
                                                                                            Dec 14 ’10 / Dec ’09)                   ‘Picks’
announced by the Fed on November 3 and possibly a third round) to
revive a lacklustre economy and boost employment points to an extended                 1.    Sulphur    153.3%          Palladium
                                                                                       2.    Silver      69.1%          Potash
period of low short-term interest rates (10-year Treasuries have backed                3.    Coking Coal 63.3%          Coking & Thermal Coal
up), triggering renewed capital inflows into commodity-intensive                       4.    Nickel      44.7%          Copper
‘emerging’ economies in a search for higher returns (some recent U.S.                  5.    Molybdenum 41.3%           Uranium

indicators such as motor vehicle production schedules for 2011:Q1 look                 The Top Ten in 2010 included: Wheat (40.5%),
                                                                                       Uranium (37.6%), Copper (32.6%), Canola (31.9%)
more positive). China’s mid-December decision to boost bank reserve                    and Lumber (31.3%). Commodities outside Index:
requirements, rather than raise interest rates to stem inflation, indicates            Palladium (103.6%) & Iron Ore (Hamersley fines
                                                                                       Australia to Japan/Asia (103.1%).
concern that QE2 will trigger ‘hot money’ inflows into China.
    Thirdly, the U.S. dollar/euro rate may lose ground again later in 2011 — boosting dollar-denominated commodity
prices — as markets react to tough fiscal austerity and reform measures taken in Europe compared with a delay in required
U.S. measures; the recent appreciation of commodity-linked currencies such as the Canadian dollar, the Australian dollar

Scotia Economics
Scotia Plaza 40 King Street West, 63rd Floor                     This Report is prepared by Scotia Economics as a resource for the
                                                                 clients of Scotiabank and Scotia Capital. While the information is from
Toronto, Ontario Canada M5H 1H1
                                                                 sources believed reliable, neither the information nor the forecast shall
Tel: (416) 866-6253 Fax: (416) 866-2829                          be taken as a representation for which The Bank of Nova Scotia or
Email:                        Scotia Capital Inc. or any of their employees incur any responsibility.

     Scotiabank Commodity Price Index is available on:, Bloomberg at SCOE and Reuters at SM1C
Global Economic Research                                                                                         December 21, 2010

and the Chilean peso will drive miners to boost U.S. dollar prices to cover effectively higher
domestic production costs, and fourthly, the introduction of new investment products such as                                China — Vital To Global
copper ETFs (Exchange Traded Funds) will attract further funds into commodities.                                             Commodity Markets
                                                                                                       30                                                                               30
                                                                                                              yr/yr % change
   Of the 32 commodities in the Scotiabank Commodity Price Index, the ‘Top Five’                                                         * 3 month moving avg.
posting the largest price gains in 2010 were all metals & minerals: sulphur                            20                                                                               20

(+153.3% , a mineral used in DAP fertilizers and a by-product of Western Canada’s oil &                                                 China - Industrial
                                                                                                       10                                                                               10
gas production), silver (+69.1% the ‘poor man’s gold’, benefitting from record ETF                                                        Production*

holdings and its role as an ‘industrial’ as well as a ‘precious’ metal), nickel (+44.7%                 0                                                                               0
alongside rebounding global stainless steel production and strike-related supply cuts in                                                      G7. Industrial
Sudbury and Voisey’s Bay) and molybdenum (+ 42.2%). While not covered in the                          -10                                                                               -10

Index, palladium (+103.6% the best performing ‘precious’ metal) and iron ore                                  China's industrial production
                                                                                                              still strong in November
(+103.1%) yielded exceptional returns for investors. Grains & oilseeds (+31-40% on                    -20
                                                                                                            98         00      02            04        06     08         10        12

drought in Russia and strong Chinese demand for U.S. corn), uranium (+37.6%), copper                         Industrial Production: China 13.3% yr/yr in
(+32.6%) and lumber (up a surprising 31.3%) rounded out the ‘Top Ten’ in 2010.                               November 2010; G7 5.7% in September;
                                                                                                             U.S. 5.4% in November.

    In 2011, our ‘Top Picks’ include palladium, copper, potash, coking & thermal coal                                          Rapid Growth In
and uranium. Palladium — primarily used in auto catalytic converters for gasoline-fuelled                                    China's Vehicle Fleet
vehicles (especially smaller engines of 1-1.5 litres), but also in electronics such as blu-ray        100
                                                                                                                 million units                                            90.0

disks & LED panels — will benefit from rapid growth in motor vehicle sales in ‘emerging’                         Vehicle Penetration – 2009
                                                                                                                 (Vehicles per 1,000 people)
                                                                                                       80                                                                             80
Asia (especially China and India) and tightening vehicle emission control standards. Vehicle                         China
                                                                                                                     United States

                                                                                                                     India                    14
penetration in China is only 45 per 1,000 people and, in India, only 14 compared with 782 in           60
the United States — pointing to huge Asian demand growth over the medium-term. Car sales                                        47.0

in China climbed 29.3% yr/yr in November (34.9% YTD). Mined supplies are quite                         40                                                                             40

concentrated, with over 80% of output coming from Russia, as a by-product of nickel
production, and from South African platinum mines. Only two primary palladium producers                20            15.5                                                             20

exist in North America (Stillwater and North American Palladium). The world supply/
                                                                                                        0                                                                             0
demand balance is expected to shift from a slight ‘surplus’ in 2010 to a significant ‘deficit’ in                 2002         2008           2009          2010F        2011F

2011 (likely to grow through 2015), despite a large increase in recycled supplies. Sales from               Scotiabank estimates.
                                                                                                            Vehicle fleet: cars, light trucks & commercial vehicles.
the Russian state stockpile, administered by Gokhran, have supplemented world supplies for
                                                                                                                                   Copper Soars
many years, but are probably now depleted. While this development has already lifted                 4.50                                                                               4.50
                                                                                                                 US$ per pound
palladium prices to a near-term high of US$769.50 per ounce on December 7, palladium                 4.00
                                                                                                                             New Record High: US$4.20
should average at least US$800 in 2011, up from US$520 in 2010 and US$263 in 2009.                   3.50
                                                                                                                             on December 14, 2010

    The capital spending cycle is beginning to swing up in mining and energy, lifting                3.00            ETFs add new layer of
                                                                                                                     demand in already tight

sales for equipment & heavy truck manufacturers and service providers. Global                        2.50
                                                                                                                     global market.
exploration spending in non-ferrous minerals has rebounded this year to about US$12.1                2.00
                                                                                                                                             Low During Credit
                                                                                                                                             Squeeze                                    2.00
bn from US$7.5 bn in 2009 and should surpass the previous 2008 peak of US$14.4 bn in                 1.50
                                                                                                                                             (Dec. 24, 2008)
2011. Junior mining companies have ready access to capital once more. Having recently                1.00
presented at ‘China Mining 2010’ in Tianjin, we can report that interest from China in
                                                                                                     0.50                                                                               0.50
Canadian assets (particularly in the junior mining space) is intense.                                            LME Copper Prices
                                                                                                     0.00                                                                               0.00
                                                                                                            80        84      88        92        96    00      04       08        12
Metals & Minerals — The Nuclear Renaissance Gets Underway
                                                                                                            Data to December 20, 2010.
The Metal & Mineral Index rose by 1.8% m/m in November — led by gains in uranium
                                                                                                                         Potash Prices Begin To
and silver. China’s 12th Five-Year Plan for 2011-15, shifting emphasis slightly from
                                                                                                                        Rally In S.E. Asia & Brazil
industrialization to a more consumer-based economy, is likely to be particularly positive           1,200
                                                                                                                 US$ per tonne

for a number of Canadian mining sectors — uranium for nuclear power (emitting                                                                     Spot Potash Prices
                                                                                                    1,000                                          (FOB Vancouver)                        1,000
virtually no greenhouse gases) and fertilizers such as potash, needed to grow feedgrains                         +
                                                                                                                  Canpotex and BPC
(corn), as rising household income allows greater meat consumption.                                  800         announce substantial                                                     800
                                                                                                                 shipments to Brazil &
    Spot uranium prices have strengthened markedly from US$52 per pound in late October              600
                                                                                                                 Malaysia in 2010:Q4 at
                                                                                                                 higher prices.                                                           600
to US$62.50 in mid-December. The base price for term contracts (prior to escalation) also
                                                                                                                     2008-09        US$633
climbed from US$62 to US$65. Comments by China’s National Development and Reform                     400
                                                                                                                     2010F          US$350

Commission’s (NDRC) Energy Research Institute that China’s target for nuclear energy will            200
                                                                                                                     2011F          US$425                     US$370
                                                                                                                                                                (Nov)                     200
be doubled in the 12th Five-Year Plan (from today’s 10.8 GWe capability from 13 reactors to
about 80 GWe by 2020 — the equivalent of 80 reactors) together with the announcement of                0                                                                                  0
                                                                                                            00         02          04         06        08          10        12
three large supply contracts with Cameco, AREVA and Kazatomprom totaling 139.9 million                      Sulphur prices (FOB Vancouver) climb from
pounds through 2020-25 — have boosted prices. While China’s ‘uncovered’ uranium                             US$144 per tonne in October to US$152 in
                                                                                                            November alongside strong international
requirements are now probably minimal through 2016 and only 30 million pounds through                       DAP demand.

Global Economic Research                                                                                        December 21, 2010

2020, it will be interesting to see the reaction of                         Scotiabank Commodity Price Index
utilities in India, South Korea, the UAE and the
United States to China tying up large volumes.            Growth Trends                          (per cent change at annual rates)
Considerable market uncertainty will prevail as                                        Weights      One        Three   One      Five     Ten
the HEU agreement expires in 2013, lifting prices.                                                 Month      Months   Year    Years   Years
    Turning to copper, while the red metal only           All Commodity Price Index        100      43.3        36.2   16.6      3.5      6.5
placed 8th within the ‘Top Ten’ best performing
                                                          Industrials                       83       44.9       35.8    15.2     2.7     6.5
commodities of 2010 (+32.6%), Copper prices
                                                            Forest Products                 40       44.9       24.2    22.4     1.8     1.8
were already high in late 2009 at US$3.17 per
pound and climbed by US$1 to a new record                   Metal and Minerals              27       23.8       51.9    23.5    12.8    13.2
high of US$4.20 on December 14, 2010,                       Oil and Gas                     16       91.8       22.1    -1.8    -6.6     4.0
surpassing the previous peak of US$4.08 on July           Agriculture                       17       33.4       39.3    26.3     9.3     6.7
3, 2008. The latest surge reflects indications by
the Fed Chairman that ‘quantitative easing’ could                                                Index 1997 = 100
be expanded beyond the US$600 bn of Treasury                                                             2010                  2009
purchases already planned through June, a                                                  Nov       Oct     Sept       Aug     Nov
rebound in China’s refined copper output in               All Commodity Price Index*     198.4 *    192.6 * 185.9      183.7   170.1
November and the introduction on December 10
of the first copper ETF in London (another two            Industrials*                   205.8 *    199.6 *    192.2   190.7   178.6
are planned for next year), adding a new layer of           Forest Products              110.8      107.4      106.1   105.0    90.5
demand to an already tight market. One                      Metal and Minerals           301.5      296.2      282.9   271.6   244.1
dominant player holds 90% of LME stocks.                    Oil and Gas*                 279.1 *    264.4 *    252.2   265.6   284.1
    As 2011 unfolds, we expect copper to touch         Agriculture                           161.6         157.8 154.7 148.8 128.0
US$5 (yielding an extraordinary 70% profit
margin over average world break-even costs             *Natural gas and propane prices are subject to revision.

including depreciation). Global supply/demand
conditions were in ‘deficit’ in 2010 (with refined consumption exceeding supplies by about 235,000 tonnes). An even bigger ‘deficit’
is expected in 2011 (560,000 tonnes), even if China’s demand growth slows to 7-8% after this year’s 13% and 28% in 2009. World
mine production has only expanded by 1.9% per annum from 2006-10, not keeping pace with demand growth. Mine output may
increase by a mere 1.4% in 2011, despite rising output in Chile (ramp-up of Antofagasta/Marubeni’s Esperanza and Teck Resources’
Andacollo), the start-up of Copper Mountain in B.C. and Vedanta’s Konkola Deep in Zambia and the ramp-up of First Quantum’s
Kansanshi mine in Zambia, Equinox Minerals’ Lumwana in Zambia and Lundin Mining/Freeport McMoRan/Gecamines’ Tenke-
Fungurume SxEw in the DR Congo. The copper price forecast has been revised up to US$4.50 in 2011 and US$4.25 in 2012.
    Spot potash prices (FOB Vancouver) continue to rally in Southeast Asia and Brazil, rising to US$370 per tonne in November from
US$351 in October and a low of US$342.50 last Fall. BPC is looking to settle contracts with China by January. Prices for the three crops
using the most potash per hectare planted, corn in the United States, palm oil in Malaysia/Indonesia and sugar cane, are all high and should
incent farmers to dramatically step-up fertilizer application in 2011. The Food and Agriculture Organization of the United Nations continues
to worry about the long-term trend towards higher food prices, expected to be at record levels by late 2010. Potash producers will likely take
care to limit overseas price increases in the first half of 2011 to accommodate buyers and not derail this year’s big rebound in volumes. India
has cut its potash fertilizer subsidies for 2011, though we think India will have to lift its potash price expectations as 2011 unfolds.
    The price of premium-grade hard coking coal from Western Canada to Japan/Asia (FOB Vancouver) is likely to rise from the current
US$209 per tonne to US$225 in the January-March 2011 quarter (JFY2010:Q4), based on the contract already agreed between the BHP
Billiton Mitsubishi Alliance and Japanese steel mills. Spot prices in China strengthened in October/November as China’s steel mills
restocked volumes ahead of winter. Prices should rise further in the April-to-June 2011 quarter to about US$250 due to recent force majeure
on shipments by many Queensland coal producers hit by La Nina-related heavy rain. Seven large new steel plants in China will require high
coke strength, benefitting Western Canadian producers. While the growth of China’s steel output may slow in 2011, construction of eight
Cross China high-speed rail links and expansion of property development to Tier 3 and 4 cities will underpin demand.
Strong Investor Interest (China & Korea) in Western Canada’s Oil Sands, Tight Oil & Shales

The Oil & Gas Index surged in November, up 5.6% m/m. WTI oil touched an intraday high of US$90 per barrel in early December
(US$91 for Brent) and is US$88 mid-month (+18.5% from December 2009). Global oil consumption has advanced by a robust 2.8% in
2010, surpassing the previous peak in 2007, with recent cold winter weather in Europe and China burning diesel in backup generators this
Fall to offset mandated power cuts (to meet a 20% reduction in power use per unit of GDP in the 11th Five-Year Plan). Supply/demand
conditions have been largely balanced, with OPEC production at 29.2 mb/d slightly below the ‘call’ for its crude. WTI oil is expected to
climb from an average of US$79 in 2010 to US$93 in the coming year (possibly US$95), boosted by ongoing strength in China’s

Global Economic Research                                                                                     December 21, 2010

petroleum demand (+13.7% yr/yr in November to a new record high), a second round of ‘strategic’ stock building by China and
delays in developing U.S. Gulf of Mexico ‘deepwater’ fields after the Macondo spill. No development or ‘rank wildcat
deepwater’ exploration permits have been issued since the drilling ban was lifted on October 12, 2010. Turning to natural gas,
we expect that the ongoing interest in developing low-cost, liquids-rich natural gas shales (Marcellus and Eagle Ford) will keep
U.S. prices on a lower plane in 2011 (US$4.40 per mmbtu). However, cheaper prices are leading to a strong revival in U.S.
industrial & power demand in the United States, with combined cycle gas turbines competitive with coal.
China Emerges As The Second-Biggest Buyer of Canadian Lumber

The Forest Products Index rose by 3.1% m/m in November alongside a contra-seasonal surge in lumber and OSB prices
and largely flat pulp & paper prices. Western Spruce-Pine-Fir 2x4 lumber prices posted a solid comeback in 2010
(+ 31.3%, rising from barely covering average mill cash costs to profitability in the B.C. Interior), despite ongoing
weakness in U.S. housing starts (a mere 592,000 units YTD; 680,000 forecast for 2011). Canadian exports of softwood
lumber to China jumped by 56% through September 2010, by 59% to Taiwan and by 27% to the Middle East compared
with a more modest 10% gain to the United States. While Russia may reduce its current 25% log export tax (which
triggered China’s initial search for overseas fibre) to gain admittance to the WTO, this change is unlikely until late 2011.

                                       Scotiabank All Commodity Price Index 1
                  280                                                                                  280
                            Growth Trends                         Index: 1997=100
                  260                                                                                  260
                            (per cent, annual rate)
                  240       Last Year        16.6                                                      240
                            Last 5 Years       3.5
                  220                                                                                  220
                            Last 10 Years      6.5
                  200                                                                                  200

                  180                                                                                  180

                  160                                                                                  160

                  140                                                                                  140
                                                                       All Items
                  120                                                                                  120

                  100                                                                                  100

                    80                                                                                 80

                                                                          All Items –                  60
                                                                      Inflation adjusted
                    40                                                                                 40

                    20                                                                                 20
                         72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

                         1. A trade-w eighted U.S. dollar-based index of principal Canadian exports.
                         2. Index deflated by U.S. Producer Price Index for Intermediate Goods.
                         – Shaded areas represent U.S. recession periods.


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