Commodities Outlook 11 Jan

Global
11 January 2008
Macro
Commodities Outlook
Commodity As An Asset Class: Like the Sirens in Greek mythology, Table of Contents
commodities have been singing an alluring melody for global investors as Commodity Views ..................................... 2
financial market dislocation has enveloped more traditional asset classes. #1 Executive Summary .............................. 3
#2 Trade Recommendations...................... 6
Global Markets Research
Instead of destruction, we anticipate another year of strong commodity #3 Trade Review ........................................ 7
price gains in 2008, most notably in the agricultural sector. #4 Commodity Indices............................... 9
#5 Global Macro....................................... 13
Oil: We believe the run-up in oil prices during the fourth quarter of 2007 #6 Commodity Cycles.............................. 16
goes beyond what can be explained by the decline in the US dollar and #7 Crude Oil & US Natural Gas ................ 17
#8 Markets vs. Analysts........................... 22
the level of global growth. We see prices averaging USD85/bbl this year. #9 US Power............................................ 23
#10 Commodity Term Structures ............ 24
Natural Gas: We expect prices will eventually benefit from inadequate #11 Commodity Volatility......................... 33
capacity additions from proposed coal projects and wind power, which are #12 Skew View & Spike Risk ................... 37
required to meet electricity generation needs. #13 Precious Metals ................................ 42
#14 PGMs ................................................ 47
#15 Industrial Metals ............................... 49
Precious Metals: The risk of further dollar weakness has not been #16 Agriculture ....................................... 61
exhausted, in our view. Consequently we see the gold price overshooting #17 Emissions.......................................... 66
this year and expect fundamentals in platinum will remain tight into 2009. #18 US Carbon Trading............................ 71
#19 Uranium ............................................ 73
#20 Bulk Commodities............................. 77
Industrial Metals: We expect this sector to recover in 2008 as US Commodities Chartbook ......................... 86
recession risk fades, the Fed stops easing, equity markets stabilise and Price Forecasts ........................................ 95
Chinese demand returns. We are particularly constructive towards
aluminium and copper.
Agriculture: Global land and water constraints as well as the need to feed
people, cattle and cars are expected to deliver new price highs this year
Research Team
We favour corn, cotton and soybeans.
Commodities: Siren Or Beacon? London
Michael Lewis
44 20 7545 2166
Jude Brhanavan
44 20 7547 1558
Hong Kong
Amanda Lee, CFA
852 2203 8376
Paris
Mark Lewis
33 1 4495 6761
Isabelle Curien
33 1 4495 6616
New York
Joel Crane
1 212 250 5253
Washington
Adam Sieminski, CFA
1 202 662 1624
Deutsche Bank AG/London

Commodities
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
11 January 2008 Commodities Outlook
Commodity Views
Energy
USD Level Δ wk Δ ytd 12M Low 12M High 5Y Avg View
WTI 96.33 -3.30% 0.36% 50.48 99.62 53.75
Brent 95.54 -2.35% 1.80% 51.70 97.84 52.40
Heating oil 2.64 -3.80% -0.31% 1.47 2.74 1.50
Gasoline (RBOB/gallon) 2.47 -3.70% -0.08% 1.36 2.57 1.54
US natural gas (/mmBtu) 7.97 1.49% 6.47% 5.43 8.64 6.97
Coal (API#2/tonne) 130.00 4.84% 4.84% 65.80 133.00 65.66
Uranium (/lb) 90.00 0.00% 0.00% 72.00 138.00 41.02
EUR Emissions Cal'10 24.48 2.01% 4.85% 12.92 26.01 20.98

Precious Metals
Spot (USD/oz) Level Δ wk Δ ytd 12M Low 12M High 5Y Avg View
Gold 879.05 2.58% 5.52% 607.92 879.05 505.54
Silver 15.49 3.72% 4.91% 11.67 15.82 8.79
Platinum 1550.00 0.62% 1.57% 1117.50 1550.00 979.88
Palladium 376.25 0.87% 1.28% 320.75 386.00 262.79
Industrial Metals
3M Fwd (USD/tonne) Level Δ wk Δ ytd 12M Low 12M High 5Y Avg View
Aluminium 2505 2.75% 3.99% 2395 2895 2066
Copper 7230 7.03% 8.31% 5340 8320 4394
Lead 2660 1.72% 4.31% 1550 3890 1237
Nickel 29895 9.91% 13.67% 25100 51600 19512
Tin 16500 0.76% 0.46% 10100 17575 8807
Zinc 2580 5.26% 8.86% 2220 4170 1966
Agriculture
Δ wk Δ ytd
st
1 nearby (USD) Level 12M Low 12M High 5Y Avg Comment
Corn 4.79 3.51% 5.10% 3.10 4.79 2.68
Cotton 0.68 0.80% 2.09% 0.46 0.69 0.55 Agriculture
Soybeans 12.67 1.46% 5.67% 6.65 12.68 6.91
Sugar 0.11 5.96% 5.08% 0.08 0.11 0.10

B earish B ullish
Wheat 9.08 -0.82% 2.54% 4.19 9.80 4.11
Source: DB Global Markets Research, Bloomberg (Prices as of close of business Tuesday)
Page 2 Deutsche Bank AG/London

Like the sirens in Greek mythology, commodities have

#1 Executive Summary been singing an increasingly alluring song for global
investors as extreme financial market dislocation has
Commodities: Singing Seductively enveloped more traditional asset classes during 2007.
However, instead of destruction, we anticipate another
• China and US monetary policy are expected
year of strong commodity price gains in 2008, most
to remain key drivers of commodity markets
notably in the agricultural sector.
during 2008. Consequently agriculture and
precious metals are our favourite sector calls Aside from underlying supply and demand
for 2008. fundamentals, which we believe remain bullish in a
• We believe rallies in the agricultural sector number of commodity markets, we expect the ebb and
are still in their infancy and as the fight flow of new risk capital entering commodities will also
between feeding people, cattle and cars be a function of two opposing forces. The first is the
intensifies we expect new price highs to be tendency of global investors to be overly optimistic
achieved across the sector. We are about asset classes that have been past winners and to
particularly constructive towards corn, cotton commit more capital to these markets. We expect the
and soybeans. second, and countervailing force, will be investor
concerns towards the increasing maturing of the
• We believe 2008 will be the year that G3 current commodity price and the possibility of a cyclical
central banks intervene to rescue the US downturn in commodity returns.
dollar. We are therefore positioning for new
The role of China
all time highs across the precious metal
We remain constructive to the ability of commodity
complex, particularly in an environment of
prices to sustain recent gains and in certain markets to
declining real interest rates in the US.
hit new price highs this year. We expect the main trade
However, we are wary that the recent run-up
balance shifts this year will be the country moving to
in gold prices may be moving temporarily
become a net importer of corn and aluminium for the
into over-extended territory, particularly if the
first time in this decade. We also expect the strength in
US dollar its seasonal tendency to strengthen
underlying GDP and income growth across China will
in January.
remain a major factor supporting commodity prices over
• Recessionary winds in the US pose the the next few years. Indeed, the steady increase in
greatest risks to the industrial metals sector, Chinese GDP per capita since 1995 is remarkably
in our view. If the economy enters recession similar to the improvement in living standards that
then we would look for a further 20% decline unfolded in South Korea and Taiwan from 1980, Figure
in the S&P500 and for equity markets to 1. On this basis, Chinese GDP per capita will reach
stabilise around July 2008. At that point we approximately USD20,000 soon after 2020.
would start to reinstate bullish front-end
strategies to accompany our bullish Figure 1: A comparison of GDP per capita income
assessment towards long-dated metal prices. in South Korea, Taiwan and China
• If, on the other hand, rapid US rate cuts avert 40,000 GDP per capita based on PPP
South Korea (Year 0 = 1980)
a growth dip, the central scenario of DB’s US 35,000
Taiwan (Year 0 = 1980)
Economics team, we believe rallies in the 30,000
GDP per capita USD
China (Year 0 = 1995)

sector will occur sooner. We are particularly 25,000
constructive towards aluminium. A reflection
20,000
of high energy prices and China’s move to
15,000
become a net importer of aluminium.
10,000
• We believe the run-up in oil prices during the 5,000

fourth quarter of 2007 goes beyond what can 0
be explained by the decline in the US dollar 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28
Number of years from 1980 for SK & Taiwan & from 1995 for China
and the level of global growth. However,
refinery capacity, oil production constraints Source: Deutsche Bank, IMF
and geopolitical issues continue to play a
very important role in boosting prices. We
Like per capita income, China’s urbanisation ratio has
believe it will require some normalising of
also been increasing for the past twenty years, by
these factors to achieve our average crude oil
roughly 1 percentage point per annum. By 2006 the
price forecast of USD85/barrel.
urbanisation ratio had reached 43.9% compared to
23.7% in the mid-1980s, or equivalent to over 13 million
people being urbanised every year. We expect China’s
Deutsche Bank AG/London Page 3

urban population to rise to 55% by 2020, bringing the between 1% and 4% of total investments, or 4 to 12
urbanisation ratio towards those prevailing currently in times more important than is the case of China today.
Malaysia and the Philippines, Figure 2.
Figure 2: Asia’s march towards increased levels Figure 4: Olympic related investments
of urbanisation
5
100 Olympic-related investments as a % of total
investments during the five years prior to the event
80 4
60
3
40
2
20
0 1
Pa d
e
m
M es
Th ia
an
do a
ng K
EU
a
rld
pa
or
n
si
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n
si
r ic
H
d
a
in
ia
hi
st
o
ne
ay
In
tn
ap
Ko
Af
Ja
W
pp
al
C
ki
e
al
Vi
0
illi
In
Si
Ph
2004 1992 1998 2000 2008 1996

Athens Barcelona Seoul Sydney Beijing Atlanta
Source: CEIC (2007), National sources
Source: Haver, London East Research Institute, Deutsche Bank
Since per capita energy consumption in urban areas is We also believe another major trend driving global
3.5 times more than that in rural areas, the urbanisation commodity markets will be increasing shortages of
trends is generating a sustained period of strong energy agricultural commodities most notably in China. Indeed
demand. Indeed assuming no change in energy rising incomes and declining levels of arable land per
efficiency and per capita income of USD20,000 by 2020 head of population in China are leading to a surge in
it would imply Chinese oil consumption of 20 million agricultural imports. We believe these trends will lead
barrels per day, roughly similar to US oil consumption to a further deterioration in the country’s agricultural
today. It is also sustaining strong consumption growth trade balance. Although there has been a recovery in
for industrial metals. Indeed we estimate that over agricultural land loss over the past few years, arable
80% of global demand for aluminium, iron ore and lead land per head per person has been on the decline for
over the 2007-08 will come from China, Figure 3. the past 30 years, Figure 5. Rapid urbanisation is likely
to sustain this trend, in our view.
Figure 5: China’s arable land per person is on the
Figure 3: Contribution of Chinese demand
decline
growth to global demand growth
Hectares of arable land per capita (lhs)
0.16 160
Copper 2007-08E
Total area under cultivation (million
0.15 hectares, rhs)
Zinc 155
0.14
Nickel
Steel 0.13 150
Lead 0.12
145
Iron ore 0.11
Aluminium
0.1 140
1978 1985 1990 1992 1994 1996 1998 2000 2002 2004 2006
0 20 40 60 80 100
Source: China Statistical Bureau

Source: Brook Hunt, UNCTAD, Tex Reports, AME, Deutsche Bank
Just as there have been fears of the US expansion Rising meat consumption is increasing the
running out of steam from December 2007 onwards, requirements for cattle feed. However, meat
there has also been concern that the conclusion of the consumption still remains low by international
Olympic Games in Beijing this summer could have a standards. Currently, per capita meat consumption in
negative effect on overall economic activity. We China is just 60kg annually. This represents just 60% of
disagree. Olympic related investments have accounted the world average and 20% of per capita meat
for only 0.3% of China’s total fixed asset investment consumption in North America.
over the past five years. In contrast, Games hosted in
Sydney, Seoul, Barcelona and Athens represented

The role of the US

We believe a falling real interest rate environment in the
US will help to sustain a bullish outlook for precious
metal prices. If the US authorities are successful in
averting a recession then we believe this will lift bearish
forces that have been depressing industrial metal prices
over the past few months.
For those investors concerned towards a potential

cyclical downturn in commodity index returns over the
next 12-18 months we recommend a long position in
the DBLCI-MR ‘Plus’. For more details see our
commodity Index article on page 9.
Conclusion
We believe the credibility of commodities as a distinct
asset class was enhanced last year. The strong
performance of commodity index returns during
extreme financial market dislocation demonstrated by
the negative correlation of commodity returns with
more traditional asset classes. We expect this will only
encourage further inflows into the complex.
Consequently, alongside tight supply-demand

fundamentals in a number of markets, we believe the
commodity bull run, which began at the end of 2001,
has further legs to run. Agricultural and precious metals
are our favourite sector call this year, with a recovery in
certain industrial metals also taking hold during the
course of the year.
Michael Lewis, (44) 20 7545 2166

Michael.lewis@db.com

#2 Trade Recommendations
Commodity Directional Trades Alpha RV Plays
sector
Index • Long DBLCI-MR • Long DBLCI-MR vs. short S&PGSCI
• Long DBLCI-MR “Plus” • Long DBLCI-CL vs. short DBLCI-OY-CL
• Long Commodities Booster Fund • Long DBLCI-OY-NG vs. short SPGSCI-NG
Energy • Bullish uranium • Long DBLCI-CL crude oil index vs. short OIX
• Long Mar’09 WTI variance swap oil equity index
• Long Mar’09 US NG variance swap • Long Jun’08 vs. short Dec’08 WTI
• Long Sep’09 US NG variance swap • Long Dec’09 vs. short Dec’10 WTI
• Short Jan’08 & long Feb’08 NG contract, and
keep rolling the positions every month
• Long DBLCI-OY-NG vs. short S&P GSCI-NG
sub-indices
• Short Feb’09 and long Apr’09 contract
Precious Metals • Long gold & platinum • Long back-end copper vs. short back-end gold
• Take profit on long gold vol via
variance swap
• Scale up sell gold vol
Industrial Metals • Short front-end industrial metals in the • Long curve flattening
near term; position to go long • Sell copper vs. buy zinc
• Long back-end industrial metals
Grains • Long grains basket • Long corn curve backwardation

• Long corn 1. Long Dec’08 corn vs. sell Dec’09 corn
• Long cotton • Long wheat curve backwardation
• Long soybeans 2. Long Dec’08 vs. short July’09
• Long Dec’08 wheat 3. Long Dec’08 vs. short Dec’09
• Long wheat curve flattening at the front-end
4. Short Mar’08 vs. Long Dec’08 or
5. Short Mar’08 vs. Long Jul’08
Source: DB Global Markets Research

#3 Trade Review
Date Commodity Trades Trade Performance
Nov 2 2007 Dry Freight: Time to Take Breath, Bearish Freight Equities
The Baltic Dry Index rallied approximately 150% in the first 10
months of 2007. However, given Asian exchange rate strength,
signs of easing port congestion and a moderation in the degree
of backwardation in the freight curve we position for the freight
rally to take breath. In addition, Asian export growth, which has
been an important driver of dry freight rates in the past, was
also at risk from a downturn in US business confidence.
Maintain short.
Nov 2 2007 RV Dry Freight: Short Panamax vs. Long Handysize Index
In addition to our directional bearish trade on freight rates and
freight equities, we also recommended a relative value trade on
different freight indices to take advantage of the significant
divergence in performance between the various vessel types.
We believe the significant out-performance of Panamax over
Handsize vessels is unsustainable. Maintain position.
Oct 5 2007 Playing Grains Seasonality: Long Mar’08 Corn

We are bullish corn but given the contango term structure we
preferred to go long a dated futures contract. Despite the
recent rally, we believe there is more upside potential going into
2008. Maintain long.
Sep 14 2007 Wheat Term Structure Trade

We believed the high spread between this year and next year
wheat was unsustainable, since it was wide enough to
encourage immediate substitution, discourage inventory re-
stocking and therefore a good sell. The spread has widened on
supporting weather and tender announcement which was
subsequently withdrawn. We continue to believe wheat might
be pressured in the near term on weakening fundamentals:
more water in Australia, India's wheat trade deficit shrinking,
China now a small net exporter of wheat. Maintain short.
Aug 3 2007 Industrial metals were identified as the expected biggest
losers on lower equity markets
In the last five years, industrial metal returns have displayed the
strongest positive correlation with the S&P500. This trade
exploited this fact and further equity market weakness would, in
our view, hurt this sector more than others. The worst three
performing commodities over the past month are all LME
metals. Front end remain defensive, but, look to go long
into Q1
Source: DB Global Markets Research, Bloomberg

#3 Trade Review
Date Commodity Trades Trade Performance
July 20 2007 RV Oil Index vs. Oil Equities

We found that crude oil index tends to outperform oil equity
index when the oil term structure is trading in backwardation,
and underform in contango. This RV play weathered the storm
of the sub-prime triggered sell-off as well as the 28% oil rally
over the past few months relatively well, in our view. We
believe a RV trading strategy is best positioned to extract alpha
from the oil market. Maintain position.
July 20 2007 WTI Curve Play: Backwardation To Stay

The WTI curve had a roller coaster ride in 2007, from steep
contango earlier the year and then suddenly flipped back into
backwardation in the middle of the year. Given the consistent
trinity: record high oil prices, falling OECD inventories and
backwardation, we adopted a curve steepening trade based on
our belief that the move from USD75/bbl to USD60/bbl between
August and September 2006 will not be repeated. In fact, not
only oil did not sell-off, the strong rally and subsequent attack of
USD100 has kept this trade in profit. Maintain long.
June 8 2007 Calm Before The Storm? Long Gold Variance Swap
June marked the low point in gold implied vol. This trade has
performed as contagion from equity and FX markets spread into
the commodities complex and specifically gold. During the
period of extreme VIX and USDJPY volatility, gold prices traded
USD20 lower and implied vol rose. Since then the gold price
has broaken above USD800/oz which has pushed gold vol
higher despite a recovery in risk appetites. Given the extreme
positioning currently in the gold market as well as seasonal
trade in the EURUSD, we would recommend taking profit and
prepare to scale up sell. Take profit and scale up sell.
Feb 16 2007 RV metals: Long Copper Forward vs. Short Gold Forward
We recommended a long copper position and funded this via
gold where we were short term bearish. We believed forward
copper was undervalued while forward gold was overvalued,
given the high level of above ground stocks in gold compared to
a copper inventory-to-consumption ratio which had fallen to a
matter of days. This position also benefited from selling
contango and buying backwardation and therefore gaining
positive carry on both legs of the trade. Maintain position.
Feb 16 2007 Bullish Back-end Copper

We believe copper was over-sold and was likely to recover, with
a stabilizing US housing market, easing China SRB metal
release, inventory re-stocking in China and rising production
cost. We have been bullish backend industrial metals and there
was no exception to this trade. We recommended going long
the back-end of the copper curve, either as a directional long or
a curve flattening trade. This trade has proved to be extremely
well timed we got in just after the copper price has bottomed.
Despite the sub-prime related sell-off the back-end copper price
has remained extremely resilient. Maintain long.

certain commodity markets, for example gold, is

#4 Commodity Indices therefore increasingly likely in our view.
Aside from the S&PGSCI, which posted negative
DBLCI-MR: Another Strong Year
returns in 2006, the universe of commodity indices has
• We believe the appeal of commodities as a therefore posted positive returns on an annual basis
distinct asset class has been enhanced in the since the end of 2001. Consequently this represents
aftermath of the US sub-prime crisis. one of the most durable rallies in commodity index
returns on record. It also introduces a greater
• We expect the DBLCI-MR to post 20% returns probability of an eventual cyclical downturn in
in 2008. This follows gains of 46.1% and commodity index returns, in our view.
49.0% respectively in 2006 and 2007. The While the majority of commodity indices has posted
DBLCI-MR expects aluminium will become positive returns since 2001, this masks a significant
the engine room for index returns this year. divergence of index performance between the
incumbent indices such as the S&PGSCI and Dow
• We believe this will prove to be a rewarding
Jones-AIG and younger commodity indices, such as the
strategy as China becomes a net importer of
Deutsche Bank Liquid Commodity Index-Mean
aluminium.
Reversion. We find that since the end of 2001, total
• For those investors concerned about a returns on the Dow Jones-AIG commodity index have
possible cyclical downturn in commodity risen 145% compared to 370% on the DBLCI-Mean
index returns, we have launched the DBLCI- Reversion, Figure 2.
MR ‘Plus’, which is able to allocate between
commodities and T-bills according to
prevailing market conditions. Figure 2: Commodity index returns since 2002
400
Total returns since
Last year proved to be another strong year in terms of the end of 2001
350
commodity index returns particularly when compared
with more traditional asset classes, Figure 1.
300
250
Figure 1: Asset class returns compared
200
2007 returns (%)
35 Bonds: DBIQ Global IG Sovereign 32.6
Emerging Markets: DBIQ EMLE 150
30 Foreign Exchange:DB Currency Returns Index
Equity:MSCI Global
25 Commodities: DBLCI-OY 100
DJAIGCI S&PGSCI LBCI RJ/CRB RICI DBLCI DBLCI-MR
20
Source: DB Global Markets Research, Bloomberg (as of end 2007)
15 12.2
10
5.4 5.4
4.0
5 This divergence in part reflects the rapid development
0 of the commodity index space over the past five years
Bonds EM FX Equity Commodities with at least 12 new commodity indices being launch
Source: DB Global Markets Research, Bloomberg over this period. Investors therefore need to be acutely
aware of the characteristics that distinguish the
numerous commodity indices in the marketplace.
Commodity returns have performed strongly despite The major determining features of a commodity index
the US sub-prime crisis and the increasing probability of are how many commodities are included and in what
a US recession. We believe this resilient index proportion, what is the selection process, which
performance during extreme financial market specific futures contracts are used for each individual
dislocation has only enhanced the appeal of commodity, how are these futures contracts rolled and
commodities as an event risk hedging asset class. are the commodities reset to base weights periodically?
The tendency of investors to be overly optimistic about Consequently, the universe of commodity indices can
asset classes which have been past winners and overly be classified according to three broad categories:
pessimistic about asset classes which have been past a) fixed weight and fixed roll index;
losers will encourage a new wave of risk capital to enter
b) fixed weight and dynamic roll index and
the complex, in our view. The risk of overshooting in
c) dynamic weight and fixed roll index.

The DBLCI-Mean Reversion and the DBLCI-MR ‘Plus’ We estimate that by the middle of this year, the DBLCI-
are therefore the only commodity indices not to adopt a MR will have increased its allocation to aluminium from
fixed commodity weight allocation, Figure 3. Instead 15% to approximately 45%. This would represent its
commodity weights on the DBLCI-MR are changed over largest allocation to this commodity since May 1992. At
time such that the index ‘over-weights’ cheap the same time, we expect the allocation to crude oil and
commodities and ‘under-weights’ expensive ones heating oil will be reduced from 65% to 35%.
according to a pre-defined mechanistic formula. Accordingly, the DBLCI-MR is indicating downside risks
to energy returns are mounting while aluminium returns
Figure 3: Agricultural commodity rallies will perform strongly.
compared
Rebalancing Launch Figure 4: Historical weights of the DBLCI-MR and
Index Rolling frequency frequency date expected change in allocations by June 2008
100%
Fixed weight, fixed roll index:
90%
Energy: monthly
80%
DBLCI All others: annual Annual Feb-03 70%
DJ-AIG Six times per annum Annual Jul-98 60%
50%
S&P GSCI Monthly Annual Jan-91
40%
RJ/CRB Monthly Monthly Jun-05 30%
RICI Monthly Annual Jul-98 20%
10%
LBCI Monthly Annual Dec-00
0%
MLCX Monthly Monthly Jun-06 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
WTI Heating Oil Gold Aluminium Wheat Corn
Daily rolling at
UBS CMCI constant maturity Monthly Jan-07
Fixed weight, dynamic roll index We believe this rising allocation to aluminium may
DBLCI-OY Dynamic Annual May-06 prove a rewarding strategy during 2008 given tightening
DBLCI-OY fundamentals in the Chinese aluminium market. China
Broad Dynamic Annual Jan-07 is the world’s largest producer of both primary
aluminium and alumina, with an estimated market share
DBLCI-OY
of 33% and 26% respectively in 2007. China is also the
Balanced Dynamic Annual Jan-07
fastest growing market for aluminium demand, with
Dynamic weight, fixed roll index: consumption increasing by 20% and 24% in 2005 and
Energy: monthly 2006 respectively, with the level 2007 registering nearly
DBLCI-MR All others: annual No rebalancing Feb-03 39%. Consequently, China plays a critical role in the
Energy: monthly outlook for global aluminium prices.
DBLCI-MR
‘Plus’ All others: annual No rebalancing Jun-07
As a result of significant smelter capacity growth, the
Chinese aluminium market has been persistently
Reweighting events on the DBLCI-MR take place when oversupplied in recent years. This has led the country
the one-year moving average price of a commodity is a to become a net exporter of primary aluminium since
whole multiple of 5% away from the five-year moving the beginning of 2001. However, this situation is
average. This strategy has proved rewarding over the changing as the Chinese authorities take steps to close
past two years as total returns on the DBLCI-MR have inefficient smelters and restrict the level of aluminium
risen 46.1% and 49.0% in 2006 and 2007 respectively. exports.
This has seen the energy allocation collapse to 5% by

the beginning of 2006 and the DBLCI-MR migrating
aggressively into corn and wheat. By the beginning of
2007 the DBLC-MR had switched tack and had begun
to build an aggressive energy position ahead of crude oil
prices were hitting triple digits.

These steps have included: In terms of roll returns, forward curves are pointing to a
divergent outlook for this year. On the one hand, roll
• January 2005: The withdrawal of an 8% export tax
returns for wheat, crude oil and heating oil are positive,
rebate and the imposition of 5% export tariff
which we expect to be sustained throughout 2008.
• November 2006: An increase in the export tariff to Meanwhile roll returns are negative for gold, corn and
15%. In addition, the tax exemption for tolling of aluminium, a reflection of the contango term structure
primary aluminium (importing alumina duty free) and in these markets. Figure 6 estimates the implied roll
exporting with a rebate was withdrawn. return for the coming year assuming the forward curve
is unchanged from current levels. It also illustrates how
• August 2007: The removal of a 5% import tax on moving to a dynamic rolling futures schedule and
primary imports, the imposition of 15% tax on adopting the Optimum Yield technology can help boost
aluminium bars and rods, and the elimination of an roll returns.
8% export rebate from aluminium extrusion and
which became effective at the beginning of August.
Figure 6: Implied roll return for components of
• December 2007: imposed new industrial production the DBLCI with & without the OY technology
guidelines setting minimum capacity requirements
Implied roll return for 2008
for primary aluminium and alumina producers. 15% on current shape of the
forward curve
Implied roll return for 2008
10% using the Optimum Yield
These measures have been successful in reducing tecnologiy
aluminium exports since September 2006 such that net

exports in 2007 will be the lowest since 2001, at under 5%
100K tonnes. Moreover, in 2008 steps to discourage

exports as well as strong domestic aluminium 0%
consumption point to the possibility of China becoming
a net importer of aluminium, Figure 5. Indeed on our -5%
estimates, China is set to constitute more than 80% of
global aluminium demand growth between 2007 and
-10%
2008 and in our view supports the bullish outlook for Wheat Crude oil Heating oil Gold Corn Aluminium
aluminium spot prices.
Figure 5: China’s move to become a net

We present our expectations for spot, roll and total
aluminium importer
returns for 2008 for the six components of the DBLCI
900
China's net trade balance in aluminium (tonnes, 000s) and DBLCI-MR in Figure 7. The possibility of the roll
return in corn and aluminium contributing positively to
700
overall returns reflects our belief that fundamentals in
500
Net exporter these markets are tightening, which will flip these
commodity forward curves from contango to
300 backwardation.
100
Figure 7: Expected composition of returns for the

-100
Net importer six components of the DBLCI in 2008
-300
1996 1998 2000 2002 2004 2006 2008? Commodity Spot Return Roll Return Total Return
Source: DB Global Markets Research, CEIC

Crude Oil Negative Positive Neutral
To assess the outlook for commodity index returns we Heating Oil Negative Positive Neutral
estimate both spot and roll returns for the individual

Gold Positive Negative Positive
components of a commodity index. In terms of spot
returns, we expect these will be positive for aluminium, Aluminium Positive Turning Positive Positive
gold, corn and wheat. We recognise the upside price
risks for crude oil, the WTI options market skews Corn Positive Turning Positive Positive
currently attaches a 10% probability of the Dec’09 WT

Wheat Postive Postive Postive
contract expiring above USD149/barrel. However, on
our forecasts we are assuming crude oil and heating oil Source: DB Global Markets Research
spot returns will be slightly lower compared to current
levels.

On this basis, we expect total returns on the DBLCI-MR Figure 8 illustrates the performance of various alpha,
to rise 20% this year. However, given the increasing beta and enhanced beta commodity allocation
maturing of the current bull run in commodity prices we strategies. We find that since August 1997, there have
believe it is increasingly prudent to consider the been only four months were monthly returns of the
possibility of a period where commodity index returns DBLCI-MR ‘Plus’ has been -5% or less. This compares
turn negative over the next 24 month period. with 15 and 18 months for the DBLCI-MR and the S&P
GSCI respectively.
The DBLCI-MR ‘Plus’
To address the risk of a cyclical downturn in commodity
index returns we launched the DBLCI-MR ‘Plus’ index Conclusion
in June 2007. Its strategy is to achieve an optimal asset
In our view, the rapid development of the commodity
allocation between a commodity index, in this case the
index space over the past five years is a sign of the
DBLCI-MR, and T-bills (cash) by detecting cyclical
building credibility of commodities as a distinct asset
upswings and cyclical downturns in global commodity
class. However, it also introduces challenges for
markets.
investors in terms of selecting the correct index for
their investment objectives.
It achieves this by rebalancing between cash and
commodities according to their relative performance
over the previous 12 month period. Such that if the
Michael Lewis, (44) 20 7545 2166
DBLCI-MR has outperformed cash in all 12 months then
mchael.lewis@db.com
the index will be fully allocation to commodities and if
cash has out-performed commodities over the past year
it will have eliminated all exposure to commodities.
Figure 8: The comparative performance of various alpha and beta commodity allocation strategies
Total Volatility** Excess Sharpe Monthly drawdown ##

Return* Return* Ratio # maximum no. of m onths < -5%
Beta allocation strategies

DBLCI TM 14.65% 20.75% 10.60% 51.08% -11.21% 19
S&P GSCI TM 7.66% 21.13% 3.83% 18.12% -14.41% 23
DJ-AIGCI SM 8.07% 14.24% 4.23% 29.68% -7.54% 13
Enhanced beta allocation strategies

DBLCI-MR TM 15.05% 16.97% 10.99% 64.77% -14.73% 15
DBLCI-MR TM 'Plus' 15.06% 12.61% 11.00% 87.20% -7.25% 4
DBLCI-OY Balanced 14.96% 13.16% 10.90% 82.81% -7.05% 5
DB Commodity Booster Index - S&P GSCI TM 16.60% 17.01% 12.48% 73.36% -9.18% 9
S&P GSCI TM 7.66% 21.13% 3.83% 18.12% -14.41% 18
SM
DJ-AIGCI 8.07% 14.24% 4.23% 29.68% -7.54% 11
Alpha-Lite allocation strategies

DB Commodity Havest Index 9.19% 3.51% 5.33% 151.76% -3.25% 0
DB Commodity Havest Index - S&P GSCI TM 10.90% 6.53% 6.98% 106.95% -6.56% 1
Other asset classes

SPTR (S&P 500 Total Return) 5.85% 17.77% 1.79% 10.08% -14.46% 13
USGATR (US Govt. All Total Return) 6.40% 4.65% 2.33% 50.09% -3.93% 0
* annualised return based on total return and excess return; ** annualised vol of the daily lognormal returns
# calculated as a quotient of excess return and the volatility: ## based on total return; Data from August 1997 to 7 January 2008

Over the past five years, industrial metals have

#5 Global Macro displayed a strong positive correlation with the S&P500,
Figure 1. Since the start of the US sub-prime crisis,
The US Economy: Flirting With copper and zinc prices have been particularly
Recession mesmerised by the performance of US equity markets.
The possibility of the US entering recession therefore
• In January 2005 we stated that the next US poses extreme dangers for the industrial metals
recession would begin in December 2007. complex given the tendency of the S&P500 to perform
This reflected the fact that the duration of badly during US downturns.
every US expansion since 1954 has been
directly proportional to the time the US
Figure 1: Long & short-run commodity
Federal Reserve has given monetary stimulus correlations versus the S&P500
to the economy. Correlation of various sub-sectors
0.6
of the S&P GSCI to the S&P500
• Consequently, the fuel tank was running 0.4
close to dry when the US sub-prime crisis
struck six months ago. Since then economic 0.2
indicators have been pointing to the
0
increasing recessionary risk enveloping the
US economy. -0.2
Since December 1982
• We expect the rapid programme of rate cuts -0.4
Last 5 Years
by the Fed over the past few months will
-0.6
avert recession (just). This is because real
Energy Precious Livestock Agricultural Industrial
interest rates today are around 200 basis Metals Metals
points lower than the average real fed funds
rate at the start of the last five US recessions. Source: DB Global Markets Research, IMF, Bloomberg
• However, in this article we examine the likely

commodity winners and losers if financial Figure 2 examines the performance of the S&P500
markets start to raise the probability of a US around US recessions since 1948. We find that on
recession even further. We find that average US equity markets decline approximately 10%
industrial metals will be most exposed over from their peak to the onset of recession and an
the coming six months. average of 18% once the US has entered recession.
• Meanwhile we expect a falling US real If the US enters recession this month, then the S&P500
interest rate environment will be bullish will have fallen by 10% since the October 2007 peak
precious metal prices, with the euro and the and consequently in line with historical averages.
gold price at risk of overshooting this year. Moreover if this cycle conforms to historical averages
then the S&P500 will decline a further 18% from
• Although a US downturn may depress the oil current levels and hit this trough in July 2008, or seven
price, for as long as world GDP growth months after the economy has entered recession.
remains above 3%, we expect OPEC will be in
Of the group of industrial metals we believe copper is
a powerful position to defend any short term
most vulnerable in the event of a US recession. Figure
price weakness. We expect OPEC will be
3 highlights the average change in inventories of the six
quick to act to defend oil prices particularly in
LME metals in the 25 weeks before and the 75 weeks
an environment of US dollar overshooting to
after the last three US recessions. We find that copper
the downside.
inventories have been the most sensitive to a
• We see few contagion effects of a US slowdown in US economy activity, with inventories
recession on the agricultural complex and doubling within three months of the US entering
consequently we believe this sector recession. Meanwhile, lead, nickel and zinc inventories
possesses good diversification properties for have tended to be relatively unaffected in the months
investors. following recession.

Figure 2: The performance of the S&P500 around US recessions since 1948
Recession period S&P500 Peak to recession start From recession start to trough Total decline
S&P500
from peak to
peak trough
Start End Months # of months % decline # of months % decline trough
Jun-48 Oct-49 16 15-Jun-48 13-Jun-49 - - 13 -19.1% -20.6%
Jul-53 May-54 10 5-Jan-53 21-Sep-53 6 -9.1% 3 -5.6% -14.2%
Apr-57 Apr-58 12 2-Aug-56 21-Oct-57 8 -11.3% 7 -11.3% -21.3%
Apr-60 Feb-61 10 3-Aug-59 25-Oct-60 8 -8.7% 7 -5.6% -13.9%
Dec-69 Nov-70 11 29-Nov-68 26-May-70 12 -14.0% 6 -25.7% -36.1%
Nov-73 Mar-75 16 11-Jan-73 4-Oct-74 10 -10.4% 12 -42.1% -48.2%
Jan-80 Jul-80 6 13-Feb-80 27-Mar-80 - - 3 -9.0% -17.1%
Jul-81 Nov-82 16 28-Nov-80 12-Aug-82 7 -7.7% 14 -21.1% -27.1%
Jul-90 Mar-91 8 12-Jun-90 11-Oct-90 1 -1.8% 4 -17.8% -19.3%
Mar-01 Nov-01 8 24-Mar-00 21-Sep-01 11 -18.7% 7 -22.2% -36.8%
Average 11 8 -10.2% 7 -17.9% -25.4%
Jan-08? 9-Oct-07 Today 3 -9.8%
Source: DB Global Markets Research, NBER
Figure 3: The average change in LME inventories Figure 4: A pre-emptive Fed should help forestall
in the past three US recessions recession
The average change in LME inventories July 1981, July 1990 % %
400 in the weeks before and after the 1981, & March 2001 = 100
Real fed funds* (average of last 5 business cycles)
1990 and 2001 US recessions 6 Real fed funds* (current) 6
350
Aluminium 5 5
300 Copper
Lead 4 4
250 Nickel
Tin 3 3
200
Zinc
2 2
150
1 1
100 * deflated by core CPI
0 0
50
"0" represents historical onset of recession
-25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 -1 (months) -1
Number of weeks before/after the US enters recession -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18
Source: DB Global Markets Research, FRB, BLS

Source: DB Global Markets Research, LME
We believe precious metals and in particular gold prices

Despite the risks, there is still a good chance that the will be a major beneficiary of a declining real interest
US can avert recession. Indeed the real fed funds rate rate environment in the US. Figure 5 illustrates total
peaked at 3% in June 2007 and has subsequently fallen year-on-year returns for gold as a function of the real
to 2%. Meanwhile, the average real fed funds rate at fed funds rate since 1970. We find that there is a loose
the start of the past five US recessions has been 5%, or positive correlation between the level of real short-term
200 basis points below where the real fed funds rate US interest rates and gold returns. Specifically gold
peaked in the current cycle. Since we expect a further returns tend to perform strongly in low or negative real
25 basis points off the Fed funds rate at the end of this interest rate environments.
month, it implies a further moderation in real interest
rates. Indeed the threat of inflation shocks ahead
provides further scope for real interest rates to be even
lower over the coming year.

Figure 5: Gold returns in different US real Conclusion

interest rate environments We believe the outlook for metals prices is bullish
100 Year-on-year returns 1970-2007 during 2008. We expect the precious metals complex
will benefit from a falling US real interest rate
80
environment and the threat of an overshooting in the
60 EURUSD exchange rate.
Gold yoy returns (%)
40 We believe the prospects for the industrial metals

20
complex are improving. However, we remain cautious
to adopting long front-end metal strategies at the
0 moment since US recession risks still remain close to
-20 the surface. Indeed if the US economy did fall into
recession during the current quarter then it would, in
-40
our view, imply a further 18% decline in the S&P500
-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9
Real short-term Fed funds rate (%) and equity markets not stabilising until July 2008. We
expect it would also encourage a further rise in copper
inventories on the LME.
In an environment where the euro is overshooting and However, if our US economists are correct and the US
central banks are poised to intervene to rescue the US can avert recession then we believe underlying
dollar, we believe OPEC will also aim to keep oil prices industrial metals demand remains strong, most notably
as high as possible in order to preserve their purchasing from China. Consequently we expect a strong recovery
power. We find that OPEC have a very good track in these metal prices during 2008-09
record in defending the oil price. Figure 6 examines the We expect oil demand fundamentals will only start to
performance of the crude oil price in the two weeks deteriorate if world growth falls below 4%. However,
before and two to three months after the cartel have we expect OPEC would only struggle to defend the oil
agreed production cuts to defend the oil price. price if global growth falls below 3%. Consequently,
We find that since the early 1990s, the cartel has a 70- we see little downside risks to our current oil price
80% success rate in defending the oil price. The two forecasts.
years here the cartel has failed were in 1998 and 2001,
periods where world GDP growth fell below 3%. On
current forecasts we expect world GDP growth to rise
4.5% in 2008 and consequently from a demand Trade recommendations:
perspective indicated few bearish forces for the oil price.
• Long gold. However, be wary of a
Figure 6: The performance of the WTI crude oil pocket of US dollar strength in the first
price before and after an OPEC quota reduction four weeks of this year.
150 Mar-93 Apr-98 Jul-98 Apr-99 • Long back-end industrial metals. Look
WTI oil price=100 in the day before quota reduction
140
to go long front end aluminium and
Feb-01 Apr-01 Sep-01 Jan-02
130
copper prices as US recession risks start
120
Nov-03 Apr-04 to fade.
110
100
90
1998
80
70
Michael Lewis, (44) 20 7545 2166
2001
60
michael.lewis@db.com
-14 -7 0 7 14 21 28 35 42 49 56 63 70
Number of trading days before and after OPEC quota reduction

• While the rally in gold and silver prices has

#6 Commodity Cycles not yet surpassed the rallies of the late 1970s
in percentage terms, they have been the most
Breaking New Records durable on record as the cycle approaches its
seventh year.
• We find that over the past forty years, rallies in
• The rally in many agricultural commodity prices
the agricultural sector have, on average, a trough
during this cycle is only still close to historical
to peak rise of 160% and a typical duration of
averages in both magnitude and duration. Yet
approximately 18 months.
inventories in a number of agricultural
• Consequently, rallies in the agricultural sector commodities have now fallen to critically low
have tended to be less pronounced and levels at a time when global demand for food,
shorter in duration than upswings in the cattle feed and biofuels is increasing rapidly.
energy and metals’ sectors. For example,
• We consequently believe the price rallies in
rallies in gold and silver prices have on average
corn, cotton, soybeans and wheat are still in
tended to be 300% in magnitude and around
their infancy.
three years in duration.
• The tendency for agricultural price rallies to be Figure 2: The duration of the current commodity
shorter and less powerful is possibly a reflection price rally compared to historical averages
of the faster supply response in this sector These are amongst the most These price rallies are
90 durable rallies on record still in their infancy
compared to other parts of the commodity
80
complex.
70
• However, the current upswing in commodity 60 Average duration of price
rally since 1970
prices is distinctive because it is proving to be
Months
50
Duration of current rally
either the most powerful or the most durable 40
on record. For example, the crude oil price has 30
risen just over 450% so far in this cycle with the 20
rally now more than six years old. Historically oil 10
price rallies have had a peak to trough rise of 0
225% and lasted for just over two years. r
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Consequently the current upswing in oil

Al
prices which began in November 2001 has Source: DB Global Markets Research, Bloomberg, IMF
been the most powerful and durable on
record. A similar distinction is held by copper • Indeed for the current rally in corn and wheat
which had a trough to peak rise of 570% prices to be the most powerful and durable in
between November 2001 and May 2006. history would require grain prices to rise a further
30-40% from here and price peaks to occur in
the first half of 2009. Soybeans and cotton
Figure 1: The magnitude of the current prices would have to rise 70% and 105% with
commodity price rally compared to historical price peaks occurring at the end of this year and
averages the first half of 2012 respectively.
1400 Average magnitude of price • In our view, this degree of price appreciation
rally since 1970 (%)
1200
may prove too conservative as it fails to take
Magnitude of current rally (%) into account that agricultural commodity
1000
prices in real terms are still cheap. If
800 agricultural prices hit all time highs in real terms
600 as has occurred in the energy and industrial
400
metals complex, then it would imply wheat, corn,
soybeans and cotton appreciating by another
200
130%, 175%, 240% and 375% respectively.
0 This would imply corn and wheat prices hitting
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USD12.5/bushel and USD20.30/bushel

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Cr
respectively and cotton and soybean prices rising

So
Al
The magnitude of the current rally is measured from the trough to the to USD3.22/lb and USD41/bushel respectively.
peak, which for many industrial metals occurred in 2006
Source: DB Global Markets Research, Bloomberg, IMF Michael Lewis, (44) 20 7545 2166

Figure 1: DB’s energy price forecasts

#7 Crude Oil & US Natural Gas
WTI Brent US Gas
• Oil markets continue to be characterized by
(USD/bbl) (USD/bbl) (USD/mmBtu)
tight fundamentals, difficult geopolitics, and
2006 66.25 66.11 6.98
slow elasticity responses that might bring
about lower prices. Q1 2007 58.27 58.62 7.18
• Finding & development costs have risen Q2 2007 65.02 68.66 7.66
much more rapidly than we expected when Q3 2007 75.15 74.55 6.24
we last changed our long-term energy price Q4 2007 90.50 88.53 7.39
deck in July 2007. 2007 72.36 72.66 7.12
• Moreover, resource nationalism, changes in Q1 2008E 90.00 90.00 8.00

fiscal terms, and geopolitical challenges to Q2 2008E 80.00 80.00 7.50
supply are also impacting prices. Q3 2008E 85.00 85.00 7.75
• Demand remains relatively unresponsive to Q4 2008E 85.00 85.00 7.75
higher energy prices due to the growth in real 2008E 85.00 85.00 7.75
incomes. Prices could be impacted by a 2009E 80.00 80.00 8.00
global slowdown in GDP, but a worldwide 2010E 75.00 75.00 8.75
recession does not seem likely.
2011E 77.00 77.00 9.50
• We expect nominal WTI and Brent oil prices
2012E 79.00 79.00 9.75
to average USD75/bbl in 2010 and USD80/bbl
2013E 81.00 81.00 10.00
in 2012-13. This compares with our prior
2014E 83.00 83.00 10.25
“mid-cycle” estimates nearer USD65/bbl.
2015E 85.00 85.00 10.50
• US natural gas prices are forecast to average Note: Nominal prices
USD8.75/mmBtu in 2010, up from a prior Source: Bloomberg, DB Global Markets Research
USD8/mmBtu.
The shocking rise in per barrel costs highlighted by
the US DOE reflects a combination of higher total
2008-10 and mid-cycle oil and gas prices finding and development costs (bonuses, royalties,
In mid-November we raised our near-term oil price labour, materials etc) and poor reserves
forecasts to reflect the reality of very high oil prices and replacement. Our prior assumption was that per barrel
the continuing tightness in global supply and demand, F&D costs would rise toward USD20 in 2010, but the
but we did not feel compelled to change our mid- new data for 2006 and continuing cost increases being
USD60s price forecasts for the "long-term" or "mid- reported by companies for 2007 along with spotty
cycle" in the 2012-2013 time frame that were set in July reserve additions suggest that F&D costs could quickly
2007. We believe there is a price where oil demand will be headed toward USD25/bbl.
induce changes in producer and consumer behaviour, Higher oil prices are being supported by rising costs in a
and we still think this price is below USD100/bbl. But self-reinforcing loop. We understand that causality
as we mentioned in July, the “equilibrium” oil price is tends to run from prices to costs and not the other way
not necessarily a constant, it can change up and down around, but unless some outside factor can forces oil
because of currency fluctuations, GDP changes, prices down, we think that costs are unlikely to soften
technology, geopolitics, taxation, environmental rules, much.
etc. On the supply side there are the competitive costs
of tar sands, heavy oil, gas-to-liquids, biofuels among Prior down-cycles in oil prices were generated by a
others. On the consumption side, technology may combination of lower oil products demand, dramatic
foster efficiency gains or offer up alternate fuels. improvements in seismic and drilling technology, and
greater access to reserves (aperatura & perestroika). A
That said, one key factor that offers compelling new repeat of this confluence of events is certainly possible,
evidence that our longer-term energy price forecasts but seems improbable over the course of the next few
need to be revised higher is rapidly increasing finding & years. Oil demand growth is increasingly being driven
development costs. The US Department of Energy has out of Asia and the Middle-East, regions not
just published data from the large energy companies immediately susceptible to economic downturns in the
showing that average worldwide F&D costs averaged US or Europe. Technology is obviously improving, but
over the three-year period 2004-2006 to have risen by does not appear to be on the verge of the enormous
over 50% from the prior 2003-2005 period, soaring from breakthroughs (3-D seismic, horizontal drilling, and
USD11.38/bbl to USD17.23/bbl. subsea completions) of the last two decades. Access
to the areas of the highest geologic potential seems to
be decreasing as “resource nationalism” moves

steadily into the mainstream of geopolitical discourse in aggressively for rights to explore. Wood Mackenzie
the producing nations. also gave warning that exploration costs could rise even
further, as the most recent activity was still benefiting
Figure 2: Global F&D costs headed to USD30
from substantially better terms negotiated in the late
30 USD per boe (constant 2006 dollars)
1990s. High oil prices are encouraging host
governments to further tighten fiscal terms.
25
Our projections for real 2007-2015 F&D costs assume
20 15% rises in 2007 and 2008, 10% in 2009, 5% in 2010,
and 2.5% per year for 2011-15. This would push F&D
15
costs over USD20/bbl now, over UDS25/bbl by 2010,
10
and toward USD30/bbl by 2015.
5 Figure 3: Oil prices and F&D costs are related
0
90 2007E - 2015E
1980-82 1987-89 1994-96 2001-03 2008-10E
80
Real Oil Price (USD/bbl)

Source: DOE/EIA, DB Global Markets Research 70 1980-2006
60 y = 2.62x + 7.53
2
R = 0.95
50
The historical costs in Figure 2 are based on
40
detailed financial and operating data and
30
information submitted each year to the US DOE/EIA
20
by the major US-based energy-producing companies 10
under the “Financial Reporting System (FRS). 0
http://www.eia.doe.gov/emeu/perfpro/ 4 6 8 10 12 14 16 18 20 22 24 26 28 30
Real F&D Costs (USD/bbl)
A majority of the companies surveyed are multinational,
with 40% of the majors’ net investment located abroad. Source: DOE/EIA, Bloomberg, DB Global Markets Research
The EIA supplements this data with information from
company annual reports and press releases, disclosures Figure 3 illustrates the relationship between oil prices
to the US SEC, news reports and articles, and various and finding & development costs. Using EIA data on
energy industry data sets. F&D costs over the period to 1980-2006, the regression
Per barrel costs come from the interaction of absolute equation is:
costs and reserve changes. A decline in reserve
additions over the past few years has been an Oil Price = 2.6x F&D costs + 7.5
important part of the overall increase in finding costs.
In 2006, the FRS companies’ reserve additions through From a cost perspective, this suggests our new nominal
drilling (excluding purchases and sales of reserves) fell oil price deck would be easily supported at USD75/bbl
27% from 2005 to 4 billion barrels of oil equivalent in 2010 and near USD85/bbl in 2015.
(boe), driven by large downward revisions of natural gas
reserves and lower extensions and discoveries of oil. In our view, the same cost/price principles discussed
above can be applied to US natural gas. The EIA data
According to the DOE/EIA, the FRS companies’ reserve on F&D costs is based on combined oil and natural gas
replacement rate for natural gas was 88% in 2006, the data calculated on a barrel of oil equivalent (boe) basis.
first time since 1992 that the FRS companies failed to In line with our higher oil price forecasts, we have
add sufficient reserves to replace natural gas increased our US natural gas price forecasts for 2010
production. The reserve replacement rate for oil was from USD8.00 to USD8.75/mmBtu and forecast US gas
59%, the fourth time in the past five years that the prices over USD10/mmBtu by 2015. .
reserve replacement rate for oil among FRS companies
fell short of par. How we got to USD100/bbl oil
Our colleagues at Wood Mackenzie recently In view of the potential problems associated with
completed a study pointing to rising development causality between costs and prices (some research
costs, particularly in the offshore sector where rising suggests that costs follow prices) we do not want to
global demand has driven drilling, subsea and rely on cost alone as a guide to our oil and gas price
production facilities costs steeply upwards. forecasts. As we see it, there are four broad categories
Governments have also driven up costs according to of drivers responsible for high oil prices:
WoodMac, as the price of exploration licences for new
acreage in prospective basins has surged. One reason Fundamentals. Demand appears less sensitive to
for this has been the greater use of public bidding price now because incomes are higher. The
rounds, in which some oil companies have bid emergence of China and India as new super-commodity
consumers along with a huge underlying base of

consumption in the US has added a strong amount of flat but the rest of the world is still growing. We expect
rising demand momentum into the markets. On the that higher prices and more sluggish economies are
supply side, oil production has shifted towards more likely to result in a tempering of the growth rates seen
technically challenging projects and less market- over the last few years that dramatically reduced spare
oriented economies. Disappointments in reaching production capacity.
output goals seem to have become the rule rather than
the exception. Lower supply and demand elasticities Supply. Non-OPEC supply growth over the period
have lengthened the time needed to rebalance. 2005-07 was significantly lower than the rates achieved
from 2000-04. We expect that in the 2008-09
Market Structure. The excess capacity in both timeframe, non-OPEC annual production growth could
production and refining during the 1980s and 1990s has approach the 0.8-1.0mmb/d range, a doubling of the
been eliminated. Getting this back has proved to be an yearly volumetric growth in 2005-07. Within OPEC,
enormous struggle. Some of the losses were Angola is streaming new output and in Saudi Arabia,
economic in nature- the low oil prices of the late 1990s capacity enhancing oil projects are well underway,
led to a period of low capital investment. Some of it significant NGL additions are expected, and natural gas
was political- as Peter Davies at BP has written, the developments could free up oil for export. Virtually all
"declines in Iraq and Venezuela were unforeseen and of the Angola and Saudi projects are light crude. The
almost certainly unforeseeable" while in our own years 2008-09 should show better production response
opinion the same could be said for the refinery than what has been delivered over the last few years.
accidents and weather interruptions that have plagued
the downstream sector. Refining. Although the potential for slippage and
accidents is still very high, downstream analysts at the
Financial/ Trade. Commodities (including energy) are IEA in Paris have compiled a data set of 2008-2010
increasingly being viewed as a standard asset class by refinery projects suggesting that capacity growth is
investors. The flow of funds into the sector has made it likely to exceed 1.5mmb/d each year over that period.
more prone to volatility. The decline in the US dollar With global demand likely to grow below that rate over
has likely encouraged demand while simultaneously the same time frame, the potential exists for growth in
reducing producers’ revenue. More restrictive trade spare refinery capacity.
practices have limited the ability of industry to respond
to these forces. Inventories. We believe that a large part of the
inventory drop over the second half of 2007 can be
Geopolitics. From the perspective of the OECD attributed to the shift in the futures curve into
nations, energy resources are increasingly concentrated backwardation. The financial incentive for the
in countries that have a mixed record of cooperation companies to reduce stocks is high. The shape of the
with traditional international energy companies. futures curve can change rapidly and dramatically, and a
Geopolitical flare-ups in countries like Nigeria have shift toward a flatter curve could result is a rebuilding of
reduced production. The threat of a military inventories and less apparent upward pressure on oil
confrontation (with the potential for enormous impacts prices.
in the energy markets) between Iran and the US rises
and falls with diplomatic setbacks and successes. The US Dollar. There is significant risk of US dollar
rate of production growth in Russia appears to have overshooting to the downside (bullish for oil) but this is
been slowed by that country's move to reassert central most likely in an environment of more tepid global
control over its resources. Iraq has not managed to growth. The emerging market currencies could be the
return to pre-war production levels nor has Venezuela more relevant forward-looking driver of the dollar as
returned to pre-strike levels. purchasing power transfers to them. Many EM
currencies, especially in Asia have further to rise against
How we might get back to USD75/bbl the dollar according to Deutsche Bank's FX strategists.
The case for weakening oil prices ultimately must rest This would imply continued upward pressures on oil
on a reversal or slowing in the drivers that took oil to prices but likely less than recently from the slide in the
USD100/bbl. dollar against the major currencies. The US dollar has
displayed a tendency to rise and fall for extended
Demand. Despite evidence that China and other Asian periods of time. On average these cycles last for seven
nations are less tied to economic conditions in the years, implying the current US dollar downtrend will
OECD countries, it seems hard to believe that Asia start to become long in the tooth during 2008.
could completely escape the impact of a slowdown in
US GDP. Our economic forecasting teams expect a However, it is worth noting that historically bear US
contraction in the US but not a severe recession, and dollar cycles have tended to persist for longer than bull
they see few signs of significant slowdown in runs with the 1985 downtrend enduring for 10 years.
China/Asia in the near term. US oil demand has gone The upswing and subsequent downswing in the US

dollar between 1995 and today bears a striking Figure 4: Oil demand and supply (mmb/d)
resemblance to the 1978-1995 US dollar cycle. If
2006 2007 2008E 2009E 2010E 2015E
history repeats itself then it implies the US dollar could
remain under pressure in 2008 and 2009, but could then DEMAND
United States 20.7 20.7 20.8 21.0 21.2 21.3
return to a period of strength (and lower oil prices) in OECD Europe 15.6 15.3 15.5 15.6 15.6 15.6
Other OECD 13.0 13.1 13.3 13.1 13.1 13.2
the 2011-13 time period.
Total OECD 49.3 49.2 49.6 49.6 49.9 50.1
USSR (former) 4.1 3.9 4.0 4.1 4.2 4.3
Funds Flow. We view the enormous move of funds China 7.2 7.5 8.0 8.4 8.8 9.2
Non-OECD Asia ex-China 8.9 9.1 9.4 9.8 10.1 10.3
into commodities in somewhat the same way as Other Non-OECD 11.1 12.0 12.4 12.4 12.7 13.0
demand growth in Asia. The secular element to this is TOTAL DEMAND 84.7 85.7 87.3 88.4 89.8 91.2
large. "Commodities as an asset class" is bringing SUPPLY
investment-grade money into the complex, but the United States 7.4 7.4 7.6 7.6 7.6 7.5
OECD Europe 5.2 4.9 4.6 4.4 4.3 4.1
speculative element exists as well. Low interest rates Other OECD 7.4 7.5 7.4 7.6 7.7 7.8
and a low dollar have encouraged speculative activity in Total OECD 20.0 19.8 19.6 19.7 19.6 19.4
USSR (former) 12.2 12.7 13.2 13.8 14.3 14.6
oil, but a turn upward in the dollar could easily reverse Other Non-OECD 15.3 15.3 15.9 15.9 15.9 15.7
the flow of hedge fund investments in oil. Processing & Biofuels 2.2 2.5 2.8 2.8 2.9 3.0
Total Non-OPEC 49.7 50.3 51.4 52.2 52.6 52.6
Geopolitics. Rebuilding the 500kb/d of production lost OPEC CRUDE OIL 28.2 30.4 30.7 31.2 32.0 33.1
OPEC NGLs 4.7 4.8 5.3 5.5 5.7 6.0
in Nigeria is proving massively difficult, but output TOTAL SUPPLY 82.5 85.6 87.5 88.9 90.3 91.7
losses do not seem to be getting worse. The attempt Implied Stk Chng -2.1 -0.1 0.2 0.5 0.5 0.5
of the new government to restore stability in the Niger Source: IEA, DB Global Markets Research
Delta has had some positive impact (fewer instances of
violence, minor improvements in oil output). The Global oil demand
potential for this to change substantially for the better Our demand forecasts are based on the assumption
by 2009 is good, in our view. The situation in Iraq has that global GDP does not stumble badly. According to
also improved marginally over the last several months. the IMF, real growth in global GDP over the period
Oil production had jumped from 2.0mmb/b in August to 1980-2006 grew at 3.5% per annum. From 1995-2006
over 2.3mmb/d in November. the rate was 4.0% per annum. The IMF is estimating
even stronger worldwide GDP growth at 4.9% pa in
The Iranian nuclear standoff, which is likely to remain 2007-08. Global oil demand from 1980-2006 grew at
unresolved (and thus supportive for oil prices) in 2008, 1.0% p.a. From 1995-2006 it accelerated to 1.8% p.a.
could enter a period of intense new negotiations after Our estimates for average growth in 2007-08 for oil
the new US president takes office in January 2009. average circa 1.6%. Assuming that global GDP
There are many who believe that a fresh diplomatic averages about 4% p.a. over the period to 2015, we
push from the US might encourage the emergence of a would expect oil demand to grow approximately 1.7%
"grand bargain" that would satisfy everybody, including each year.
Israel. The most likely timeframe for such a
development would be 2009. Global oil supply
Relatively strong non-OPEC liquids (crude oil,
condensate, NGLs, and biofuels) will characterize the
period out to 2010. Over this 3-year period, we
estimate about 2.0mmb/d of growth. Above-ground
risk are greater threats to this performance than the
problems posed by resource limits or other below-
ground issues. The years after 2010 are murkier. Our
country and regional non-OPEC supply forecast suggest
that output could peak sometime between 2010 and
2015 unless “not in my backyard” restrictions in many
countries are relaxed.
How high could oil prices go?

Figure 5 examines the purchasing power of an average
G7 consumer in terms of the oil price. Since the
beginning of this decade the price of oil relative to per
capita incomes has risen dramatically and so oil
purchasing power has declined. The average number of
barrels an average G7 consumer was able to buy over
the entire time span shown is circa 1000 barrels of oil
and in 2007 stood at 566 barrels. However, for

purchasing power into deteriorate to the 1980-81 low of Figure 6: US natural gas balances (bcf/d)
325 barrels, we would need to see oil at circa
2005 2006 2007 2008E 2009E 2010E 2015E
USD130/bbl in 2008 or USD150/bbl in 2012.
CONSUMPTION
Residential 13.2 11.9 13.3 13.5 13.7 13.9 14.8
Figure 5: Oil cost relative to G7 income Commercial 8.4 7.9 8.4 8.5 8.6 8.7 9.3
Industrial 18.1 18.1 18.3 18.4 18.5 18.5 19.0
G7 per capita income divided by the price of oil Electric Utilities 16.1 17.1 17.8 18.2 18.6 18.9 20.9
3000 Other 4.5 4.8 4.8 4.7 4.7 4.6 4.3
Oil price decline helps to
boost the purchasing Total Demand 60.2 59.8 62.7 63.3 64.0 64.7 68.3
2500
Number of barrels of oil
power of a G7 consumer DOMESTIC SUPPLY

2000 Alaska 1.2 1.2 1.2 1.1 1.0 1.0 6.8
Gulf of Mexico Offshore 8.3 7.5 7.8 7.7 7.5 7.4 6.7
1500
Other US 40.1 42.1 42.3 43.0 42.9 42.4 40.3
1000 Total Dry Gas Production 49.7 50.7 51.3 51.6 51.3 50.8 53.9
Higher oil prices cut
the purchasing power Net Storage Withdraw 0.1 -1.2 0.7 0.0 0.0 0.0 0.0
500
of a G7 consumer Other & Balance 0.5 1.1 0.6 0.0 0.0 0.0 0.0
0 Total Domestic Supply 50.4 50.6 52.7 51.8 51.3 50.8 53.9
1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 Exports 2.0 1.8 1.8 1.8 1.8 1.8 1.7
IMPORTS 11.9 11.0 11.8 13.3 14.4 15.7 16.1

Source: DB Global Markets Research, IMF
Canada 10.1 9.3 8.9 8.8 8.7 8.8 7.8
LNG 1.7 1.7 2.4 4.5 5.8 6.8 8.3
In an environment of a weak US dollar, elevated Source: DOE/EIA, DB Global Markets Research
geopolitical risk, strong world growth and persisting
concerns that non-OPEC oil production may be peaking
we expect oil prices will continue to trade expensively Conclusions
when measured in real terms and relative to per capita There is no obvious “tipping point” price that quickly
incomes. Consumers and producers should, in our forces demand lower and supply higher. The demand
view, not be surprised to see a period of oil price shock of 1980-81 was caused at least as much by fear
strength extending into the middle of next decade. of war, and the possibility that supplies would not be
However, if one assumes G7 purchasing power will available at any cost, as it was by “high” oil prices. The
eventually move higher, then it is unlikely that oil prices potential to substitute coal, gas and nuclear power for
will be sustained over USD100/bbl. expensive oil is now seriously limited by environmental
regulations, resource problems, and voter opposition.
US natural gas supply and demand outlook The massive scale of the global oil and gas system and
The main challenge in the US natural gas markets over the long lead-times needed to make changes suggest
the next few years will be dealing with the prospects that rapid “reversion to mean” scenarios are now
for demand growth in the face of declining domestic US artefacts of history.
production. The use of natural gas in the electric power
markets and the growth in natural gas as the preferred It is possible to imagine a period of slower global
fuel in housing markets is likely to boost overall gas economic growth (driven by an increasing drift towards
consumption despite weakness in the industrial and
protectionism, perhaps) - or technological innovations
“other” categories.
on supply or demand) that could result in a
Even with strong upstream investment, rising costs and USD60/barrel world. We can also envision a
accelerating decline rates (especially in newer projects) USD100/bbl world characterized by rapid economic
will likely constrain gas output growth in the coming progress in China and India combined with the failure of
years. Canadian natural gas production is suffering the OPEC’s and other countries’ state-directed oil
same problems and new frontier supplies are years companies to invest in capacity. We have set our mid-
away. Consequently, LNG will have to serve as a cycle (2012-13) oil price forecast at USD80/bbl
balancing item. This could be a problem in as much as (nominal).
investment decisions on upstream LNG projects around
the globe are being slowed as producers struggle with
the same material and labour shortages that are being Adam Sieminski (202) 662-1624
experienced in virtually every area of engineering adam.sieminski@db.com
construction. Eventually, we see US natural gas prices
re-connecting with oil prices as these global LNG and
labour issues outweigh domestic considerations.

Since 2004 we have advised commodity consumers,

#8 Markets vs. Analysts producers and investors alike that a more reliable
forecast for crude oil in the coming year is to take the
Mud Wrestling: Bout 10 Reuters consensus price forecast at the start of the
year and add 31%.
• The contest between markets and analysts as
to who is the superior crude oil price We find that applying this rule today yields an average
forecaster during this commodity price rally is Brent crude oil price of USD95.5/barrel (USD72.9 x
now in its tenth year. 1.31). However, the most recent consensus price
forecast is from Reuters December poll. To be
• We find that since 1999, the futures market consistent with earlier years we need to apply the 30%
has been a better predictor than analysts on rule to January survey which will be published after we
seven out of the past nine occasions. go to press. If we assume the consensus oil price has
risen to USD75/bbl, in line with higher spot prices since
• Since 1999, the analyst community has Christmas then it assumes oil prices are likely to
consistently under-estimated the crude oil average just over USD98/bbl.
price. Their forecasting error over this period
has been +31%. The futures markets’ Tracking the futures market’s forecasting error
forecasting error is lower at +18%. Another route to assess the likely oil price for the
coming year is to examine the Calendar Brent swap
• If the average analyst forecasting error
price at the start of the year and compare it with the
between 1999 and 2007 persists into this
final outturn. We fid that like analysts the futures
year, then it implies Brent crude oil prices
market has also consistently under-estimated the
averaging USD96/barrel.
strength in crude oil prices. However, the forecasting
• If the average forecasting error of the futures error is lower at 18%.
market between 1999 and 2007 persists into
2008, then it implies the Brent crude oil price
averaging USD110/barrel. Figure 2: The futures market has tended to be a
more reliable predictor of oil prices in the year
In January 2004 we published the report “Tracking The
Forecasting Error Of Commodity Analysts”. The report ahead
examined the consensus price forecast for crude oil at
120 Calendar Brent swap price at 18%
the start of the year with the eventual outturn. We 110
the start of the year
found that the analyst community had consistently 100 Outturn

under-estimated the oil price by an average of 30% 90 Average absolute forecasting
error 1999-2007 = 18%
between 1999 and 2003. 80 24%
USD/barrel
70 0%
In the subsequent four year period the forecasting error 60 18%
has not improved. For the entire 1999 to 2007 period 50
22%
the analyst community has always under-estimated the 40
-11%
22% 22% 0%
final oil price and by an average of 31%, Figure 1. 30
39%
20
10
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008f
Figure 1: Analysts have systematically under-
Source: DB Global Markets Research, Reuters
estimated the strength in crude oil prices since
1999
Consequently if we apply this forecasting error to the
100
31%
Brent forecast at the start of the year current Cal’08 Brent swap price yields an expected
90
Outturn average oil price for 2008 of USD110/barrel. Even at
80 Average forecasting error 1999-2007 = 31%
18%
these levels, the oil price would still be cheaper relative
70 15% to per capita income than it was at the beginning of the
1980s.
USD/barrel
60 43%
50
40 53% Michael Lewis, (44) 20 7545 2166

30
54% 25% michael.lewis@db.com
2% 29%
20 43%
10
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008f
Source: DB Global Markets Research, Reuters

#9 US Power Wind is another 31% of the mix (40 GW), but for peak
availability purposes, only 10-15% (4-6 GW) of that can
A Moratorium on Coal? be reliably counted. Capacity factors are determined by
dividing actual energy produced in a given period by the
• With electricity demand growing at 1.7%
maximum possible output running full time at rated
annually, we believe approximately 75GW of
power. Typical annual average power capacity factors
capacity must be added to the system
are 20-40% for wind, but over shorter periods of time,
between 2008 and 2013.
installed wind power is often discounted much further,
• Nearly 60% of the 130 GW of capacity although this may be improving as geographic diversity
additions planned for the US over the next five and grid inter-connections are improving.
years are coal and wind projects.
• Permits for coal power plant projects are being
denied by state public utility and Figure 1: US electric power capacity growth
environmental commissions that find 2008-2013 (GW)
themselves under serious pressure to respond
Other
to climate change warnings. Renew able,
14.6, 11% Coal, 35.7, 28%
• Wind power is typically de-rated by 85%to
90% for purposes of calculation peak load
needs. Speeding up “other renewable fuel”
projects and nuclear is not practical.
Wind, 40.4, 31%
• More intensive use of existing natural gas fired
generation and more gas new-build may be
required to avoid electricity shortfalls. Natural Gas,
Nuclear, 1.2, 1% 36.9, 29%
• In our view, natural gas futures prices for the
period after 2010 do not reflect this problem. Source: Wood Mackenzie, DB Global Markets Research
US electricity consumption grew by annual rates of If there is any slippage in delivery on the renewable
4.2%, 2.6%, and 2.3% in the 1970s, 1980s, and 1990s, projects (another 15 GW), the reliability problem gets
respectively according to data from the US DOE/EIA. worse. Conservation (or less demand) would help, but
The EIA is assuming a long-term growth rate of about probably not soon enough to have a significant impact.
1.3% per year in the new Annual Energy Outlook 2008 A total of 12 GW of new-build nuclear capacity has been
which leads to lower projections of electricity proposed for 2015–2016, but this comes too late to
generation. Because of relatively strong near-term GDP meet demand requirements to 2013-14.
assumptions, however, the EIA is assuming a “normal”
growth rate of 1.8% for electricity use in 2009. Recent
forecasts by Wood Mackenzie put US electricity sales There are a number of regions in the US that soon will
growth at 2.0% annually to 2010 and 1.7% per year fall short of the generation capacity levels required to
thereafter. On a base of circa 975 GW of installed net maintain a 15% reserve margin for electricity. Florida,
summer capacity, this implies a need for 15-20 GW per New York, and significant portions of the Mid-Atlantic,
year of growth. Southeast, and Midwest regions could fall below their
target capacity margins within two or three years if
additional supply-side and demand-side resources are
There are approximately 130 GW of electric power not brought into service.
currently under development or proposed in the US
out to the year 2013 according to estimates by
WoodMac (see Figure 1). Coal plants are 28% of the Besides turning out the lights, the only answer, in our
mix (36 GW), but acceptance of the climate change view, is more gas-fired combined cycle gas turbine
message in the US appears to have placed an effective (CCGT) cogeneration projects. This will be the only way
moratorium on new coal projects. It is almost to add the capacity that can be put in service between
impossible to get a public utility commission to grant a now and 2013.
permit for a new coal plant that is not carbon capture
and sequestration (CCS) "capable". Since mid-2007,
plans for new coal plants in Kansas, Wyoming,
Oklahoma, North Dakota, Texas and Florida have been Adam Sieminski (1) 212 250 2928
rejected by state utility and environment commissions adam.sieminski@db.com
or cancelled due to regulatory uncertainties.

#10 Commodity Term Structures Oil: Backwardation Returns

Winners & Losers o And here to stay?
• Oil: Backwardation Returns

Trade recommendation:
o And here to stay?
• Long Jun-08 vs. short Dec’08 WTI
• US Natural Gas: Sticky contango
• Long Dec’09 vs. short Dec’10 WTI
o The world has turned upside down,
again
o Will backwardation ever return? The WTI curve had a roller coaster ride in 2007, from
• Wheat: How deep is your love? steep contango earlier in the year to sudden
backwardation by the middle of 2007, Figure 1.
o Moderating level of backwardation,
Poised to flip back to contango?
• Corn: Good News or Bad News? Figure 1: WTI forward curve flipped from steep
o Will backwardation finally arrive?
contango to steep backwardation in just one
month
• Industrial Metals: Curves flatten, but, what’s
next? Will the US Fed come to the rescue?
o Aluminium: Steep backwardation to
19 Ju ly 2007
replace the current steep contango?
o Copper: Will contango steepen?
o Nickel & Zinc: From flat to flatter?
Trade recommendations:
Crude oil
• Long Jun-08 vs. short Dec’08 WTI 20 June 2007

US natural gas:
• Short Jan’08 and long Feb’08 future
contract, and keep rolling the positions
every month
• Long DBLCI-OY-NG vs. short S&P GSCI- The strength in oil prices over last summer was in stark
NG sub-indices contrast to the environment of record high oil prices in
2006. At that time, USD78 oil was occurring with
• Short Feb’09 and long Apr’09 contract OECD inventories rising and the WRI forward curve in
Wheat contango forward curve, which we dubbed the
inconsistent trinity. The rally in oil prices in the second
• Short Mar’08 vs. Long Dec’08 or half of last year was therefore more fundamentally
• Short Mar’08 vs. Long Jul’08 based it was occurring at a time when OECD
inventories were declining and the market was in
Corn
backwardation.
• Long Mar’08 corn
• Long Dec’08 corn vs. sell Dec’09 corn
Consequently we adopted a curve steepening trade
Industrial metals based on our belief that the move from USD75/bbl to
• Maintain long back-end USD60/bbl between August and September 2006
would not be repeated in 2007, Figure 2. In fact, not
• Front end remain defensive, but, look to only did WTI crude oil not sell-off like it did in 2006, but
go long into Q1 the strong rally and subsequent attack of the USD100
level has kept this curve trade in profit.

Figure 2: Why USD75 oil in 2006 was different absolute inventory level at Cushing remains low and the
from USD75 oil in 2007? This chart shows why: aggregate US crude oil inventory level keeps on falling.
the oil market supply-demand balance was tight
in 2007, but, it was not in 2006
Figure 4: WTI term structure vs. Cushing crude
oil inventory level
Cushing Crude Stocks (million bbls, lhs) -4.0
30 M2-M4 Nymex WTI spread ($/bbl, inverted scale, rhs)

-3.0
17 July 2006
-2.0
25
-1.0
20 contango
0.0
1.0
15
18 July 2007 2.0
10 3.0
Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08

Figure 5: Total US crude oil inventory has been

Historically, the WTI curve always trades in
backwardation in a bull run and in contango in a bear run. falling
2005 and 2006 were the exceptions as OPEC 380 US Crude Oil Stocks (million bbl)
5-Year Range (2001-2005)
engineered steep contango by flooding markets with 365 5-Year Average (2001-2005)
crude oil to safeguard long term oil demand growth and 2006(monthly data)
2007(monthly data)
350
fight off geopolitical fears. 2007(weekly data)
335
320
Figure 3: Historical WTI prices vs. forward curve
305
Historic WTI Price versus Forward Curve (USD/bbl)
100 290
90
275
80
260
70 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
60 Source: DB Global Markets Research

50
40
For the oil bulls, we believe a curve play offers better
30
risk adjusted returns than an outright long. For new
20 longs, we would recommend travelling down the curve
10 and going long the spread at the deferred part of the
Aug-84
Aug-85
Aug-86
Aug-87
Aug-88
Aug-89
Aug-90
Aug-91
Aug-92
Aug-93
Aug-94
Aug-95
Aug-96
Aug-97
Aug-98
Aug-99
Aug-00
Aug-01
Aug-02
Aug-03
Aug-04
Aug-05
Aug-06
Aug-07
Aug-08
Aug-09
curve, such as Dec’09 vs. Dec’10.

Looking into 2008, we expect backwardation to

remain in the crude oil market given still tight
market fundamentals. With OPEC’s decision to leave
production unchanged at the end of last year, more
complex refineries coming back online and demand
remaining extremely robust despite high prices, we
believe the WTI curve is likely to steepen again. Indeed,
although Cushing inventory has increased over the past
few weeks, the sudden flattening of the forward curve
seems not to be warranted especially since the

Figure 6: WTI term structure US Natural Gas: Sticky Contango

97.0
WTI forward curve (8 Jan 2006) o The world has turned upside down, again
96.0
95.0 o Will backwardation ever return?

Jun-08
94.0
93.0 Trade recommendations:

Dec-08
•
92.0
Short Jan’08 and long Feb’08 future
91.0
contract, and keep rolling the position
90.0
every month
Dec-09
89.0
88.0
Dec-10
• Long DBLCI-OY-NG vs. short S&P GSCI-
NG sub-indices
87.0
•
Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11
Short Feb’09 and long Apr’09 contract
The US natural gas forward curve is characterised with

Trade recommendations: a strong seasonal pattern with the forward winter price
trading substantially higher than the forward summer
• Long Jun-08 vs. short Dec’08 WTI price.
However, the seasonality predicted by the forward

curve seldom turns into reality. Indeed, over the past
12 years, natural gas has spent more time trading in
contango than in backwardation and this trend is only
getting worse.
Figure 7: Since 1995, US natural gas has spent

most of the time trading in contago
4.0 NatGas contango (M01-M02)
backwardation
NatGas backwardation (M01-M02)
3.0
2.0
1.0
0.0
-1.0
-2.0
contango
-3.0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Since January 1995, US natural gas has spent 82% of

the time trading in contango (M01-M02). However,
from Winter 2002 onwards, the US natural gas M01-
M02 spread has traded in contango 90% of the time,
and from Winter 2004 onwards, the percentage has
risen to 98%. Indeed, the strong seasonality that was
once a common feature of the US natural gas market is
evaporating, a result of both weaker winter heating
demand and stronger summer cooling demand, in our
view.

Figure 8: Dwindling seasonality in the US natural The first strategy is to go short the Jan’08 and long
gas market Feb’08 NG futures contract, and keep rolling these
positions every month. However, we prefer to
implement this strategy via indices to save us from the
strong winter premium trouble of rolling the futures every month.
2005 over summer
winter premium across the whole
term structure has declined since
The second strategy is to go long the DBLCI-OY-NG
2004, and long-dated gas is now sub-indices and go short the S&P-GSCI-NG sub-
trading in contango to the front-end
indices. We believe the OY technology will outperform
a pre-defined fixed rolling strategy implemented by the
S&P GSCI which rolls the front-line contract every
almost zero
winter premium
month. In a contango environment this becomes a
losing strategy as it leads to a substantial negative roll
2006
return.
2007
Figure 10: Term structure play via commodity

Source: DB Global Markets Research sub-indices
200%
Currently the forward curve is pricing in an almost zero 150%
winter premium for 2008 and a drastically lower winter

premium from 2009 onwards. 100%
Cumulative returns
50%
Over the winter 07/08 period we expect record high 0%
levels of storage to persist. Given normal weather we

would expect to end the current heating season on -50%
March 1, 2008 with 1600bcf of gas in storage. If it stays Long SPGSCI NG index
-100%
warm this winter, we would expect to see even more Long DBLCI-OY-NG index
gas in storage. -150%

Long DBLCI-OY-NG vs. short SPGSCI NG index
Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08
Figure 9: US natural gas inventory level
billion cubic feet The third strategy is to go short the Feb’09 and long
3500
the Apr’09 NG contract, this expresses our view that
3100 the winter premium will narrow further, similar to what
2700 has happened over the past few winters.
2300
1900
1500 • Short Jan’08 and long Feb’08 future

contract, and keep rolling the positions
1100
every month
700
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec • Long DBLCI-OY-NG vs. short S&P GSCI-
5-Yr Normal 2006 2007 2008 Actual 2008 Projected NG sub-indices
Source: DOE/EIA, DB Global Markets Research • Short Feb’09 and long Apr’09 contract
We are therefore recommending a few strategies to

express our view that contango is likely to stay in the
US nat gas market.

Wheat: How deep is your love?

Figure 11: Wheat December time spread closed
o Moderating level of backwardation; poised
with profit
to flip back to contango?
300
250
Wheat Mar'08-Dec'08 time
Trade recommendations: 200
spread (USD/Bu)
profit
Wheat Dec'07-Dec'08 time
•
spread (USD/Bu)
Short Mar’08 vs. Long Dec’08 or 150 Trade entry: 14-Sep-07
• Short Mar’08 vs. Long Jul’08 Current level: 08-Jan-08

100 (plus positive roll returns)
50
backwardation
In September this year we outlined why we believed
0
the high spread between this year and next year wheat
contango
was unsustainable, since it was wide enough to -50
encourage immediate substitution, discourage inventory Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07
re-stocking and therefore a good sell. Source: DB Global Markets Research
Figure 12: Wheat term structure has flattened

Since then the spread has narrowed substantially from
USc247 when we instigated the trade to a mere USc83 over the past four months. We expect it to
as of Dec 7, 2007. flatten further
950
Wheat forward curve
900
During the last few weeks of 2008 the spread has 850 Jan 2008
widened on supporting weather and tender 800
announcements, some of which however were 750
subsequently withdrawn. We continue to believe 700 Dec 2007

wheat might be pressured in the near term on 650
weakening fundamentals: for example, India's wheat
600
trade deficit is shrinking, China is now a small net
550
exporter of wheat and the possibility that after tow Sep 2007
500
years of drought sufficient water levels will arrive in Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09
Australia. We are therefore maintaining our curve

flattening view in wheat. Source: DB Global Markets Research

Corn: Good News or Bad News? Indeed the total area harvested in the US for corn,
soybeans and wheat has stayed relatively stable since
o Will backwardation finally arrive? 1990, Figure 15. Consequently any increases in one
crop tend to occur at the expense of another.
Trade recommendations: Figure 15: Area harvested for US major crops

• Long Mar’08 corn
100
Hectares (million)
• Long Dec’08 corn vs. sell Dec’09 corn 90
Corn Soybean Wheat
80
70
As discussed in the agricultural article, one of our 60
favourite crops for 2008 is corn. Indeed corn has 50
staged an impressive rally during the last few months of 40
2007 and has finally managed to post positive returns 30
on the year. 20
10
0
1980 1985 1990 1995 2000 2005
Figure 13: Mar’08 corn prices
Source: USDA, DB Global Markets Research
500
The game of musical chairs between US corn, wheat
Corn Mar'08 (USD/Bu) and soybean production has intensified over the past
450 Trade entry: 05-Oct-07 few years due to the substantial divergence in price
Current level: 08-Jan-08
trends in these markets. For example, in 2006 soybean
400
acreage gained at the expense of wheat and corn
acreage. However in 2007, the strong rally in corn
prices during the previous year (81%) opposed to the
350
disappointing gains in soybean prices (+14%) led to US
farmers to shift plantings our of soybeans and into corn.
300
Figure 16: US crop plantings: a game of musical
chairs: A crop’s gain is another’s loss, as
250
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 indicated by the changes in area harvested each
Source: DB Global Markets Research year
10
Year-on-year changes in area harvested
Hectares (million)
In our view, the weakness in corn prices during the 8
Corn Soybean Wheat
second quarter of 2007 was mainly driven by a surge in 6
US corn production, Figure 14 which had been triggered larger area
4
by US farmers switching out of certain crop production harvested
such as soybeans and into corn. 2
0
Figure 14: US corn production by year
-2
smaller area
US corn production -4 harvested
13.4
13.0 2007-08 -6
2004 2005 2006 2007
12.6
2004-05 Source: USDA, DB Global Markets Research
12.2
Bushels (billions)
11.8
2005-06
11.4 Going into 2008, we believe the game of musical chairs
11.0
is likely to continue but this time corn acreage is cut and
plantings recover in soybeans and wheat. Therefore,
10.6 2006-07
together with the increasingly tight market in China
10.2
M J J A S O N D J F M M J J
which we believe is set to become a net importer in
Month US corn production estimate by the USDA w as made corn over the next year, we are positioning for the corn
Source: USDA, DB Global Markets Research price to rally further and the corn curve to flip into
backwardation.

Industrial Metals: Curve has flattened,

but, will the Fed come to the rescue? Figure 17: Aluminium forward curves in 2007
o Aluminium: Steep backwardation to 3,000

Aluminium forward curves (2007)
2-Jan-2007
replace the current steep contango? 2,900
o Copper: Will contango steepen? 2,800
o Nickel & Zinc: Flat, flatter, flattest? 2,700
2,600
2,500
2,400
• Maintain long back-end 2,300

28-Dec-2007
• Front end remain defensive, but, look to 2,200

go long into Q1 on stronger signs of the 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27
forward month
US economy
Figure 18: Aluminum forward curve in H107,

Metal curves have flattened, but, what’s next? steep backwardation
3,000
Over the past two years we have been convinced that Aluminium forward curves (Jan'07-Jun'07)
industrial metal curves would flatten. We have traded 2,900
around this theme mainly by either going long the back- 2,800
end of the curve or via curve plays. Indeed, industrial 11-May-2007
2,700
metal curves have flattened substantially in both
periods of rising and falling markets. Now that the 2,600
16-Jan-2007
curve has flattened, in this section we are outlining our 2,500
expectation for metal curves during 2008.
2,400
2,300
2007 review 2,200

To celebrate the start of 2008 we have designed a new 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27
forward month
set of charts to track the journey of the term structure
of industrial metals during the course of 2007. From
Figure 17 to Figure 24, each chart plots the forward
curve of each metal at a 5 business day intervals, with Figure 19: Aluminium forward curves Sep-Dec
each line representing the metal term structure on a
2007, steep contango
particular day.
3,000
Aluminium forward curves (Sep'07-Dec'07)
2,900
Aluminum 6-Nov-2007
2,800
The most dramatic curve moves have taken place in the
aluminium market as shown in Figure 17. Aluminum 2,700
started 2007 trading in a steep backwardation, 2,600

represented by the orange line in Figure 17, and
2,500
finished the year in a steep contango, the blue line. 11-Sep-2007
2,400
Whether a long position in aluminium in 2007
28-Dec-2007
makes money or not is largely dependent on which 2,300
part of the curve the long position has been

2,200
adopted. Front-end would have meant losses and 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27
forward month
back-end profit.
We have examined the aluminium curves in greater
detail over the H107 period, Figure 18, and for the last
four months of 2007, Figure 19. Aluminium spent the
first half of 2007 trading in backwardation and the last
four months in contango.

Copper Nickel
Copper was also no exception to this curve flattening The same trend has occurred, but, at a different time.
trend, albeit at a slower pace. Copper spent the first 10 Nickel prices surged during the first part of 2007
months of 2007 trading in backwardation, Figure 20. peaking at USD51,600/tonne. It is was therefore no
Subsequent to the October sell-off the copper curve surprise that the nickel curve steepened during this rally,
had flattened substantially and currently front-end Figure 22.
copper is trading in a very small contango.
Just as nickel rallied hard, it fell even harder to lose lost

Figure 20: Copper forward curves, Jan-Oct 2007 more than half of its peak value and at one point
touching the low of USD25,100/tonne. The nickel curve
8,500 has consequently flattened together with the sell-off
Copper forward curves (Jan'07-Oct'07)
and is currently trading in a small contango at the front-
8,000
end.
7,500 2-Oct-2007
7,000
Figure 22: Nickel forward curves Jan-May 2007,
6,500 backwardation was the norm
60,000
6,000 Nickel forward curves (Jan'07-May'07)
55,000 11-May-2007
5,500
50,000
5,000
6-Feb-2007
45,000
4,500
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27
forward month 40,000

35,000
30,000
Figure 21: Copper forward curves, Oct-Dec 2007,
9-Jan-2007
copper finally joined the curve flattening camp 25,000
during the last three months of 2007 20,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27
8,500
forward month
2-Oct-2007 Copper forward curves (Oct'07-Dec'07)
8,000
7,500
Figure 23: Nickel forward curve Jun-Dec 2007,
curve has flattened since the sell-off in June and
7,000
has never turned back
55,000
Nickel forward curves (Jun'07-Dec'07)
6,500 June 2007
50,000
18-Dec-2007
45,000
6,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27
forward month 40,000
35,000
30,000
25,000
Jul - Dec 2007 the nickel forwad curve has stayed flat 28-Dec-2007
for the second half of 2007
20,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27
forward month

Zinc Figure 25: Inventories on the LME

Zinc was not only the worst performing industrial
Copper peak 3-May-02
metals in 2007 in terms of spot price performance, but, 140 Inventory peak=100
Supassed the last peak
on 31-Oct 2007 Lead peak 7-Aug-02
it was also the worst performing commodity across the 120 Tin peak 9-Aug-02
five broad commodity sectors last year. Just as the Nickel peak 2-Feb-06
100
over-riding trend in zinc prices last year was down, so Aluminium peak 23-Jan-04
80
the same story applies to zinc forward curve: flat. Zinc peak 13-Apr-04
Indeed, zinc is the only metal under investigation were 60
trends were one-way, namely curve flattening. 40
20
Figure 24: Zinc forward curves in 2007 0

0 100 200 300 400 500 600 700 800 900 1000 1100 1199 1299 1399
Number of days after LME inventories peaked

4,500
Zinc forward curves (2007)
2-Jan-2007 Source: DB Global Markets Research
4,000
3,500 Trade recommendations:

• Maintain long back-end
3,000
• Front end remain defensive, but, look to

2,500
go long on stronger signs of the US
economy and an end to Fed easing
18-Dec-2007
2,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27
forward month
Amanda Lee, (852) 2203 8376

Curve outlook amanda-ps.lee@db.com
In the near term we expect curve flattening remains the
central theme in the industrial metals market. We
maintain our belief that back-end metal prices will
outperform and the front-end will continue to suffer
given its strong sensitivity towards the Fed funds cycle
and the US equity market.
However, as outlined in the Global Macro article, we

believe the market is over pessimistic regarding the US
economy and it is underplaying the strength in Chinese
metals demand. Consequently we are positioning to go
long front-end metals on signs of stronger US economic
growth.
A final look at the inventory level of the metals suggest

to us that zinc has the strongest potential to deliver
surprises in both price appreciation and curve moves
given inventory levels on the LME close to their 5-year
low and the proximity of current prices to production
cost and which may temporarily over-power the threat
of looming capacity expansion in China. In terms of
nickel, we believe this market has the least potential to
surprise to the upside given inventory is currently sitting
at a 7-year high, Figure 25.

#11 Commodity Volatility While the longer dated implied vol remains higher than
the realised vol, this gap has been closing, Figure 2.
A Mixed View
Figure 2: WTI 12M implied vs. realised vol
Crude oil
• Long Mar’09 variance swap
US natural gas:
• Long Mar’09 variance swap
• Long Sep’09 variance swap
Gold
• Take profit on long gold variance swap
• Scale up sell
Industrial metals
• Aluminium vol offers good value vs.
copper and nickel vol Source: DB Global Markets Research
With longer dated implied vol trading at lower 20% we

Crude oil: long back-end vol via variance swap believe it offers good value such as via a variance swap
trade. Figure 3 summarises the realized volatility of fix
The WIT crude oil implied vol curve seems to have dated contracts. Starting from the Dec’03 contract
taken its lead from the flat price term structure, in our each contract in Figure 3 has realized vol finishing
view. Curve flattening is not unique to the crude oil flat somewhere between 23% and 29%. Currently Mar’09
price. The vol curve was trading in contango two years implied vol is trading at roughly at 23% and
ago and is now currently in backwardation, Figure 1. consequently we believe it offers good value to go long
The assault of triple digit oil has pulled up front-end the variance swap. Given the tight oil market supply-
crude oil implied vol which is trading close to the 6-year demand fundamentals we believe volatility will remain a
average. However, back-end vol has barely participated constant feature of the crude oil market in 2008.
in this rally and is currently trading close to the lower
quartile. Figure 3: WTI dated contracts realised vol
WTI 260 day realised volatility
30.0
Figure 1: Crude oil volatility level 27.5
25.0
65% 65%
Oil implied vol cone: current curve vs. past 6-year distribution
22.5
60% 60%
The blue boxplot for each month shows:
i) the interquartile range (blue box) 20.0
55% ii) the 5-95 percentile range (whisker) 55%
iii) the median of the 6-year history (dashed line) 17.5
50% 50%
Median
15.0
45%
09-Jan-06 45%
09-Jan-07 12.5
40% 09-Jan-08 40%

10.0
35% 35%
7.5
Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07
30% 30%
Dec-03 Dec-04 Sep-05 Dec-05 Jan-06 Mar-06 Jun-06
Sep-06 Dec-06 Jan-07 Mar-07 Jun-07 Sep-07 Oct-07
25% 25%
Nov-07 Dec-07 Jan-08 Dec-08 Jun-09 Dec-09
20% 20% Source: DB Global Markets Research

15% 15%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Forward month

US natural gas: Like WTI, go long back-end vol via The realised vol of a range of fixed dated nat gas
variance swap. contract is summarised in Figure 6. There is a
After the spike to USD15/mmBtu in December 2005 substantial upward journey of each contract as it
natural gas has spent the last two years trading in a approaches its expiry date. All contracts except one has
very tight range, Figure 4. Other than the occasional realised vol finished above 30%.
swings natural gas prices have been kept prisoner in
the USD6-8/mmBtu range for two years despite the Figure 6: US NG dated contracts realised vol
historical tendency for natural gas to be the most
Natural gas 260 day realised volatility
volatile commodity and the market characterised with 50.0
extreme overshooting both to the upside and downside. 45.0
40.0
Figure 4: US natural gas price
35.0
16 30.0
Natural Gas price
14 25.0
12 20.0
15.0
10
USD/mmBtu
10.0
8 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07
Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07

Oct-07 Nov-07 Dec-07 Mar-08 Jun-08 Dec-08 Mar-09 Sep-09
6
4
2
Although the natural gas market has been lacklustre for
0 the past two years we believe spike risk has not been
1990 1993 1996 1999 2002 2005 totally eliminated. In fact, as discussed in the next
Source: DB Global Markets Research article , the nat gas vol skew currently shows a
substantial bias to upside price risk. We expect
Range bound trading naturally leads to a decline of the weather will remain a key driver and with the dwindling
realized volatility and in tandem the implied vol. Figure seasonality we believe going long variance swap offers
5 shows that the current vol term structure is good potential for vol pickups.
substantially lower than the year-ago one. However,
the nat gas vol term structure remains steeply Among the contracts we believe the Mar’09 and Sep’09
backwardated despite front-end trading substantially variance swap offers best value. Realized vol of the
lower. September contract is the highest with Sep’06 finishing
at 49% and Sep’07 at 38%, while Mar’06 at 42% and
Figure 5: US natural gas implied vol forward Mar’07 at 40%. Mar’09 contract includes next winter
which is a plus but implied vol is trading higher at 36%,
curve, current vs. year-ago
this compares to Sep’09 trading at 30% which might
also benefit from summer hurricanes activity.

Gold vol: take profit and scale up sell Base metals: Aluminium vol offers good value vs.
We bought gold vol in June 2007 close to the low and copper and nickel vol
therefore we were well positioned for the risk aversion Among the base metals complex, only aluminium
that swept through global financial markets over the implied vol is trading within the box which represents
summer and the contagion effects that ensued on the interquartile range of 6-year worth of data. Copper,
precious metals volatility. zinc, and nickel vol are all trading at or above the
interquartile range.
This trade has performed as contagion from equity and
FX markets spread into the commodities complex and Figure 9: Aluminium volatility level
specifically gold. During the period of extreme VIX and
USDJPY volatility, gold prices traded lower and implied 34%
Aluminium implied vol cone: current curve vs. past distribution
34%
vol rose subsequently.
31% 31%
28% 28%
Figure 7: 12M gold vol
25% 25%
30% Trade
Gold 12M implied vol 22% 22%
Opened
28%
19% 19%
26% 16% 16%
24% 13% 13%
10% 10%
22%
M01 M02 M03 M06 M09 M12 M24 M27
6-year median 07-Dec-07 09-Jan-08
20%

18%
16%
Figure 10: Copper volatility level
14%
Copper implied vol cone: current curve vs. past distribution

12% 50% 50%
Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07
45% 45%
40% 40%
Subsequently with the gold price breaking the 35% 35%
USD800/oz level gold vol has rallied further despite a

30% 30%
recovery in risk appetites. Indeed, the entire gold vol
term structure is trading well above historic levels, 25% 25%
Figure 8. Given the extreme positioning currently in the 20% 20%

gold market as well as potential seasonal strengthen in
15% 15%
the EURUSD during the first four weeks of the year, we
would recommend taking profit and prepare to scale up 10% 10%
M01 M02 M03 M06 M09 M12 M24 M27
selling.

Figure 8: Gold implied volatility level
30% 30%
Gold implied vol cone: current curve vs. past distribution
28% 28%
26% 26%
24% 24%
22% 22%
20% 20%
18% 18%
16% 16%
14% 14%
12% 12%
10% 10%
1M 2M 3M 6M 1Y 2Y 3Y 4Y

Figure 11: Zinc volatility level
55% 55% Trade recommendations:

Zinc implied vol cone: current curve vs. past distribution
50% 50%
Crude oil
45% 45% • Long Mar’09 variance swap
40% 40% US natural gas:
35% 35% • Long Mar’09 variance swap
30% 30%
• Long Sep’09 variance swap
25% 25%
Gold
20% 20%
• Take profit on long gold variance swap
15% 15%
• Scale up sell
10% 10%
M01 M02 M03 M06 M09 M12 M24 M27 Industrial metals
Source: DB Global Markets Research • Aluminium vol offers good value vs.
copper and nickel vol
Figure 12: Nickel volatility level

60% 60%
Nickel implied vol cone: current curve vs. past distribution
Amanda Lee, (852) 2203 8376
55% 55%
amanda-ps.lee@db.com
50% 50%
45% 45%
40% 40%
35% 35%
30% 30%
25% 25%
20% 20%
M01 M02 M03 M06 M09 M12 M24 M27

#12 Skew View & Spike Risk B. Spike Risk for Oil & Gas
What Are Option Markets Saying? • According to the options market skew, there
is a 10% chance that the Dec’09 WTI contract
A. Market Positioning Risks will expire below USD61/bbl or above
USD149/bbl, against the futures price of
• Net speculative positioning data provide a USD92/bbl.
good indication of market sentiment and
directional views among the speculative • Similarly, for US natural gas, our model
community, in our view. indicates that the Dec’09 NG contract has a
10% chance that it might expire below
• Alternatively, the market bias of a particular USD5.7/mmBtu or above USD18.9/mmBtu,
commodity can also be inferred from the futures reference at USD9.6/mmBtu.
options volatility skew.
• We believe combining the vol skew with the
speculative positioning data provide a more A. Market Positioning Risks
comprehensive indication of the overall Assessing market sentiment and positioning is very
market positioning and sentiment. crucial to any investment or hedging decision because
while it is nice to ride on the trend but risk also
• For example, currently speculators are net increases substantially for over-crowded trade. The
long EUR according to the IMM data while very first stop for market positioning is always the
the EURUSD options skew has shown the positioning data reported by the CFTC, Commodity
strongest favour towards EUR put options Futures Trading Commission.
(USD call options) since November 2000.
• IMM bulls plus options bears mean the
market is more balanced in our view and Alternatively, the market bias of a particular commodity
therefore not as one-sided as implied by the can also be inferred from the options volatility skew.
IMM data alone. That is, euro bulls are We believe combining the vol skew with the
buying puts to hedge their directional long speculative positioning data provide a more
position in our view. comprehensive indication of the overall market
positioning and sentiment.
• On the other hand, in the gold market, both
the CFTC net speculative positioning and
options skew are overtly bullish gold and so To take the currency market as an example, as shown
helping to propel the gold price to new highs in Figure 1, currently speculators are net long EUR and
and possibly above what is implied by the indeed the long position has been intact since early
current level of the US dollar. 2006.
• Extreme one-sided bullishness combined
with the tendency of the USD to strengthen
in the first four weeks of January suggests to Figure 1: Speculative EUR Positions
us that the gold price is most vulnerable to a
sell-off currently. If a correction were to 140 Net non-commercial positions on IMM, (lhs)
1.36
occur we believe this would simply deliver 120 EUR/USD, (rhs)
another opportunity to buy given our 1.28
100
medium term bullish view towards the
80 1.20
precious metals sector.
60
• In the crude oil market, speculators are mildly Net long 1.12
long while the options market has a strong 40

1.04
favour on calls. 20
0.96
• In the US natural gas market, the speculative 0
community is extremely bearish while the -20 0.88

options skew has shown a strong bullish
-40 0.80
bias, possibly indicating gas bears are 1999 2000 2001 2002 2003 2004 2005 2006 2007
hedging with gas calls.
Source: CFTC, DB Global Markets Research

However, this bullishness is not shared by the currency In fact, our DB Positioning Indices, which take account
options market. Figure 2 compares the latest vol skew of the IMM, CTA, real-money investor positions, option
of the EURUSD 12-month option with the one six risk reversals and weekly analyst survey data, is
months ago. In July 2007 the vol skew is relatively showing an overall short position in the euros.
balanced between calls and puts option reflecting the
then range bound market during the first half of 2007.
The current vol skew has shown a strong favour Figure 4: DB Positioning Indices (DB PI*)
towards put option.
Figure 2: EURUSD 12M skew favours puts
2.5
EURUSD 12M vol skew
07-Jan-08
2.0
30-Jul-07
deviation from ATMF (vols)
1.5
1.0
stronger put skew
0.5
Source: as of January 7, 2008, DB Global Markets Research
*The DB PI comprises of positioning and sentiment data from five key
0.0
segments of the FX markets. We use IMM, CTA and real-money investor
positions as indicators of positioning; option risk reversals and weekly
-0.5 analyst survey results as measures of sentiment. Each of the five inputs is
10P 25P ATMF 25C 10C ranked on a scale of -10 and +10, where +10 is the most bullish that
segment has been and -10 the most bearish. The DBFX PI is then simply
Source: DB Global Markets Research the average of these inputs.
Indeed, the EURUSD options skew is showing the Gold: CFTC vs. skew view
strongest favour towards EUR put options (USD call
options) since November 2000 as indicated by the 12- This balanced view however is not shared by the gold
month 25-delta risk reversal trading at the lowest level market despite the currency move is a big driver of the
in 7-years as shown in Figure 3. gold price in our view.
In fact, there has been a big divergence between

Figure 3: EURUSD 12M 25 Risk Reversal is
EURUSD risk reversal and gold risk reversal, Figure 5.
trading at 7-year low
Over the past four years, EURUSD and gold RR largely
1.50 tracks each other and the current divergence is the
EUR 12m 25 Risk
Reversal
biggest seen in years. This is particularly remarkable
1.00 given the ATMF implied volatility of gold and EURUSD
has stayed relatively inline over the past 18 months,
0.50 Figure 6, and the correlation between gold and
EURUSD remains firm.
0.00
-0.50
-1.00
Jan-99 Dec-99 Nov-00 Oct-01 Sep-02 Aug-03 Jul-04 Jun-05 May-06 Apr-07
IMM bulls plus options bears mean the market is more

balanced in our view and therefore not as one-sided as
implied by the IMM data alone. That is, euro bulls are
buying puts to hedge their directional long in our view.

Figure 5: EURUSD Risk-Reversal and Gold RR Figure 7: Gold 12M skew favours calls
normally tracks each other – biggest divergence
10.0
seen in years Gold 12M vol skew
stronger call skew
7 Gold 12m 25 Risk Reversal 1.2 8.0

07-Jan-08
deviation from ATMF (vols)

1.0
6 EUR 12m 25 Risk Reversal (rhs) 30-Jul-07
6.0
0.8
5
0.6
4.0
4
0.4
3 0.2 2.0
0.0
2
0.0
-0.2
1
-0.4 -2.0
0 10P 25P ATMF 25C 10C
-0.6
-1 -0.8
Nov-03 May-04 Nov-04 May-05 Nov-05 May-06 Nov-06 May-07 Nov-07

Figure 8: Gold speculative positions
240 K C o nt rac ts US $ /o z 850

Figure 6: EURUSD 12M vol vs. gold 12M vol 210
180 Long 750
150
650
120
90
550
60
30
450
0
-30 350
-60 S hor t
-90 250
J an-00 J an-01 J an-02 J an-03 J an-04 J an-05 J an-06 J an-07 J an-08
N o n-C o m m erc ial N et P o s it io ns (LH S) G o ld P ric e (R H S)
Source: CFTC, DB Global Markets Research
Therefore, both the CFTC net speculative positioning

and options skew are overtly bullish gold and so helping
to propel the gold price to new highs and possibly
above what is implied by the current level of the US
The gold 12M skew is currently showing a very strong dollar. We believe gold options are being purchased to
call skew as shown in Figure 7 while CFTC data is also express a bullish view on gold, rather than a hedge
indicating a massive net long position among the against any potential sell-off.
speculative community, Figure 8.
Conclusion : Buy on dips in gold

Extreme one-sided bullishness combined with the
tendency of the USD to strengthen in the first four
weeks of January suggests to us that the gold price is
most vulnerable to a sell-off currently. If a correction
were to occur we believe this would simply deliver
another opportunity to buy given our medium term
bullish view towards the precious metals sector.

Crude oil: CFTC vs. skew view Figure 11: US natural gas speculative positions
In the crude oil market, speculators are mildly long
70 K Co ntracts 17
while the options market has a strong favour on calls. US$ /mmB tu
50
15
30 Long
13
10
Figure 9: WTI speculative positions
11
-10
160 K Co ntracts 120 -30 9

US$ /bbl
130 Long -50

7
100
-70
100 5
80 -90
70 3
-110 Short
40 60
-130 1
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
10
40
No n-Co mmercial Net P o sitio ns (LHS) Natural Gas P rice (RHS)
-20
20 Source: CFTC, DB Global Markets Research
-50
Shor t
-80 0
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Figure 12: Natural Gas vol skew
No n-Co mmercial N et P o sitio ns (LH S) C rude Oil P rice (R HS)
Source: CFTC, DB Global Markets Research 10.0%

NatGas vol skew (Dec'08)
8.0% 07-Jan-08
The crude oil skew in fact has moved from a strong put 6.0%
24-Aug-07
deviation from ATMF
skew to a strong call skew over the past few months,

Figure 10 possibly reflecting the strong demand of 4.0%
“lottery ticket” type of far out of the money calls. 2.0%
0.0%
Figure 10: WTI vol skew -2.0%
-4.0%
10.0% 07-Jan-08
WTI vol skew (Dec'08) 10P 20P 30P ATM 30C 20C 10C
24-Aug-07
8.0%
deviation from ATMF
6.0%
4.0%
2.0%
0.0%
-2.0%
4P 15P 28P ATMF 36C 19C 5C
US Natural gas: CFTC vs. skew view

In the US natural gas market, the speculative
community is extremely bearish while the options skew
has shown a strong bullish bias, possibly indicating gas
bears are hedging with gas calls. Again, a more
balanced market positioning in our view.

B. Spike Risk for Oil & Gas Figure 14: US Natural gas probability density
function –very fat right tail as well
Other than position bias, the vol skew, and in particular
Probability Density Function: US Natural Gas
the fatness of the tails, also provides useful information
on price spike risk.
The probability density function of WTI crude oil is

shown in Figure 13, the skew surface is compared to
the Black-Scholes surface (a flat vol skew is assumed in
the Black-Scholes world implying a constant vol across
strikes). The 10% left and right tails are also highlighted
in Figure 13.
2 4 6 8 10 12 14 16 18 20 22 24
According to the options market skew, there is a 10% Skew surface right tail - 10% left tail - 10% Black-Scholes
chance that the Dec’09 WTI contract will expire below Source: DB Global Markets Research
USD61/bbl or above USD149/bbl, against the futures
price of USD92/bbl.
While we believe upside price risk remains in the crude Amanda Lee, (852) 2203 8376
oil market on geopolitics, weather, USD overshooting, amanda-ps.lee@db.com
escalating cost and tight market fundamentals, USD149
oil seems far too high in our opinion. We do not believe
triple digit oil is sustainable and longer term we are
expecting the crude oil price heading back to USD80 in
2008-09.
Figure 13: WTI probability density function – very

fat right tail
Probability Density Function: WTI
30 50 70 90 110 130 150 170 190 210
Skew surface right tail - 10% left tail - 10% Black-Scholes
Similarly, for US natural gas, our model indicates that

the Dec’09 NG contract has a 10% chance that it might
expire below USD5.7/mmBtu or above
USD18.9/mmBtu, futures reference at USD9.6/mmBtu.

Given the increasing maturity of the current cycle and

#13 Precious Metals & The US the tendency of the US dollar to overshoot during the
latter stages of a cycle, we attach a high probability of
Dollar the US dollar hitting even higher levels of
undervaluation against the euro. In previous turning
The Threat Of Overshooting
points of the US dollar, the exchange rate has hit levels
of misalignment of around +/-40% versus Purchasing
• We believe exchange rate and precious metal Power Parity. If this were to occur during this cycle it
markets are at serious risk of overshooting in would imply EURUSD rising to 1.62.
2008.
Figure 2: EURUSD vs. Purchasing Power Parity
• This reflects Fed easing, a falling US real
interest rate environment, the current US 1.60 1.60
dollar cycle becoming increasingly long in the 41% 39% Numbers refer
28%
tooth and the non-linear relationship to the scale of
1.40 PPP mislignment 1.40
between the gold price and the US dollar.
• For gold to surpass its all time high in real 1.20 1.20
terms, as has occurred in crude oil, it would

imply the gold price hitting USD1,260/oz. 1.00 1.00
While our price objectives are more cautious,
these alternative targets give an indication of 0.80 -25% 0.80
EURUSD
how far the gold price rally could run. 20% Band
-37%
PPP EURUSD
Behavioural finance theory tells us that investors often 0.60 0.60
1973 1977 1981 1985 1989 1993 1997 2001 2005
tend to be overly optimistic about asset markets which
have been past winners and overly pessimistic about Source: DB Global Markets Research
asset markets which have been past losers. As a
While we expect new lows in the US dollar it is
result, this often leads asset prices, and in particular
understandable that some market participants may be
exchange rates, to overshoot relative to fair value. We
looking for a bigger picture turn in EURUSD given the
believe we will enter a period of exchange rate and
over 20% undervaluation of the US dollar vs. DB’s PPP
commodity price overshooting over the coming year.
estimate. To address this theory we examine the
US dollar cycles cumulative Black-Scholes knockout probabilities for
Since the birth of floating exchange rates in 1972 the various levels of EURUSD over various time horizons.
US dollar has displayed long-run cycles of rising and
We find that the implied probability of EURUSD trading
falling for extended periods of time. On average, cycles
the 1.30 level, which would be equivalent to a 10%
in the US dollar trade-weighted index and against the
correction from current levels, stands at 18% in one
euro have lasted for seven years, Figure 1.
year and 30% in two years. Conversely the probability
of the 1.50 level being reached is 78% in one year and
Figure 1: Magnitude & duration of past US dollar 83% in two years time.
cycles
Figure 3: Cumulative Black-Scholes EURUSD
USD Cycle Start End Years Change knockout probabilities
Bear 1-Jan-73 10-Jul-80 6.6 -14.1% 90%
1.50
80%
Bull 11-Jul-80 25-Feb-85 4.7 63.4%
70%
1.55
Bear 26-Feb-85 8-May-95 10.2 -43.2% 60%
1.35
50%
Bull 9-May-95 27-Feb-02 6.8 -40.1% 40% 1.60
1.30
30%
Average* 7.1 40.2% 1.25
20%
Bear 28-Feb-2002 Current 5.8 -24.0% 10%
* Average percentage change is in absolute terms. 0%

US dollar cycles are measured by the US broad trade-weighted index 3M 6M 9M 12M 18M 2Y 3Y
Source: DB Global Markets Research, US Federal Reserve


These probabilities would assume market players (ii) Bull cycles have typically been preceded by a
anticipate an extended period of US dollar weakness significant narrowing in the US trade deficit.
similar to the early 1990s when the US dollar was Although the US current account deficit has
trading around 20% undervalued against the synthetic fallen from 6.2% in 2006 to an estimated 5.1%
euro for a number of years. We find that current levels of GDP in 2008, the deficit still remains large.
of implied EURUSD volatility suggest a range of 15%, We believe this will constrain a turnaround in
or EURUSD fluctuating between 1.38 and 1.58. the US dollar’s fortunes for the time being.
Since the current US dollar cycle is becoming (iii) The start of a new uptrend in the US dollar has
increasingly long in the tooth, investors need to tended to coincide with a turn in interest rate
consider at what point the US dollar will embark on a differentials in favour of the US dollar.
new long-term uptrend. To assess the likely timing of However, we expect rate differentials between
such an event we examined past turning points in the the US and Euroland will continue to shift
US dollar and find six valuable lessons, all of which against the US dollar during 2008.
suggest an imminent turn in the US dollar is unlikely:
(iv) A trend reversal in the US dollar has historically
(i) Turning points in the US dollar have been been associated with longer-term turns in
asymmetric such that downturns from up- capital flows. However, US credit markets
cycles have been inverted (V-shaped) while have been the primary channel of capital
upturns from down cycles have tended to be inflows into the US in recent years.
preceded by an extended bottoming-out Consequently ongoing stress in the US credit
period. Put another way, US dollar bear cycles and housing sectors are expected to hinder a
tend to be more durable than bull cycles. This turnaround in US capital flows in the near term.
would imply that a new long-term uptrend in
(v) The pressure for adjustment from valuation
the US dollar may be several years away.
extremes is greater when the US dollar is
Assuming this dollar bear cycle conforms to uniformly cheap rather than unevenly so. At
historical averages then it would imply the US the moment, while the dollar is cheap against
dollar will not embark on a new long term the euro, on a trade-weighted basis the US
uptrend until August 2010, or 8.5 years. dollar has not yet overshot, which reflects the
Alternatively, if one assumes the current US fact that the US dollar is still expensive against
dollar cycle will continue to track the 1985- the Japanese yen and most Asian emerging
1995 US dollar cycle, then it implies the US market currencies. This is therefore lowering
dollar only hitting rock bottom in September the pressures for a reversal in the US dollar
2011, Figure 4. currently.
(vi) Every turn in the US dollar since 1978 has
Figure 4: The 1985 and 2000 US dollar bubbles coincided with aggressive rounds of G3 foreign
compared exchange intervention, Figure 5. For the time
being dollar weakness is not yet a policy
200 USDDEM: October 1978
1985 & 2000 US
& June 1995 rebased to 100 headache for public sector authorities. IT
dollar bubbles burst
180 assists in dampening inflationary pressure s in
Europe, in a rising commodity price
160
environment, while it helps cushion the
140 USD hits rock slowdown in the US economy. As a result, we
bottom in
September 2011
believe investors should only position for dollar
120
strength or at the very least stability in the US
100 dollar exchange rate when central banks start
80 Oct 1978-Dec 1987 intervening and buying the US dollar.
Jun 1995-Current
60
0 24 48 72 96 120 144 168 192 216
Months after trough

Figure 5: EURUSD central bank intervention The assess the extent to which the precious metal
since 1980 prices could overshoot we examine prices in real terms,
Figure 7. We find that despite the rapid real price
1.70 EUR selling 1.70
G3 action to stop
appreciation that has already occurred in this cycle, gold
the dollar falling EURUSD price would need to rise an additional 40% from current
1.50 1.50
EUR buying levels to surpass the all time high in real terms hit at the
Louvre Accord (1987)
1.30 to stabilise the dollar 1.30 beginning of the 1990s while silver prices would have
to rise an additional 350%. This would be equivalent to
1.10 1.10 gold hitting USD1,250/oz.
0.90 0.90
Figure 7: Gold & silver prices in real terms
0.70 Plaza Accord (1985) G3 action to stop 0.70
1400 Deflated by US PPI 80
to push the dollar lower the euro falling Real gold price (2005
US dollars, lhs)
0.50 0.50 1200 70
81 84 87 90 93 96 99 02 05 08 Real silver price (2005
US dollars, rhs) 60
1000
Before 1999, FX invention rounds are conducted in USDDEM
Source: DB Global Markets Research 50
800
40
The threat of an overshooting in the US dollar poses 600

30
considerable contagion risks to the commodities 400
20
complex. Indeed over the past three months we have
200
witnessed a sudden increase in the correlation between 10
crude oil, gold and certain agricultural commodities to 0 0
the US dollar. We believe overshooting risks are most 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006
acute in the precious metals markets and in particular Source: DB Global Markets Research
gold. This reflects the historically non-linear relationship
between the US dollar and the gold price such that
since 1980 the gold price has tended to react more to In terms of duration, the current gold price rally has
incremental changes in the US dollar when the US been the longest since the gold price became freely
dollar is trading at depressed levels, Figure 6. floating in August 1971. However, in terms of
magnitude, the gold price would need to surpass
Figure 6: The non-linear relationship between USD1,320/oz to be comparable to the rally in gold prices
the gold price & the DXY dollar index that occurred in the first half of the 1970s.
DXY
DXY vs gold price, 1980-2007
170
Figure 8: Gold rallies in comparison
150
Low High Magnitude Duration
130 USD/oz USD/oz (% change) (months)
110 Aug-71 to Feb-75 35.4 183.9 419% 42
90 Aug-76 to Jan-80 103.5 850.0 721% 41
70 Jun-82 to Feb-83 296.8 509.25 71.6% 8

0 100 200 300 400 500 600 700 800 900
Gold price (USD/oz)
Feb-85 to Dec-87 284.3 499.8 75.8% 34
Apr-01 to present 255.6 864.9 238% 81
Although the gold price had been rising before August 1971, we take this
as the start point for this rally since it marks the date the US government
informed the IMF that the US dollar would no longer be convertible into
gold. This consequently leads to the collapse of one of the main pillars of
the 1944 Bretton Woods system.
Highs and lows in the gold price relate to closing prices

To assess the options market probabilities to the gold Figure 10: Producer de-hedging is expected to
price outlook, we examine cumulative Black-Scholes slow
knockout probabilities. We find that the market is
600
attaching a 48% and 63% probability of the gold price
hitting USD1,050/oz in one and two years’ time 400
respectively.
200
Tonnes
0
Figure 9: Cumulative Black-Scholes gold
knockout probabilities -200
%
100 -400
900
90 850
950 -600
80
800 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007E 2008E 2009E
1000
70
1050
60 750 Source: DB Global Markets Research estimates
50
40
Investment demand remains strong
30
Investment demand remains one of the important
20
sources of physical gold demand and a key price driver.
10
The popularity of gold ETFS has increased dramatically
0
3M 6M 12M 24M
since their launch in March 2003. In 2007, the total
amount of physical gold held by the eight ETFs we track
Source: DB Global Markets Research; Spot reference USD888/oz
rose an additional 40%, Figure 12. The launch of a new
gold futures contract on the Shanghai Futures Exchange
this month may also attract a new layer of investment
Demand-supply fundamentals demand into the market.
While we expect production levels to recover further
this year, we expect producer dehedging and
Figure 11: ETF physical gold holdings since 2003
investment demand will support the gold price. During
2007 and despite a number of new mines coming 1000
online and record high gold price global mine production ETF securities
ZKB (Zurich)
rose slightly in 2007 to 2,522 tonnes. Rising production 800 IAU (AMEX)
in Russia, China and Australia was offset to some GLD (JSE)
GLD NYSE)
degree by falling production in South Africa and North 600 GBS (LSE)
America. We expect global gold mine production will
Tonnes
GOLD (ASX)
CEF (TSX)
recover further in 2008 helped by increasing production
400
from Australia and China.
200
Producer de-hedging has continued in 2007, reducing
the global hedge book to 995 tonnes from 1,368 tonnes
0
in 2006. We believe producer de-hedging will remain a 2003 2004 2005 2006 2007
main theme in the gold market, at least over the next
Source: CPM, DB Global Markets Research estimates
two years, reflecting the strong gold price outlook and
strong shareholder opposition towards hedging.

Figure 12: Gold supply-demand balance Figure 14: Silver supply-demand balance
T o nn e s 2005 2006 2007E 2008E 2009E M illio n T ro y O unc e s 2005 2006 2007E 2008E 2009E
Total Supply 4,110 3,674 3,889 3,972 4,054

M ine Pr oduction 2,550 2,473 2,522 2,585 2,650
Total Supply 776.4 773.2 774.1 788.3 797.0
Se condar y Supply 886 849 887 927 964 M ine Production 515.3 502.7 521.1 538.3 551.0
Official Se ctor Sale s 674 352 480 460 440 Peru 102.7 111.6 110.5 112.0 116.0
Mexico 93.0 96.5 101.3 106.4 108.5
Total Demand 3889 3751 3949 4026 4202
A ustralia 77.0 57.0 63.0 65.9 67.0
Fabr ication 3,138 2,742 2,774 2,901 3,039
Jew ellery 2,707 2,284 2,300 2,415 2,536 United States 39.5 36.7 39.0 38.0 37.0
Industrial 431 458 474 486 503 Canada 36.1 31.6 27.7 26.0 24.5
Inve s tm e nt 620 673 802 938 1,070 Other 167.0 169.4 179.5 190.0 198.0
ETF and similar 208 260 360 468 560
Se condary Supply 226.1 244.5 245.0 244.0 242.0
Bars, coins
& medallions 412 413 442 470 510 Old Scrap 205.0 215.0 217.0 215.0 212.0
Pr oduce r De -he dging 131 336 373 187 93 Coin Melt 5.0 7.0 5.0 4.0 3.5
Indian Scrap 16.1 22.5 23.0 25.0 26.5
Market Balance 221 -76.9 -60.1 -53.4 -148
Gove rnm e nt Sale s 35.0 26.0 8.0 6.0 4.0
Source: World Gold Council, CPM, DB Global Markets Research
Total Demand 807.3 714.7 707.8 705.8 705.8

Fabrication 807.3 714.7 707.8 705.8 705.8
The silver price has been trading cheap relative to gold Photography 207.6 177.5 162.7 149.6 137.7
price for the past few months, Figure 14. The advent of Jew ellery & Silverw are 288.8 241.9 241.5 242.7 242.7
digital cameras has removed one of the main industrial Electronics and Batteries 101.9 114.0 121.7 127.8 136.1
uses for silver. Today photographic demand as a Other Industrial A pplications 209.0 181.3 182.0 185.6 189.4
percent of total fabrication demand has fallen from 32%

Market Balance -30.9 58.5 66.2 82.5 91.2
in 2003 to an estimated 21% this year. Partly offsetting
(excluding investm ent dem and)
this reduction in silver’s industrial use has been the Source: CPM, DB Global Markets Research
growth in other areas such as electronics, and catalyst
use.
Figure 13: Producer de-hedging is expected to

slow Trade recommendations:
• Long gold in February given the
overextended nature of the rally and the
risk of seasonal strength in the US
dollar the
• Long silver
Silver trades
cheap to gold
Michael Lewis, (44) 20 7545 2166

Jude Brhanavan, (44) 20 7547 1558
jude.brhanavan@db.com

Figure 1: Platinum supply-demand balance

#14 PGMs
400 Market balance ('000 oz, lhs) Forecast
1700
Strong Fundamentals Continue Platinum price (USD/oz, rhs)
200 1500
• We believe the case for robust platinum 1300

0
group metals demand and higher prices 1100
remains firmly intact. The prospect of a
-200 900
structurally strong rand strengthens this
700
case, especially for long-term prices. -400
500
• We believe the basis for the strength in the -600 300
PGM prices continues to be founded in 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008e
accelera ting consumer demand, most
significantly in autocatalysis. Source: Deutsche Bank, Johnson Matthey
• Although there has been elevated speculative

involvement in the PGM markets in the few
Palladium
years, it is with just cause. The fundamentals
We believe that in time, the palladium market
of these markets are strong; thus we believe
fundamentals will improve, with symptomatic evidence
markets are likely to continue attracting
of reverse substitution in autocats as well as improved
speculative involvement.
jewellery off-take. Although the last two years have
seen declines in off-take, we believe consumers have
Platinum absorbed a fair amount of the high levels of
We believe the platinum market will continue to be in manufacturing purchases seen in 2005, which bodes
deficit for the foreseeable future. We are forecasting a well for the future. Unfortunately, we expect the
414k ounce deficit for 2007, and a 214k deficit in 2008. overhang of above-ground stocks at around 6m ounces
While our official forecast is for a marginal surplus in in Zurich and anywhere between 2m ounces and 10m
2009, this could just as easily be a deficit if production ounces in Russian stock may limit price advances.
issues at the major producers are not rectified.
Although higher platinum prices may well accelerate Figure 2: Palladium supply-demand balance
palladium substitution in autocats, we believe the risks
1900 Forecast 750
to our platinum forecasts are balanced, in the absence Market balance
('000 oz, lhs)
of a substantial shift in the USD. 1400 650
Palladium price
(USD/oz, rhs) 550
900
450
We expect continued penetration of diesel vehicles into 400
Europe, but more importantly, the US as the authorities 350
-100
there have been showing increasing support for diesel- 250
powered vehicles of late. While the market typically -600
150
expects a penetration rate of around 3% in the US over
-1100 50
the next few years, industry figures suggest that this
could be as high as 5-8% within the next five years. -1600 -50
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008e
This could result in additional demand of around 300k-
500k ounces per annum. Continued high oil prices have Source: Deutsche Bank, Johnson Matthey
also the potential to accelerate research into fuel cell

technology, although our assumptions include minimal Aside from the above-ground stocks, we are also
demand from this sector for years to come concerned that autocat scrap will increase considerably
over the next few years. Vehicle manufacturers
switched aggressively from platinum into palladium in
the mid- to late-1990s and with the average vehicle’s
lifespan being around 12 years, we could see autocat
recycling increase to as much as 1.5m ounces p.a. over
the next few years.

Our final concern is that the private and public sector in Conclusion
Russia may attempt to “manage the palladium market” In our view, the case for PGMs is easily explained. The
if prices move much higher than spot to provide peace metals have highly unique and desirable physical
of mind to vehicle manufacturers in an attempt to characteristics, making them useable in a number of
ensure that the price spikes at the beginning of the industrial applications. PGMs have the unique ability to
decade that resulted in massive write-downs of stock catalyse reactions, many of which have desirable
will not be repeated. environmental consequences. Many of these
applications happen to be in areas that face increasingly
Rhodium
strenuous environmental legislation, requiring the use
We expect the rhodium market will remain extremely
of more catalytic material.
volatile given the relative illiquidity of the market.
Rhodium is heavily exposed to autocats (85% of
demand) and we expect demand from this sector to
Also, in the case of autocats, which account for more
remain strong given tightening regulatory environment
than 50% of the consumption of all PGMs, legislation
for the various forms of nitrous oxides (NOxs). Rhodium
has tightened to such an extent that it has become a
is particularly important in reducing NOx emissions that
strategic and “critical path” item for automotive
occur predominantly in diesel vehicles and in a “lean-
manufacturers. On the supply-side, reserves are highly
burn” environment. As manufacturers continue to
concentrated and barriers to entry very high. This
strive for efficiency in gasoline engines, we would
enables producers to essentially design their own
expect an increase in the population of “lean-burn”
returns by controlling the rate of new supply.
engines.
The biggest industry risk, in our view, is that significant

Although small in the context of the overall market,
price spikes perhaps worsened by the growth in
consumption by the glass manufacturing industries
Exchange Traded Funds permanently damage certain
(particularly LCD glass) should remain supportive from
PGM demand categories, which would create more
the current base. Ultimately, however, we expect the
secular problems for the business as a whole. While it
long-term price to settle at levels substantially below
seems that the days of continued delays and project
spot as mining operations in South Africa continue to
cancellations have passed, we have experienced
migrate to the UG2 and Eastern Limb reef horizons.
persistent smelting accidents in the industry over the
These carry significantly higher rhodium content than
last few years. If repeated, we expect this would keep
the traditional Merensky reef horizon.
PGM prices higher for longer. More recently, the SA
government and the SA PGM industry’s tougher stance
against mine accidents has further contributed to lower
In the short to medium-term, however, we have
than anticipated production levels.
recognised that the impact of continued supply shocks
such as production issues at AngloPlat and Lonmin in
particular in a tight, illiquid market will likely result in the
current high prices being sustained for at least the next
few years and have amended our forecasts accordingly. • Long platinum
We have consequently raised our 2008 and 2009
forecasts significantly.
Figure 3: Rhodium supply-demand balance Gary Pearson, (27) 11 775 7247

gary.pearson-sa@db.com
300 7000
Market balance ('000oz, lhs)
6000
200 Rhodium price (USD/oz, rhs)
5000
100
4000
3000
0
2000
-100
1000
Forecast
-200 0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008e
Source: Deutsche Bank, Johnson Matthey

tariff regime among other base metals to

#15 Industrial Metals discourage exports, we recognise a degree of
risk that such a move in the zinc market has the
Longer Life on Stronger Fundamentals potential to tighten supply. We dropped our
2008 price forecast by 21% to USD2,304/t
• Summary: Although industrial metals prices may (USc104.5/lb) and the 2009 forecast by 7% to
struggle in the first half of the year against US USD2105/t (USc96.5/lb). However, we increase
economic jitters, we maintain a favourable our 2010 and 2011 forecasts by 14% and 22%,
medium-term outlook across the complex. In our respectively.
view, providing the world continues to realise
• Lead: The impressive lead price performance last
sustainable growth, and particularly as long as
year occurred as a result of an unexpected
the developing markets make up an increasingly
reduction in concentrate and refined supply. We
larger proportion of that growth, metals markets
expect prices to ease to a more sustainable level
will remain strong. We remain convinced that
in 2008 as a key mine in Australia restarts
trends in China will continue to have a substantial
shipments although strong battery demand in
impact on the metal price outlook.
China will continue to support demand. We
• Copper: We expect that copper price weakness moderately increased our 2008 forecast to
seen in the back half of last year will continue USD2,326/t (USc105.5/lb) and left our 2009
while concerns over the US economy persist. estimation unchanged at USD1,692/t
However, we remain positive on the medium- (USc76.8/lb).
term outlook. While global inventories remain
low, the global market balance will remain tight
in 2008 against below trend concentrate Figure 1: Industrial metals prices rebased
production and robust demand from the key
250 Aluminium
emerging markets. We revised our 2008 forecast Copper
225
down 2% to USD7,165/t (USc325.0/lb), but Nickel
200
raised the 2009 forecast to USD6,752/t Zinc
Lead
(USc306.3/lb). 175
Tin
• Aluminium: Although aluminium continued to 150
under perform versus other metals in the 125
complex in 2007, we believe the metal has one 100
of the most optimistic price outlooks. The steep 75

rise in energy costs will pressure global smelter
50
growth, in our view, and in collusion with the Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08
impact of China’s eventual shift to a net

importer, we expect the global market balance Source: Reuters, DB Global Markets Research
will head toward deficit in 2008 and 2009. We
have moderately decreased our forecast in 2008 Last year the industrial metals sector was the worst
to USD2,679/t (USc121.5/lb), but increased our performing across the commodities complex, largely as
2009 estimated by 11% to USD2,684/t a result of the credit crisis the ensuing poor
(USc121.8/lb). performance of global financial markets. Nevertheless,
• Nickel: We expect nickel prices will remain by historical standards, prices across the complex
stable as the global stainless steel market ramps remain at elevated levels compared to their long-term
up production in the beginning of the year as well mean as a result of supportive supply and demand
as from Asian producers re-entering the market fundamentals. In our view, these conditions will
after the Chinese New Year holiday. Despite continue at least in the medium-term, avoiding a
cyclical highs in inventories, the primary nickel reversion to mean averages. This year’s vigorous M&A
market balance is set to record a market deficit in activity in the sector demonstrates the conviction
2008. We also believe substitution risks will not producers hold over the on-going strength of this cycle.
become a major threat this year. We reduced This view does not, however, exclude the existence of
our 2008 forecast by 10% to USD29,625/t price volatility or cyclicality. Market trends in the last
(USD13.44/lb) and our 2009 numbers by 2% to half of 2007 served as a reminder of the influence that
USD27,888/t (USD12.65/lb). macroeconomic shocks hold over the industrial metals
• Zinc: Although zinc consumption trends remain complex, often leaving fundamentals ignored. Thus in
robust in 2008, we are expecting the global zinc the shorter-term, we think the complex will see more
market to record its first market surplus since pressure in the first half of 2008 against global market
2003, largely as a result of a surge in Chinese jitters.
smelting capacity in the second half of the year.
However, given the recent shift in the Chinese

Figure 2: Metallgesellschaft Metals Index vs Dow exports. We agree – recent research found that a 1%
Jones Industrial avg decline in US GDP translates into a 0.2% decline in
emerging markets exports. In terms of the magnitude
14,200 460
of the impact of a US slowdown on China, we find that
13,900
440 a 1ppt deceleration in the US will likely result in a
420
reduction less than 1ppt (on average at only 0.5ppt) in
13,600
China’s GDP growth. This implies that even if the US
400
13,300
GDP growth falls from 2.2% in 2007 to 1.2% in 2008,
380 the Chinese economy should continue to grow at
13,000 around 10.4%.
360
12,700 Dow Jones Industrial Index (lhs) 340

M GM I (rhs)
China: The driver of growth
12,400 320 We remain convinced that trends in China will continue
Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08
to have a substantial impact on metals prices.
Source: Reuters, DB Global Markets Research Consumption growth in 2008 is likely to be highly
resilient given rapid income growth, rising wealth effect
Macro signals outside of the US point to strong from the assets market, and progress in social sector
demand which we expect will be good for metals reforms. We expect investment growth to sustain at
Our favourable view of the metals complex in the the current pace (about 25% yoy).
medium term is based on a supportive global
macroeconomic outlook. Providing the world continues Figure 4: China’s macro indicators remain strong
to realise sustainable growth, and particularly as long as
45 24.0
the developing markets make up an increasingly larger % %
proportion of that growth, metals markets will remain 20.0

36
strong.
16.0
27
Figure 3: Global industrial production (yoy %chg) 12.0
18
remain resilient – thus far 8.0
20.0 USA
9 Chinese FAIG 6mma (lhs)
Japan Chinese Industrial Production 6mma (rhs) 4.0
15.0 EU Chinese Retail Sales 6mma (rhs)
China (6m m a) 0 0.0
10.0 Oct-97 Oct-99 Oct-01 Oct-03 Oct-05 Oct-07
5.0
Source: Reuters, DB Global Markets Research

0.0
-5.0 A consequence of this continued strong growth profile

-10.0 is an increase to the contribution of China to global
growth of demand for commodities, which we forecast
-15.0
Nov-97 Nov-99 Nov-01 Nov-03 Nov-05 Nov-07
will reach 74% in 2008. We believe this is still a
conservative estimate, as risks to Chinese growth
Source: CHR Metals, DB Global Markets Research
appear to be biased to the upside.
Thus far in 2008, much of the market’s focus remains

Figure 5: China’s contribution of Chinese growth
on the global implications of a possible US recession.
to global demand growth, 2007-08
While our global economics team rates the chances of
100%
avoiding a recession is greater than entering one, it is
clear the US economy is headed for a downturn. DB 80%
forecasts that the GDP growth of OECD economies will
slow to 1.9% in 2008 from 2.2% in 2007. 60%
40%
At the same time, the outlook for most developing
economies is less dire. For example, the World Bank 20%
recently lifted its economic growth estimate for East

0%
Asia in 2007 and 2008, predicting growth would reach a
re
nc
r
ad
l
m
ee
ke
pe
decade high of 8.4% for the region in 2007. The

O
iu
Le
Zi
ic
St
p
in
n
Co
de
Ir o
m
lu
upgrades were mainly due to the unexpected and large

Cr
A
domestic demand-led acceleration of growth in China

Source: Brook Hunt, UNCTAD, IISI, DB Global Markets Research
which occurred despite a weakening in U.S. import
demand and a resulting slowdown in the region's

Chinese trends will influence metals markets Copper

China’s public profile in 2007 was not always positive The copper market is set to remain tight over the next
with headline-grabbing issues such as lead in toys, two years. By historical standards, copper prices remain
chemicals in seafood, an overvalued currency and unfair high while (also by historical standards) global stocks
trade practices. Given that 2008 is China’s “coming remain low. Essentially, concentrate production has not
out” party with the Beijing Olympics, the central been able to keep up with demand growth.
government is understandably keen to paint an
improved picture, particularly in terms of issues such as Prices came under pressure last year from October in
the environment, energy use and trade practices. line with global market concerns over the health of the
US economy and the possible spillover effects. Further
As such, we have identified several measures Chinese pressuring the copper price was a steady build in LME
authorities are undertaking that will have a significant inventories. However, the rise in LME stocks was
impact on commodities prices in 2008 and beyond. accompanied by falling Chinese exchange stocks over
While many measures have been announced but largely the same period. They fell by 65,020t over the second
unsuccessful in the past, in our view, these particular half of the year as the temporary surplus arising from
policies will be taken more seriously as they are strong imports in Q2 was steadily worked off. By the
headline issues, particularly in the year of the Olympics. end of the year, they were close to the 20,000t level
that has tended to define the floor of Shanghai Metals
Over the last two years, the National Development and Exchange stocks over the last few years. Indeed this is
Reform Commission (NDRC), China’s top economic a primary factor in our confidence that Chinese refined
planning body, has made significant changes to trade imports will re-accelerating in the coming months.
tariffs in attempt to ease trade friction by curbing the
country’s growing trade surplus, but also to further Figure 6: SFE, LME, and Comex copper stocks
strengthen its control over the growing metals
industries which consume vast amounts of energy and 250,000 Shaghai Futures Exchange, tonnes (lhs) 50,000
LM E stocks, tonnes (lhs)
are highly polluting. The NDRC hopes that reducing Com ex, tonnes (rhs) 45,000
210,000
exports and increasing imports may solidify the 40,000
purchasing power of the yuan and help treat the 170,000
35,000
overheated economy. At the same time, these policy
130,000 30,000
changes have serious implications on global market
balances in many key commodities, namely aluminium, 90,000
25,000
zinc and steel. 20,000

50,000
15,000
More recently, the NDRC in December issued new 10,000 10,000

industrial production stipulations as part of a drive to Dec-06 Feb-07 Apr-07 Jun-07 Aug-07 Oct-07 Dec-07
increase scale and efficiency and reduce wasteful use

of resources. The guidelines sets minimum capacity Source: Reuters
requirements for a number of metals production such
as alumina, copper and galvanised steel projects, Supply
essentially weeding out the least efficient and dirtiest Over the last several years, market surpluses have been
plants. New secondary aluminium plants must have a forecast but failed to eventuate. In terms of
minimum capacity of 50Ktpy and new aluminium concentrates, this is due to the delay and lack of any
fabrication plants one of 100Ktpy. Lead and zinc mines large-scale mine commencement as well as persistent
with a lifespan of less than 15 years or annual output of supply disruptions. As an illustration, a strike at
less than 30Kt were also restricted. Southern Copper’s Cananea mine is now well over four
months old, leaving copper-in-concentrate production at
The cumulative effect of the these policy changes as one of the world’s largest mines down 33% in 2007
well as others which are sure to come effectively over the previous year.
increases exporters costs of production and will either
force domestic prices higher or trim production growth
rates. Either scenario will have a material effect on
international prices across the sector.

Figure 7: Brook Hunt copper market balance Figure 9: Copper refined capacity by region
forecast vs outcome Kt 2005 2006 2007 2008 2009 2010
600
China 2921 3406 4124 4712 5264 5519
Capacity growth 16.3% 16.6% 21.1% 14.3% 11.7% 4.8%
400
-81% % of global supply 14.7% 16.5% 18.6% 20.3% 21.6% 21.9%
W Europe 2081 2093 2124 2180 2242 2267
200 Capacity growth -0.7% 0.6% 1.5% 2.6% 2.8% 1.1%
107% % of global supply 10.4% 10.1% 9.6% 9.4% 9.2% 9.0%
0 Chile 2979 3075 3418 3568 3620 3615
Capacity growth -1.2% 3.2% 11.2% 4.4% 1.5% -0.2%
-200
-2% % of global supply 14.9% 14.9% 15.4% 15.4% 14.8% 14.3%
-138% Forecast USA 1927 1900 1926 2004 2069 2061
-400 125.18% Actual Capacity growth -1.3% -1.4% 1.4% 4.0% 3.3% -0.4%
-600
% of global supply 9.7% 9.2% 8.7% 8.6% 8.5% 8.2%
Japan 1605 1630 1750 1728 1728 1728
-800 Capacity growth 3.7% 1.6% 7.4% -1.3% 0.0% 0.0%
% of global supply 8.1% 7.9% 7.9% 7.4% 7.1% 6.9%
-1000 Total World Smelting
19,929 20,684 22,209 23,219 24,403 25,226
2003 2004 2005 2006 2007 2008E Production
Capacity growth 5.2% 3.8% 7.4% 4.5% 5.1% 3.4%
Source: Brook Hunt, DB Global Markets Research
Source: Brook Hunt, ICSG, DB Global Markets Research
However, we expect the situation to begin turning Demand

around only in 2010, when significant new concentrate On the demand side, the US housing and construction
capacity comes on line. downturn continues to reduce consumption levels and a
recovery is not expected to occur until the end of the
Figure 8: Comparison of DB mined production year at the earliest. Fabricators in the US are reporting
estimates in 2007 and 2008 slow order books in the first quarter as the residential
Concentrate Production housing decline is showing no signs of recovery. The
Capacity 2007 2010 % change
Congo 150 363 141%
Japanese construction sector is also likely to suffer this
Zambia 340 675 99% year in light of new stricter building regulations.
USA 723 999 38%
Kazakhstan 452 613 36% In the industrialising world, a very different scenario is
Indonesia 775 1,050 35%
playing out. In China, demand for copper intensive
Australia 820 1,064 30%
Total 12,547 14,590 16% products such as electric motors, air conditioners,
SxEw Production Capacity computers, motor vehicles and refrigeration remains
Congo 15 307 1947% robust and shows no signs of slowing down. Wire and
Zambia 213 283 33%
cable manufacturers continue to report full order books
USA 507 612 21%
Total 3,040 3,943 30%
against strong demand in the power sector. Similarly,
Total world production India plans to vastly expand its power infrastructure to
15,588 18,533 19%
capacity meet surging demand. According to government data,
Source: Brook Hunt, DB Global Markets Research
India’s power production needs to grow by 15-20%
annually to meet demand.
Refined supply growth has struggled primarily as a
result of the unequal growth rates between
Figure 10: Primary copper demand by region
concentrates capacity and smelter capacity. Against the
backdrop of constant supply disruptions and a lack of Kt 2005 2006 2007 2008 2009 2010
China 3815 3967 4570 5027 5630 6137
any unused idled mine capacity, rapid expansion of Demand growth 7.0% 4.0% 15.2% 10.0% 12.0% 9.0%
smelter capacity has triggered a deficit in the global % of global demand 22.5% 22.6% 25.2% 26.5% 28.3% 29.7%
concentrates market. As a consequence, refiners must EU 3537 3864 3678 3733 3771 3786
Demand growth -6.2% 9.2% -4.8% 1.5% 1.0% 0.4%
enter into low treatment and refining charges (TC/RCs), % of global demand 20.8% 22.0% 20.3% 19.7% 18.9% 18.3%
pressuring the least efficient smelters to reduce output USA 2270 2130 2083 2094 2110 2121
Demand growth -6.2% -6.2% -2.2% 0.5% 0.8% 0.5%
or even shut down for this reason we expect China’s % of global demand 13.4% 12.1% 11.5% 11.1% 10.6% 10.3%
refined output will grow at a slower pace in 2008. Rest of World 7362 7574 7795 8090 8388 8612
Demand growth 1.0% 2.9% 2.9% 3.8% 3.7% 2.7%
% of global demand 43.3% 43.2% 43.0% 42.7% 42.2% 41.7%
Total Primary Demand 16,983 17,535 18,126 18,943 19,899 20,656
Demand growth -0.3% 3.2% 3.4% 4.5% 5.0% 3.8%
Source: Brook Hunt, ICSG, DB Global Markets Research

Figure 11: DB Copper Supply/Demand Model smelting capacity in North America and Europe, much
Mt 2005 2006 2007 2008 2009 2010
of it is proving to be uneconomical because of energy
World refined production
costs. Furthermore, the imminent greenhouse gas
16.54 17.32 18.13 19.10 20.22 21.11
emissions legislation has serious implications on
smelting. According to a recent study by industry
World refined consumption 16.98 17.53 18.13 18.94 19.90 20.66
consultant CRU, at 35/t CO2, a smelter using 100%
Market balance -0.45 -0.21 0.01 0.16 0.32 0.46
coal fired electricity would need to add USD500/t
(aluminium equivalent) to its costs.
Stk-to-Consptn ratio (wks) 2.6 2.8 2.8 3.1 3.8 4.8
Production growth is also at risk as a result of China’s
Average cash price (USc/lb) 167.0 305.1 321.6 325.0 310.0 250.0 attempt to curb production in energy intensive
Average cash price (USD/t) industries. The country’s trade governing body has
3,682 6,725 7,090 7,165 6,834 5,512
instituted a series of policies aimed at reducing exports
Source: Brook Hunt, ICSG, WBMS, DB Global Markets Research
and encouraging imports of primary aluminium.
Consequently, we expect China will become a net
importer of aluminium this year
Aluminium
While aluminium maintained its status as the laggard of Figure 13: Changes to the Chinese aluminium
the industrials metals complex in 2007, we find several tariff regime
market fundamentals suggesting 2008 may prove to be Nov-06 Raised tax on exports of primary aluminium to from 5% to 15%
different. This conclusion comes from two factors: Nov-06 Removal of tax exemption for tolling of primary aluminium
Chinese efforts to curb production and higher energy (importing alumina duty free) and exporting with a rebate
Jul-07 Cancelled 8-11% tax rebates on exports of rod, bar, extrusion,
costs. profile and wire made of primary aluminium
Aug-07 Imposed a 15% tax on exports of rod and bar made of primary
aluminium
Supply Aug-07 Cancelled a 5% tariff on imports of primary aluminium
Although global exchange stocks of primary aluminium Source: Bloomberg, DB Global Markets Research
are at a relatively high level by historical standards, the
stock-to-consumption ratio is at all-time lows, indicating Figure 14: China’s net primary aluminium trade
that despite strong production growth, consumption 160
Net visible trade balance, Kt (+/- export/import)
growth is outpacing supply.
130
12-month moving average
100
Figure 12: Aluminium stock-to-consumption
70
ratio
40
6,000 Kt Total com m ercial stocks (LHS)Weeks 16
10
Long-term equillibrium ratio 14
5,000
Stock to consum ption ratio (RHS) -20
12
4,000 -50
10
3,000 8 -80
6
2,000 Source: Reuters, DB Global Markets Research
4
1,000
2
Other factors have also conspired to pressure Chinese
- 0 aluminium output. After surging by 34% in 2007,
3Q87 3Q89 3Q91 3Q93 3Q95 3Q97 3Q99 3Q01 3Q03 3Q05 3Q07
production growth is expected to come in at only 18%
Source: Brook Hunt, WBMS, DB Global Markets Research in 2008 and just 11% in 2009. The primary reason for
the sharp production growth in 2007 was better
Meanwhile, input costs for primary aluminium are set to availability of domestic alumina at lower prices which
climb dramatically as a consequence of the steep rise in encouraged idled capacity to be reactivated. However, it
energy costs. As energy costs make up around a third is expected those smelters that were likely to restart in
of total smelting costs, aluminium is extraordinarily a more economically favourable environment will have
sensitive to energy price shocks. It takes around 15,000 already done so. A decline in Chinese domestic
kilowatts per hour to produce one tonne of the metal. aluminium production would drive up domestic prices,
making exports unattractive.
For example, Chalco recently announced it has shut
160Kt of capacity at a plant in southern China due to
power shortages because of lower production of
hydropower, which also threatened aluminium
production in Sichuan province where producers are
also making output cuts. While there is some spare

Figure 15: Primary aluminium production by region Figure 17: DB Aluminium Supply/Demand Model
Kt 2005 2006 2007 2008 2009 2010 Mt 2005 2006 2007 2008 2009 2010
China 7806 9375 12600 14868 16503 17741 World refined production
Production growth 16.7% 20.1% 34.4% 18.0% 11.0% 7.5% 31.97 33.98 38.17 42.04 44.61 47.86
% of global production 24.4% 27.6% 33.0% 35.4% 37.0% 37.1%
North America 5382 5334 5622 5790 5802 5802 World refined consumption 31.91 34.38 38.06 41.98 44.84 47.75
Production growth 5.3% -0.9% 5.4% 3.0% 0.2% 0.0%
Market balance 0.05 -0.41 0.11 0.06 -0.23 0.11
W Europe 4345 4174 4334 4763 4749 4663
Production growth 1.2% -3.9% 3.8% 9.9% -0.3% -1.8%
% of global production 13.6% 12.3% 11.4% 11.3% 10.6% 9.7% Stk-to-Consptn ratio (wks) 4.91 3.94 3.71 3.44 2.95 2.89
Russia 3662 3729 3945 4245 4338 4473
Production growth 1.5% 1.9% 5.8% 7.6% 2.2% 3.1% Average cash price (USc/lb) 86.1 116.6 119.8 121.5 121.8 110.0
Rest of World 10771 11364 11666 12378 13215 15182 Average cash price (USD/t)
Production growth 6.8% 6.3% 12.3% 10.2% 6.1% 7.3% 1,899 2,570 2,641 2,679 2,684 2,425
% of global production 33.7% 33.4% 30.6% 29.4% 29.6% 31.7% Source: Brook Hunt, WBMS, DB Global Markets Research
Total 31,967 33,976 38,167 42,045 44,607 47,861
Production growth 6.8% 6.3% 12.3% 10.2% 6.1% 7.3%
Source: Brook Hunt, WBMS, DB Global Markets Research
Nickel
Demand We expect nickel prices to remain stable in 2008 as
Despite concerns over the US economy toward the end supply remains ample against a healthy increase in
of 2007, primary aluminium consumption growth demand. Stainless steel producers in the US and
recorded a robust 10.7 over 2006. The primary risk for Europe will ramp up production in the beginning of the
the metal this year is that it is more exposed to US year and we expect upward demand pressure once
weakness as its more of a developed world metal Asian producers re-enter the market after the Chinese
because of its use in packaging, high-end car New Year holiday.
manufacturing and aerospace. Nevertheless, emerging
market consumption trends – led of course by China - Supply
are set to continue at a robust pace with automobile Following a sizeable market deficit in 2006, the primary
ownership growing at vast rates and high urban nickel balance shifted to surplus in 2007 after demand
investment levels supporting aluminium intensive dried up on the back of the steep H1 price appreciation
construction and consumer goods products. and subsequent stainless steel production cutbacks. In
2009 we are forecasting a return to deficit conditions as
Figure 16: Primary aluminium demand by region global mine production growth with struggle to meet
Kt 2005 2006 2007 2008 2009 2010 the sharp demand profile.
China 7083 8790 12200 15372 17832 20328
Demand growth 20.3% 24.1% 38.8% 26.0% 16.0% 14.0%
% of global demand 22.2% 25.6% 32.1% 36.6% 39.8% 42.6% Figure 18: Major new nickel production
USA 6375 6347 5900 5976 5815 5795 Kt nickel contained in
2008 2009 2010 2011 2012 2013
Demand growth 2.0% -0.4% -7.0% 1.3% -2.7% -0.3% ores & concentrates
% of global demand 20.0% 18.5% 15.5% 14.2% 13.0% 12.1% Talvivaara (Finland) 14.0 33.6 37.8 40.5 42.0 42.0
W Europe 6512 6801 7003 7087 7165 7222 RTuba/Tag'ito/Hina.etc
95.0 144.0 154.0 122.0 114.0 112.0
Demand growth -1.5% 4.4% 3.0% 1.2% 1.1% 0.8% (Philippines)
% of global demand 20.4% 19.8% 18.4% 16.9% 16.0% 15.1% Onca Puma (Brazil) 14.5 58.0 58.0 58.0 58.0 58.0
Rest of World 11942 12445 12957 13546 14025 14407 Ravensthorpe (Australia) 31.0 43.6 46.9 49.9 49.9 49.9
Demand growth 6.5% 4.2% 4.1% 4.5% 3.5% 2.7% Goro (New Caledonia) 0.0 60.0 60.0 60.0 60.0 60.0
% of global demand 37.4% 36.2% 34.0% 32.3% 31.3% 30.2% Koniambo (New Caledonia) 35.0 60.0 60.0 60.0
Total 31,912 34,382 38,060 41,982 44,837 47,752 Jinchuan (China) 73.8 80.3 103.8 109.8 109.8 109.8
Demand growth 6.5% 7.7% 10.7% 10.3% 6.8% 6.5% Total global mine
1,792 1,948 2,029 2,056 2,073 2,054
Source: Brook Hunt, WBMS, DB Global Markets Research production
Production growth 7.5% 8.7% 2.4% 0.1% 0.9% -1.0%
Source: Brook Hunt, INSG, WBMS, DB Global Markets Research
Outlook
Given that aluminium has been trading near the cost of Nickel pig iron update
production, any increase in input costs will certainly China began importing laterite ores in 2005 in order to
exert upward pressure on prices. The major risk in this produce a low nickel bearing product called pig iron, a
scenario is that the longer forward prices remain at substitute for primary nickel. Although cheaper to
elevated levels, the more announcements we’ll see of produce than purchasing primary nickel at LME prices,
new smelter projects, particularly in regions with access pig iron is also characterised as labour intensive, energy
to lower energy costs such as in Africa, Russia and the inefficient and pollutive process However, significant
Middle East. At the same time, these new plants would levels of imports did not commence until March 2006,
certainly have comparative cost advantage and would precisely when the LME nickel price began an
force the small smelters in North America and Western unprecedented rise to an all time high fourteen months
Europe to shut down as they creep up the cost curve. later. Given the rapid reduction of lateritic imports
against the sharp correction of the nickel price in June
2007, the production of pig iron is clearly sensitive to

stepped up regulation of its policies of upgrading and

Figure 19: DB Nickel Supply/Demand Model improving the efficiency of the country’s highest
Kt 2005 2006 2007 2008 2009 2010 polluters, many of whom are in the steel industry. While
World refined production 1288 1361 1463 1542 1674 1809 many such measures have been announced but largely
unsuccessful in the past, in our view, these particular
World refined consumption 1264 1376 1429 1570 1659 1787 policies will be taken more seriously as environmental
destruction becomes a top headline issue.
Market balance 23.4 -15.4 33.5 -28.0 14.2 21.4
Stk-to-Consptn ratio (wks) Demand

5.7 4.0 5.0 3.7 3.9 4.3
Stainless steel production fell by almost 17% yoy in the
Average cash price (USc/lb) 14,751 24,237 37,208 32,794 28,440 19,842 third quarter of 2007 as a result of high nickel prices and
a concerted de-stocking phase of global stainless steel
Average cash price (USD/t) 6.69 10.99 16.88 14.88 12.90 9.00 inventories. Following these cutbacks, we expect
Source: Brook Hunt, INSG, WBMS, DB Global Markets Research production will recover this year. In, Europe, most mills
the price. The key to understanding the degree of threat depleted their expensive depot stock and service
to substitution of primary nickel is the cost of nickel pig centres reduced most of their inventories and orders
iron production. Through discussion with producers and increased in the last half of Q4. Like European
independent consultants, we estimate the average cost producers, production began to ramp up in December,
in 2008 to be around USD22,200/t (USD10.10/lb). though the US mills did not appear to want to commit
to large scale production increases until more orders
Figure 20: Chinese imports of lateritic ore used in were received, probably reflecting apprehension over
housing market and economic worries. In Asia, where
nickel pig iron production
the market initially appeared to recover more quickly
1600.0 Kt The Philippines (lhs) USD/t 60,000
Indonesia (lhs) than in Europe and the US, the situation deteriorated in
1400.0 New Caledonia (lhs)
LM E nickel price (rhs)
50,000 December and Chinese producers were forced to cut
1200.0
prices for the first time in four months against slower
40,000
1000.0 than expected demand and a sharp drop in the LME
800.0 30,000 nickel price in November/December. It is expected that
600.0
20,000
a major upturn in Asian demand for stainless steel will
400.0 not occur until after the Chinese New Year.
10,000
200.0
0.0 0 Figure 21: Primary nickel demand by region

Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07
Kt 2005 2006 2007 2008 2009 2010
Source: INSG, DB Global Markets Research China 195 249 311 380 422 486
Demand growth 21.4% 27.3% 25.0% 22.2% 11.2% 15.1%
% of global demand 15.5% 18.1% 21.7% 24.2% 25.5% 27.2%
So far, most pig iron produced has only really been USA 135 142 151 153 154 155
Demand growth 4.8% 5.2% 6.5% 0.8% 1.2% 0.7%
suitable for utilisation in the lower grade 200 series of % of global demand 10.7% 10.3% 10.6% 9.7% 9.3% 8.7%
stainless steel, though some producers are using European Region 410 439 433 455 472 498
electric arc furnaces to make higher grades that can be Demand growth -7.1% 7.1% -1.3% 4.9% 3.9% 5.5%
% of global demand 32.4% 31.9% 30.3% 29.0% 28.5% 27.9%
used in the higher quality 300 series stainless. Although Rest of World 524 546 534 583 610 647
it is estimated greater production of higher quality pig Demand growth -5.3% 4.3% -2.3% 9.1% 4.8% 6.0%
iron for use in 300 series stainless will occur in 2008, % of global demand 41.4% 39.7% 37.3% 37.1% 36.8% 36.2%
Total 1,264 1,376 1,429 1,570 1,659 1,787
there are a few caveats that help minimise the potential Demand growth -1.6% 8.8% 3.9% 9.8% 5.7% 7.7%
for considerable substitution from primary nickel. Source: Brook Hunt, INSG, WBMS, DB Global Markets Research
First is the sensitivity to the LME nickel price which in Outlook

the last quarter of 2007 showed more stability than any In summary, we think prevailing market fundamentals
other period in the year. Stainless steel producers are colluding to provide a more stable nickel price in
require a certain level of price consistency. Also, the 2008, though supply-side risks always have the
rainy season in top importer the Philippines will likely potential to shock a market which is delicately balanced.
limit ore shipments to China between January and From our last review in early September, we have
March. Perhaps more importantly, production of the reduced our 2008 forecast by 10% to USD29,625/t
higher qualities of pig iron requires blast furnaces, many (1343.8USc/lb) and the 2009 expectation by 2% to
of which are small-scale and significant polluters. Pig USD27,888/t (1265.0USc/lb).
iron producers took over obsolete blast furnaces that
were no longer producing steel because of a National
Development and Reform Council (NDRC) directive
requiring the closure of all furnaces smaller than 300
cubic meters. As we noted above, China’s NDRC has

Figure 22: Nickel supply analysis Demand

2500 Kt Possible Projects
Stainless steel production cutbacks in the second half
Probable Projects of 2007 weighed on demand for molybdenum.
Highly Probable Projects
2000 Actual/Projected Refined Production
However, as stainless steel mill orders improve, the
World nickel dem and demand for molybdenum was revived at the end of the
1500
year and we expect that dynamic to provide significant
support to the molybdenum market.
1000
While the molybdenum market balance moved negative
500
in 2006 and even further negative in 2007, the spot
price of molybdenum has been relatively stable for the
0
last three quarters of 2007. This increasingly negative
2003 2005 2007 2009 2011 2013 market balance, coupled with the bullish outlook for
Source: Brook Hunt, INSG, WBMS, DB Global Markets Research stainless steel pointing to increased demand, and
worries about Chinese supply, mean that molybdenum
prices are poised to rise in H108. The risk remains that
the stainless steel market doesn’t recover as early as
Molybdenum
expected, or unexpectedly high molybdenum supply
Molybdenum is a unique alloy which is used in a variety
from China or other sources.
of applications, primarily as corrosion resistance and
strength in stainless steel and in wrought and super
Figure 24: Molybdenum price
alloys. With one of the highest melting points of all the
elements, it is also used in electrical and electronic 40
devices such as many high temperature heating

elements, radiation shields, glass melting furnace 30
electrodes and heat sinks for matching silicon for
semiconductor chip mounts. Molybdenum is
predominantly bought and sold through long-term 20
contracts.
10 Molybdenum price
After a remarkable run in which molybdenum prices (USD/lb)
saw an over-80% increase from the end of 2003 until
0
June 2005, prices fell off their highs. However, prices
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
found new strength in the first quarter of 2007 and
remained at their highs for the remainer of the year. Source: Reuters
Supply Zinc
While primary supply remained tight at the end of 2007, The decline in the zinc price that started at the end of
increased year-end stock sales lifted upward pressure 2006 on fund-based technical selling and as the market
on prices. Western mine output remained flat in 2007. anticipated a move to a market surplus continued in
Not long after large-scale producer Thomas Creek 2007. Despite the sharp fall, global exchange
Metals cut its 2008 production forecast, a landslide at inventories remained at very low levels as the expected
one of its key assets will likely bring the year’s total surplus has yet to materialise and we estimate the
down further. global zinc market was 260Kt in deficit in 2007.
Chinese molybdenum output was up 50% this year.

Figure 25: Zinc global exchange stocks
However, it is not clear how much of this increase will
800 200.0
be matched by increased domestic consumption. Global Exchange Stocks, Kt (lhs)
LM E Cash Price, USc/lb (rhs)
Adding to the uncertainty, future supply from China may 160.0
be affected by expectations that China may raise its 600
export tax on ferromolybdenum to 15%, as reported by 120.0
CRU. 400
80.0
Figure 23: Primary molybdenum supply and

200
demand, 2005-2007 40.0
Millions lb 2003 2004 2005 2006 2007

Global Consumption 345.8 385.9 388.3 426.4 440.9 0 0.0
Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07
Global Supply 344.9 389.2 400.0 426.3 434.5
Source: Brook Hunt, ILZSG, DB Global Markets Research
Global Market Balance -0.9 3.4 11.7 -0.1 -6.4
Source: CRU

Supply world was unable to fill the zinc market supply gap
In 2008, we are expecting the global zinc market to evident from 2003, China brought more metal to the
record its first market surplus since 2003, largely as a party. The country recorded a small net export balance
result of a surge in Chinese smelting capacity in the in 2006 and according to our estimates, China will
second half of the year. Evidence of this is starting to remain a net exporter for the foreseeable future.
manifest as exchange stocks in China are rising and are
currently at an all-time high of 55.5Kt. There is one important caveat to this scenario which
has only recently developed. As detailed above, the
This trend has also been reflected in recent annual zinc Chinese government is stepping up its efforts on
treatment charge (TC) negotiations which are expected restricting the export of high energy consumption and
to swing in favour of smelters as a consequence of an polluting industries. We expect authorities will
anticipated concentrate surplus and lower zinc prices. In eventually scrap the 5% export rebate on Special High
2007 the treatment charge benchmark was USD300/t. Grade (SHG) zinc with 99.995% purity (the grade of
As a result of this year’s weakness, we expect terms to metal traded on the international market), as soon as
be settled around the USD340/t level. mid-2008 as well as imposing an export duty later in the
year. There are two important implications to the tariff
Figure 26: Refined zinc production by region changes. First, in the shorter-term, exporters will likely
Kt 2005 2006 2007 2008 2009 2010
rush to get as much material out on the market before
China 2761 3163 3726 4448 5068 5278 the changes are made which will affect their bottom
Production growth 9.5% 14.6% 17.8% 19.4% 13.9% 4.1% line. A flood of metal will tip the global market balance
North America 1056 1079 1072 1120 1195 1195
Production growth -7.4% 2.2% -0.7% 4.5% 6.7% 0.0%
deeper into surplus territory than we are currently
Western Europe 2072 1971 2023 2106 2091 2063 forecasting. The second implication is less bearish – in
Production growth -5.8% -4.9% 2.6% 4.1% -0.7% -1.3% the longer term, the export duties could prompt a
Australia and Asia 2243 2355 2405 2699 2766 2861
Production growth -0.2% 5.0% 2.1% 12.2% 2.5% 3.4%
slowdown in Chinese refined production growth and
Total 10,128 10,555 11,335 12,418 13,258 13,625 begin to tip the global market balance in the other
Production growth -0.1% 4.2% 7.4% 9.6% 6.8% 2.8% direction. It would require a substantial rise in zinc
Source: Brook Hunt, ILZSG, WBMS, DB Global Markets Research
prices before exports would again become attractive.
Any swing factor in the zinc market in 2008 will come

Figure 28: Changes to the Chinese zinc tariff regime
from production and exporting trends in China. The
Jan-04 Cut export rebate to 11% of 17% VAT
country had traditionally been a large net exporter of
refined zinc until 2004 when the government began Jan-05 Cut export rebate to 8% of 17% VAT
tinkering with the tariff regime to discourage exports Jan-06 Cut export rebate to 5% of 17% VAT
and encourage greater imports. The effect was
immediate and imports began in earnest, sending China Sep-06 Cancelled a 5% tax rebate on exports of HG (lower quality) zinc
well into net import territory in 2004 and especially Jan-07 Imposed a 5% tax on exports of HG zinc
2005. Not incidentally, this was also the period in which
Jun-07 Increase tax on exports of HG zinc to 10%
the zinc price soared to all-time nominal price highs.
mid-08 Considering imposing a 5 or 10% tax on SHG (high quality) zinc exports
Figure 27: China’s net refined zinc trade balance
mid-08 Considering removing a 5% tax rebate on exports of SHG zinc
vs price
Source: Bloomberg
Annual net visiible trade balance
600 Kt 3500
USD/t, (rhs)
450 3000 Demand

Meanwhile, consumption trends remain robust. Zinc
300 2500
demand is driven by galvanized steel production and
150 2000 ultimately construction. Trends in Chinese consumption
dominate global zinc consumption growth, now
0 1500
representing over 30% of demand for zinc. While
-150 1000 consumption growth in the United States fell in 2007
and will likely drop even sharper in 2008, we believe the
-300 500
strength in emerging market demand will more than
1996 1998 2000 2002 2004 2006 2008*
offset those losses. China leads total global growth
*2008 estimate
patterns and with fixed asset investment representing
>50% of GDP, we continue to see upside risk to
However, in mid-2006, Chinese exports began to Chinese zinc demand estimates (11.5% in 2007 and
increase from 2006 as a consequence of the attractive 11.0% in 2008).
LME price and a sharp increase in Chinese concentrate
mining and smelting capacity. While the rest of the

Figure 29: Refined zinc consumption by region Figure 32: DB Zinc Supply/Demand Model
Kt 2005 2006 2007 2008 2009 2010 Mt 2005 2006 2007 2008 2009 2010
China 2853 3166 3531 3919 4370 4872 World refined production
Demand growth 18.0% 11.0% 11.5% 11.0% 11.5% 11.5% 10.10 10.53 11.31 12.48 13.36 13.60
% of global demand 26.9% 28.4% 30.5% 32.2% 34.0% 36.3%
USA 1182 1224 1163 1151 1181 1187 World refined consumption 10.61 11.15 11.59 12.18 12.87 13.41
Demand growth -5.1% 3.5% -5.0% -1.0% 2.6% 0.5%
% of global demand 11.1% 11.0% 10.0% 9.5% 9.2% 8.9%
Market balance -0.51 -0.59 -0.26 0.33 0.53 0.22
Western Europe 2233 2323 2346 2382 2441 2442
Demand growth -4.7% 4.1% 1.0% 1.5% 2.5% 0.0%
% of global demand 21.0% 20.8% 20.2% 19.6% 19.0% 18.2% Stk-to-Consptn ratio (wks) 4.0 2.0 0.8 2.1 4.2 4.8
Asia (excl Japan & China) 1980 1991 2025 2103 2180 2211
Demand growth 4.1% 0.5% 1.7% 3.9% 3.7% 1.4% Average cash price (USc/lb) 62.7 148.6 154.5 105.0 95.0 105.0
% of global demand 18.7% 17.8% 17.1% 16.3% 15.4% 14.8%
Total 10,610 11,150 11,592 12,181 12,866 13,409 Average cash price (USD/t)
Demand growth 3.0% 5.1% 4.0% 5.1% 5.6% 4.2% 1,383 3,277 3,407 2,315 2,094 2,315
Source: Brook Hunt, ILZSG, DB Global Markets Research Source: Brook Hunt, ILZSG, DB Global Markets Research
While we remain relatively bearish on the price outlook

in 2008 and 2009, our supply and demand model shows
Lead
that market conditions are set to improve in 2010
Lead had one of the most remarkable price runs of the
against a forecast concentrate deficit that will tighten
year, largely as a result of two factors – a change in
the market. Mine supply is actually set to record
Chinese export taxes and the termination of exports
negative growth in 2010 and 2011. We therefore
from a mine in Western Australia which prevented
remain positive on the longer-term outlook for zinc.
around 3% of global concentrates from entering the
market. Those factors, coupled with an already tight
Figure 30: Mined zinc production by region (Zn in market balance against low supply and resilient demand
zinc and bulk concentrate) – particularly out of China – made lead an attractive
Kt 2006 2007 2008 2009 2010 2011 investment destination. As a consequence, like nickel,
Australia 1341 1526 1785 1886 1807 1616 lead joined the real price all-time high club in 2007,
Production growth -0.3% 13.8% 16.9% 5.7% -4.2% -10.6%
L America 2052 2437 2761 2907 2820 2731 peaking in October at USD3989/t (180.9USc/lb), 136%
Production growth 2.2% 18.8% 13.3% 5.3% -3.0% -3.1% above where prices began the year.
China 2937 3200 3440 3610 3610 3610
Production growth 13.3% 8.9% 7.5% 4.9% 0.0% 0.0%
N America 1331 1448 1708 1819 1591 1471 Figure 33: LME lead price vs stocks
Production growth -3.6% 8.8% 17.9% 6.6% -12.5% -7.6%
120 Kt LME total stock (lhs) USD/t 4000
Total 10,370 11,328 12,764 13,578 13,571 13,226
4.4% 9.2% 12.7% 6.4% -0.1% -2.5% LME 3-month closing price (rhs)
Production growth
100 3500
3000
80
Figure 31: Zinc supply analysis 2500
60
20000 Kt 2000
18000 Possible Expansions 40

1500
Probable Expansions
16000
Base Case M ine Capacity 20 1000
14000 World refined zinc consum ption
0 500
12000
Jan-06 Jul-06 Jan-07 Jul-07 Jan-08
10000
8000
6000
Supply
4000 One major factor affecting the lead market in 2007 was
2000 changes in the Chinese tariff regime. The first change
0 came in December 2006 after the Ministry of Finance
2004 2006 2008 2010 2012 removed the 13% export rebate on refined lead exports
Source: Brook Hunt, ILZSG, DB Global Markets Research as well as scrapping the 13% lead-acid battery rebate
and reducing the rebate on some lead alloy products to
5%. Chinese lead exports fell over 80% mom in
January 2007. Next, an export tax of 10% was imposed
on refined lead which took effect from June 1.
Furthermore, it is expected that export duty could be
increased to 15% in mid-2008. Between January and
November 2007, Chinese refined lead exports were
down 54% yoy as producers obviously favour higher
domestic lead prices as opposed to increased exporting

costs. Given that China accounts for roughly 30% of Figure 35: Primary lead demand by region
global lead exports, the physical manifestation of this Kt 2005 2006 2007 2008 2009 2010
development is a tightening of refined metal supply in China 1850 2169 2516 2893 3183 3437
industrialized countries. Demand growth 32.0% 17.2% 16.0% 15.0% 10.0% 8.0%
% of global demand 24.2% 27.3% 30.4% 33.2% 34.9% 36.3%
USA 1598 1605 1613 1621 1635 1646
Figure 34: China’s net refined lead trade Demand growth 6.3% 0.4% 0.5% 0.5% 0.9% 0.6%
% of global demand 20.9% 20.2% 19.5% 18.6% 17.9% 17.4%
70 Net visible trade balance, Kt (+/- export/import)
Removal of export rebate W Europe 1662 1639 1639 1613 1610 1620
60
12 month moving average Demand growth -0.7% -1.4% 0.0% -1.6% -0.2% 0.7%
% of global demand 21.7% 20.6% 19.8% 18.5% 17.7% 17.1%
50 Rest of World 2547 2545 2507 2586 2688 2774
Demand growth -0.6% -0.1% -1.5% 3.2% 3.9% 3.2%
40 % of global demand 33.3% 32.0% 30.3% 29.7% 29.5% 29.3%
Total 7,657 7,958 8,275 8,713 9,115 9,477
30
Demand growth 7.2% 3.9% 4.0% 5.3% 4.6% 4.0%
20
10
Outlook
0 We expect lead prices to ease to a more sustainable
level in 2008 as Ivernia restarts concentrate shipments.
Source: Brook Hunt, ILZSG, DB Global Markets Research Prices have staged a modest rebound since mid-
December after news of the temporary closure of
The other major factor affecting supply-side dynamics refined capacity in Yunnan province in China that
occurred in March when the Australian Department of producers blamed on high production costs as the
Environment and Conservation suspended the lead result of the removal of a local tax break and the sharp
export license from the Western Australian port of decline in international and domestic prices. The plants
Esperance in March 2007 after thousands of birds died are not expected to resume operations before late
due to lead dust poisoning at and around the port. It February. These two supply constraints highlight the
also investigated excessive levels of nickel dust during biggest risk lead prices face in 2008 against a tight
loading. Ivernia’s Magellan mine, which is responsible market balance. We moderately increased our 2008
for around 3% of global concentrate supply has been forecast to USD2326/t (105.5USc/lb) and left our 2009
unable to make shipments to its customers since then. estimation unchanged at USD1692/t (76.8USc/lb).
However, in early December, Ivernia announced it
expects to get permission to ship lead in concentrate Figure 36: DB Lead Supply/Demand Model
via Fremantle port in March-April 2008. This news had
Mt 2005 2006 2007 2008 2009 2010
an immediate effect on lead prices and we expect there
World refined production 7.56 7.89 8.04 8.72 9.21 9.69
will be a further correction once those exports resume.
World refined consumption 7.66 7.96 8.27 8.71 9.12 9.48
Demand
On the demand side, consumption levels remain robust, Market balance -0.09 -0.07 -0.23 0.01 0.10 0.21
largely on the back of battery demand in China. Growing
demand for cars, light vehicles and electric bicycles Stk-to-Consptn ratio (wks) 2.1 1.5 0.0 0.0 0.6 1.7
reflect the continuing social and economic
Average cash price (USc/lb) 44.3 58.4 117.2 105.5 76.8 65.0
transformation occurring in china (as well other
emerging market economies). The level of Chinese Average cash price (USD/t) 977 1287 2584 2326 1692 1433
demand growth in 2007 was slightly lower than in 2006
as a result of the spike in price and the removal of the Source: Brook Hunt, ILZSG, DB Global Markets Research
export rebate for lead-acid batteries, but China still

remains by far the largest lead consumer. We expect
demand levels to ease against governmental efforts to
control monetary policy, though that risk profile of lower
demand growth is clearly skewed toward the upside.

Tin Chinese refined tin demand was exceptionally strong in

While most metals across the LME complex were Q407, during which China actually became a net
choppy in 2007, tin prices rose steadily throughout the importer of refined tin. This shift, along with the strong
year, and closed the year up 67%. Annual average consumption outlook, likely drove China to levy the tin
prices are at their highest since 1980. This strength export tax described above.
follows a similarly robust 2006, which saw prices
increase by almost 70% as well. Figure 38: Chinese refined tin net trade balance
8.0
Supply Kt
6.0
According to CRU estimates, world refined tin
production fell 2% in 2007. Indonesian supply issues 4.0
continued to dominate supply-side fundamentals in

2.0
2007, as the government continued its efforts to
consolidate refined and concentrate tin production. 0.0
Indonesia is the world’s second largest producer of

-2.0
refined tin, behind China. The Indonesian Trade
Minister recently announced that there was no plan to -4.0
enact official supply quotas to limit exports. In the
Net visible trade balance, Kt (+/- export/im port) 12 m onth m oving average
place of quotas, Indonesia would likely continue to
strictly implement its existing export licensing system.
The politics of tin supply control have confounded
Outlook
outside observers, and continued Indonesian supply
There are a number of factors that could weaken tin
uncertainty is expected in 2008.
prices in 2008. A US recession or a slowdown in global
growth could undercut tin demand. At the same time, if
Meanwhile, top producer China introduced a 10% tax
Indonesia loosens its grip on its tin production, a surge
on refined tin exports from January 1, 2008 in an
in tin supply could enter the global market. Also, the
apparent push to keep more for its own rampant
current price of tin relative to current stock levels is
demand. This tax will likely dent exports, and in turn
unprecedented in the last two decades, suggesting that
reduce global supply.
a price correction might be in order.
Figure 37: Global tin exchange stocks vs price However, the most likely scenario is that worldwide
40 Global Exchange Stocks, Kt (lhs) 800.0 supply will likely remain depressed in 2008 with
LM E Cash Price, USc/lb (rhs) continued Indonesian regulatory uncertainty and the
700.0
newly introduced Chinese tin export tax. This weak
30
600.0
supply outlook, coupled with strong 1H07 consumption
500.0 expectations and an already tight supply and demand
20 balance all point to continued gains for tin prices in
400.0
2008. We have increased our forecast in 2008 by 21%
10
300.0 to USD14,716/t (667.5USc/lb) and by 7% in 2009 to
200.0 USD9,976/t (452.5USc/lb).
0 100.0
Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07
Source: Reuters, DB Global Markets Research Joel Crane, (1) 212 250 5253
joel.crane@db.com
Demand
According to CRU estimates, consumption was flat in
2007. Coupled with falling supply, this led to an annual
supply deficit of approximately 8,000t. While
consumption stagnated throughout the first three
quarters of 2007, Q4 consumption picked up in every
major market, which caused the supply and demand
balance to tighten at the end of the year. The electronic
solder business, the primary source of demand,
continues to increase demand for tin as the growing
trend for lead-free solder persists. Consumption is
expected to continue to be strong in the first half of
2008, causing further balance pressure.

Figure 1: The world’s Top 13 commodity

#16 Agriculture producers*
The Global Fight For Food 500 Agricultural output in 2007-08 (million tonnes) Sugar
Soybean
450
Rice
• The United States and China dominate in 400 Wheat
350 Corn
terms of global agricultural production.
300
However, what distinguishes the two 250
counties apart is their role on global export 200
markets. While the US is consistently among 150
the top two exporters of many agricultural 100
commodities, China is becoming increasingly 50

0
reliant on agricultural imports.
o
a
il
S
m
na
an
nd
a
az
•
ic
di
-2
in
ad
si
si
U
na
st
hi
la
This deteriorating in China’s agricultural trade
ex
us
ne
In
nt
EU
Br
an
C
ki
ai
et
ge
M
R
do
Pa
Th
Vi
C
Ar
In
position reflects improving living standards
and hence a shift to more high protein diets. * We rank countries according to the combined output of corn, wheat,
rice, soybeans and sugar (cane & beet) production
This process is still in its infancy since China Source: USDA
currently consumes just 60kg of meat per
annum or 60% of the world average and 20%
of per capita meat consumption in North What distinguishes the US and China apart is that the
America. US is not only among the top two producers of many
agricultural commodities (with the exception of rice),
• Moreover agricultural land per head of
but, it also holds a similarly dominant position in terms
population has been falling for the past 30
of world exports. For example, in 2006-07 the US
years in China.
accounted for 60%, 43% and 22% of world exports for
• The most significant deterioration in China’s corn, soybeans and wheat respectively.
agricultural trade position has been in
soybeans while the country is now in danger
of becoming a net importer of corn for the Figure 2: US & world exports of a selection of
first time since the mid-1990s. agricultural commodities
• We expect the expansion in world ethanol 120 Rest of world exports (million tonnes)
and biodiesel production will sustain strong US exports (million tonnes)
demand for corn and soybeans as well as 100
pushing inventory-to-use ratios to critically 80

low levels.
• For the current rallies in corn and wheat to 60
become the most powerful and durable on 40

record it would require price appreciation of a
further 30-50% and price peaks to occur in the 20
first half of 2009. For prices to hit all time

0
highs in real terms would require price gains Wheat Corn Soybeans Sugar Rice (milled)
of a further 170% and 100% respectively.

Source: USDA
• For the current rallies in soybeans and cotton
to become the most powerful and durable on
record it would require price appreciation of a In contrast, China is becoming increasingly dependent
further 70% and 105% and price peaks to on agricultural imports. This reflects improving living
occur in June 2012 and October 2008 standards and hence a shift to more high protein diets.
respectively. For prices to surpass their all Even so there is significant scope for this to rise further
time highs in real terms would require an since Chinese meat consumption remains low by
additional 240% and 375% respectively. international standards. Currently per capita meat
consumption in China amounts to just 60kg annually.
• We are therefore maintaining agricultural as
This represents 60% of the world average and 20% of
our favourite commodity sector during 2008.
per capita meat consumption in North America. Land
The United States and China dominate in terms of the constraints are also a cause for concern. While there
production of the four main agricultural commodities: has been some reversal in agricultural land loss over the
corn, wheat, rice and soybeans. Their production is past few years, agricultural land per head of population
more than double their nearest rivals, India and the EU, has been on a declining trend for the past 30 years,
Figure 1. Figure 3.

Figure 3: China’s arable land per head of Figure 5: China is moving to become a net
population is on the decline importer of corn and sustaining its high trade
Hectares of arable land per capita (lhs) deficit in cotton
0.16 160
Total area under cultivation (million China's net trade balance in:
20000
0.15 hectares, rhs)
155 15000 Sugar Corn
0.14
10000 Wheat Cotton
5000
0.13 150
0
0.12
-5000
145
0.11 -10000
-15000
0.1 140
-20000
1978 1985 1990 1992 1994 1996 1998 2000 2002 2004 2006 Tonnes (000s)
-25000
Source: China Statistical Bureau 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Source: USDA
These trends are leading to a sharp deterioration in the

country’s agricultural trade balance, with the most
noticeable deterioration in the country’s net trade Global ethanol and biodiesel production is forecast to
balance in soybeans, Figures 4. China is now the grow rapidly over the next few years, Figure 6.
world’s largest importer of soybeans in the world, with However, world ethanol production continues to be
approximately 40% of the world’s soybean exports concentrated in the US and Brazil.
heading to China. The dramatic increase in soybean
oilseed imports has stemmed from rising demand for Figure 6: Global ethanol and biodiesel
higher protein foods and hence increased animal feed production
demand. Moreover the country’s dominance in the
global textile sector has also meant that the country is 20 World ethanol production
also the world’s largest cotton importer. World biodiesel production
15
Figure 4: The past few years has seen a dramatic

Gallons (billion)
increase in Chinese net soybean imports

10
5000 Tonnes (000s)
0 5
-5000
-10000
0
-15000 China's net trade balance in:
2006 2007 2008 2009 2010
-20000 Soybean oil

Source: Potash Corp
-25000 Palm oil
-30000 Rapeseed oil
-35000 Soybean oilseed

In the US, corn remains the primary feedstock for
-40000 ethanol production and has been an important source of
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
the increase in global corn consumption during 2007.
Source: USDA According to the USDA, an estimated 60% of corn
consumption growth globally last year was attributable
Aside form the rising trade deficit in soybeans and to the US ethanol industry, Figure 7.
cotton, China may soon become a net importer of corn
for the first time in more than a decade, Figure 5. We
believe such a shift in the country’s trade position will
propel the corn price to all time highs as it is coinciding
with the increasing use of ethanol production in the US.

Figure 7: Contribution to the increase in global Figure 9: Global inventory to use ratios for corn,
corn consumption (%) wheat and soybeans
Corn stock-to-use ratio Total available stocks
8 US ethanol production 180 divided by daily consumption
Wheat stock-to-use ratio
China 160 Soybean stock-to-use ratio
Rest of the world
6 140
120
Days of use
4 100
80
2 60
40
0
20
0
-2 1965 1970 1975 1980 1985 1990 1995 2000 2005
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: USDA
Source: USDA, IMF
Despite the significant tightening in fundamentals
across the agricultural sectors as well as recent price
Similarly the use of soybeans as a feedstock in the US appreciation we believe prices have significant upside
and European biodiesel sector has been responsible for potential. Indeed price rallies appear to be still in their
just over 50% of global soybean consumption growth infancy in both magnitude and duration terms.
between 2005 and 2007, Figure 8. Indeed price appreciation for many agricultural
commodities so far in this cycle is still close to historical
Figure 8: Contribution to the increase in global averages. Figure 10 compares rallies across a variety of
agricultural commodities and examines the average
soybean consumption
duration and magnitude of each rally since 1970. We
10 U.S. and EU biofuels
compare what has happened today not only versus
China
Rest of the world historical averages, but, also with the most powerful
8
rally that has taken place over the past 40 years.
6
Figure 10: Agricultural commodity rallies

4
compared
2 Duration
Cycle type Magnitude (months)
0
Corn Average 131% 20
-2 Most powerful 237% 41
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Current 150% 24
Source: USDA, IMF
Cotton Average 113% 22
Most powerful 204% 59
The rising demand for agricultural commodities for Current 49% 18

human and animal consumption as well as ethanol and Soybean Average 118% 15
biodiesel purposes has contributed to a significant Most powerful 300% 26
drawdown in inventories for these commodities. We
Current 137% 16
track inventory-to-use ratios, which illustrate how
quickly (in days) the world would exhaust available Sugar Average 244% 25
supplies if production in these commodities ceased Most powerful 910% 32
today. It shows that corn and wheat inventory-to-use Current 34% 7
ratios have been declining for the past six years and
Wheat Average 139% 26
have now reached multi-decade lows.
Most powerful 353% 39
Current 218% 24
The average rally excludes the current cycle. The most powerful rally in
terms of magnitude and duration are not necessarily occurring at the same
time.

We find that soybean prices would need to rise a Conclusion

further 69% and the rally to extend beyond October We believe fundamentals across the agricultural sector
2008 for it to be the most durable and powerful rally on are set to tighten further this year. We believe the rapid
record while cotton prices would need to double and increase in agricultural imports in China is particularly
the rally to extend beyond 2012 for it to be the most bullish for soybeans, cotton and corn.
powerful and durable rally on record, Figure 11.
Moreover land and water constraints globally as well as
the expected growth in world ethanol and biodiesel
Figure 11: What prices have to do in this cycle to production at a time when global grain inventory-to-use
become the most durable and powerful rallies in ratios are falling to critically low levels are mixing a
history cocktail of substantial upside price shocks in this sector,
Current Target Price gain in our view. We are therefore maintaining our bullish
USD price price (%) Peak date outlook for this sector.
Sugar 0.11 0.30 165% February 2012
Aside from index and futures plays to express a bullish
Cotton 0.69 1.40 104% June 2012
agricultural view, Figure 13 outlines a selection of equity
Soybeans 12.49 21.10 69% October 2008 routes.
Wheat 9.32 13.30 43% March 2009
Corn 4.67 6.27 34% June 2009 Figure 13: Possible companies that would
Source: DB Global Markets Research benefit form higher agricultural prices
Price &
Company Ticker DB Comment & View
However, these targets may still be too conservative in USD67.9 US nitrogen fertilizer.
our view. One of the lessons from the energy and
Agrium Inc. AGU US NR
industrial metals complex has been that at some point
during the current cycle prices in real terms have hit all Leader in agribusiness and
Archer-Daniels- USD45.0 grain processing, mainly
time highs. Figure 12 examines the degree of price
appreciation form current levels that would be required Midland Co. ADM US wheat and oilseeds. Hold
for a selection of commodities to hit their all time highs USD127.0 Leader in US/Latam
in real terms reached over the past 40 years. Bunge Limited BG UN agribusinesses, soya
processing. Buy
Figure 12: How far prices today are from their all
EUR171.0 European potash fertilizer
time highs in real terms
K+S AG SDF GR Hold
Difference between the current price
1600 1510 and the all time high in real terms (%) Global leader in biotech,
1400 USD120.0 seeds and traits. Corn, soya
1200 Cheap Expensive Monsanto Co. MON US and cotton exposed NR
1000
816
CAD138.0 World leader in potash
800
Potash Corp. POT CN fertilizer NR
600
474 439 Global wheat/corn
375
400
240
CHF307.8 agrochemical and seed play
174 156 145
200 129 128 101 Syngenta AG SYNN VX Buy
68 63 56
0
0 NOK278.5 Global leader in nitrogen
e
S o on
ad
ru r
ns
r
oa
er
l
nc
l
at
m
oi
ke
pe
ga
ffe
or
Ti
ol
iu
he
lv
Yara International YAR NO fertilizer Buy

ea
Zi
Le
t
oc
de
ic
G
ot
op
Su
C
Si
in
Co
N
yb
C
um
C
C
Al
Prices as of cob January 8, 2008

Source: DB Global Markets Research, IMF, Bloomberg
Not surprisingly, crude oil is currently the most

expensive commodity if priced on this basis while sugar
is the cheapest. Indeed of the 10 cheapest
commodities valued on this basis, seven are in the
agricultural complex. For example corn and soybeans
would need to rise approximately 170% and 240% from
current levels to surpass their all time highs in real
terms hit during the 1970s.

Figure 14: Equity routes to gain agricultural

exposure
500
Sygenta
450
Agrium
400 Bunge
Mosanto
350
Potash
300
250
200
150
100
50 30 December 2005=100
0
Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07
Theme 1: Farmland
• Long corn, cotton, soybeans &wheat
• Long corn farms, farmland REITS, grain
elevators
Theme 2: Farming services
• Long faming machinery, fertilizers,
water resources, GM crop tech
Theme 3: Farming economies
• Long the agricultural exports such as
Brazil and Argentina
Theme 4: Margins squeezed
• Short the grain users: bakert, soft drinks
companies, beer and food industry,
distilleries, ethanol producers
Theme 5: Cattle time spread
• Short the nearby and long the far
forward of the cattle future on any
drought
These 6: RV curve play
• Long May’08 vs. short Jul’08 corn time
spread to position for the curve to flip
into backwardation
Michael Lewis, (44) 20 7545 2166


(1) EU Target: A 20% reduction in GHG

#17 Emissions emissions by 2020
Banking on Higher Prices: We See The EU is now committed to achieving a reduction in its
GHG emissions of 20% relative to 1990 levels (Figure 1).
EUAs at EUR35/tonne over 2008-20 Although this is not a commitment to an absolute cut –
• The EU has a very ambitious energy-policy the target allows for the continuing use of credits from
package out to 2020 which we think points to CDM/JI projects as offsets against excess emissions –
significantly higher carbon prices over 2008-20. it is nonetheless an extremely ambitious target, and this
The package comprises three main pillars: is for three main reasons.
• First, achieving a 20% reduction in the EU’s First, taking 2010 as the mid-point of the Kyoto
greenhouse-gas (GHG) emissions against 1990 compliance period and hence the baseline for
levels by 2020; calculating the “effort required” to the new target of
20% below 1990 levels, then on current projections the
• Second achieving a 20% improvement in the
EU will have to achieve a reduction in emissions over
EU’s energy efficiency by 2020, thereby reducing
primary-energy consumption by 20% against 2010-20 of almost the same absolute magnitude as that
business-as-usual (BAU) assumptions; expected over 1990-2010.
• Third, consuming 20% of all primary energy by Figure 1: EU GHG emissions targets 1990-2020
2020 from renewable sources, and building 12 (Mt)
large-scale carbon-capture and storage (CCS)
7,000
plants in the EU by 2015.
6,000 5,810
• These policy targets imply a very tough ETS cap 5,196
for Phase-3 of the scheme, and we estimate a cut 5,000 Expected 4,648
reduction Reduction
of 17% -- or 366Mt per year – to the EU-wide cap 4,000 achieved required
4,279
from 2013. -614
4,157
-548
3,000 3,423
• Moreover, the fact that EUAs are bankable 2,000

between Phases 2 and 3 of the ETS means that
1,000
arbitrage should ensure a common price 1,531
1,039 1,225
(adjusted for the cost of carry) over 2008-20. 0
1990 Kyoto Baseline 2010E Projected levels 2020E Target
• As a result, we are forecasting an EUA price of eastern Europe EU 15
E35/t for 2008, and, after adjusting for the cost of

Source: European Environment Agency, DB Global Markets Research
carry, the same price over both Phase 2 and
Phase 3.
• Furthermore, the EU Parliament’s proposals for Second, the reduction over 2010-20 will have to occur
regulating the emissions of the aviation industry without the one-off factors that largely explain the
from 2011 are very tough, and although we do
actual reduction in emissions projected to be achieved
not think that these proposals will be
by the EU over 1990-2010 . The main factors here are (i)
implemented in full, we nonetheless think that
the aviation industry will be a significant net the step reduction in eastern European emissions in the
buyer of EUAs from 2011. This reinforces our 1990s that occurred as a result of the collapse of the
price target for EUAs. Soviet system and the ensuing industrial recession in
these countries (including the former East German), and
• Potential catalyst: Of key importance will be the (ii) the so-called “dash for gas” in the UK in the 1990s.
European Commission’s announcement on 23
January 2008 concerning its plans for improving
the ETS from 2013.
Third, we then need to factor in the BAU emissions
growth that would occur as the EU economy grows
over 2010-20.

Figure 2: Projected EU emissions to 2010 and Figure 4: EU projected “effort required” by 2020
2020 (Mt) after efficiency savings (Mt)
6,000 5,810
5,552
5,500 800
5,196
5,000 Expected Expected 700
4,500 reduction BAU increase -197
achieved +356 600
4,000
4,279 -614
3,500 500 Assumed average
4,460
3,000 4,157
400 reduction from
2,500 746
Efficiency Target by 2020
2,000 300 549
1,500 200
1,000
1,531 100
500 1,039 1,092
0 0
EU 27 Kyoto Baseline 2010E 2020E BAU Assumed BAU Assumed "Effort
eastern Europe EU 15 Emissions by 2020E Required"
Source: European Environment Agency, DB Global Markets Research Source: DB Global Markets Research
We assume annual emissions growth of 0.7% over

We assume that the demand-side target of reducing
2010-20, which means that by 2020 annual emissions
primary-energy consumption by 20% by 2020 will
would be 904Mt above the EU’s target on a BAU basis
reduce the average annual “effort required” over 2010-
(Figures 2 and 3).Adding the implied effort required in
20 by 197Mt (Figure 4). As a result, we assume that the
each year over 2011-20 together and then dividing by
EU’s other policy measures will have to reduce
ten gives us an average “effort required” over 2010-20
emissions by an average of 549Mt per year over 2011-
of 746Mt, Figure 3.
20 if the target of a 20% reduction in GHG emissions by
However, notwithstanding the very ambitious scale of 2020 is to be achieved.
the EU’s 20% emissions-reduction target by 2020, the
Commission has developed a much more coherent
energy policy than it had in the past to help meet this
(2) We expect a much tougher ETS cap from
objective.
2013…
We assume that although the ETS currently accounts

Figure 3: EU gap between 2020 BAU emissions for only about 45% of total EU emissions, and that even
and 2020 target (Mt) with the full addition of the aviation sector from 2012 it
Gap against 2010 Gap against BAU Average Gap will still only account for about 50% of total emissions,
1,000 a disproportionately large burden of the “effort
904
900 required” to reach the 2020 emissions target will be
800 746
700
placed on the ETS in general, and the power-generation
600 548 sector in particular.
500 1,037
400
734
300
200 As a result, we assume that 67% of the burden for
100 meeting the “effort required” over 2010-20 will be
0
-133 assumed by the ETS, and 33% by the non-ETS sectors
-100 -186
-200
of the EU economy. In terms of the impact this has on
EU 15 eastern Europe the size of the ETS cap over Phase 3 of the scheme,
then on our estimates it would imply a reduction of
Source: European Environment Agency, DB Global Markets Research 366Mt per year relative to the Phase-2 cap over 2008-
12, Figure 5.
This policy comprises three main elements: (i) a target

to improve energy efficiency in the EU by 20% by 2020;
(ii) a target stipulating that 20% of the EU’s primary-
energy consumption by 2020 should come from
renewable sources; and (iii) a target to develop 12 large-
scale CCS plants by 2015.

Figure 5: ETS assumed sectoral burden sharing, Figure 6: ETS, assumed average residual
2013-20 (Mt) abatement required, 2013-20 (Mt)
Annual average Assumed Remaining ETS reduction

Assumed 400
600 "Effort Required" Burden-Sharing gap to cover required
Supplementarity
Assumed
Criterion of 45% 350
500 1/3 Non -ETS
use of
82
183 300 CERs/ERUs
400
Total Assumed 250
CERs/ERUs CERs/ERUs from 141
300 200
549 allowed allowed Renewables/ 366
ETS 150 CHP
200 Non-ETS
2/3 366 43% 106
247 100
100 ETS 143
57% 141 50
0
0
Source: DB Global Markets Research Source: DB Global Markets Research
At the same time, we think that the Commission will As a result, assuming that the full renewable-energy
interpret the supplementarity criterion governing the target were met by 2020, the ETS sector would have a
use of CDM/JI credits in the ETS more strictly beyond remaining gap to cover via domestic abatement
2010 in order to reflect the increased reliance on its measures within the ETS of 82Mt per year over 2008-
supply-side targets for renewable energy and the 12, Figure 6.
construction of CCS plants laid down in its energy policy
Indeed, the 82Mt number is conservative to the extent
out to 2020. We therefore assume the Commission will
that we have above assumed that the target for
allow only 45% of each Member State’s “effort
achieving 20% of primary-energy consumption from
required” to be met via the use of CDM/JI credits over
renewable sources by 2020 is achieved in full. Evidently,
2013-20.
if the target is not achieved in full, then other things
being equal the emissions savings will be lower and the
residual abatement required by the ETS sector
(3) and this is bullish for EUA prices in both correspondingly higher. As a result, a range of 80-
Phase 2 & Phase 3 100Mt per year for the residual abatement required
In order to work out the EUA price implied by our within the ETS seems a reasonable assumption to
assumed “effort required”, we need to calculate the make.
residual amount of abatement required within the ETS. Moreover, we do not think it will be possible for ETS
To do this, we need to answer two questions: installations to cover their entire EUA shortfall over
Phase 2 from CERs/ERUs either, and that up to 30Mt
per year of abatement will have to be achieved via fuel
(i) What will be the impact of the policy measures switching in the power-generation sector over 2008-12.
relating to the target for sourcing 20% of all
primary-energy consumption from renewable
sources by 2020? If we assume that this full And crucially, Phases 2 and 3 of the ETS are linked
saving is achieved by 2020, then this translates via the bankability of Phase-2 EUAs into Phase 3.
into average annual emissions savings over 2011-
20 of 143Mt if we further assume that this is In other words, any EUAs that are not used in Phase 2
achieved in linear fashion over this period. are carried over as a matter of course into Phase 3. In
In turn, this would mean that of the 366Mt other words, there is mandatory 100% banking of
average annual “effort required” for the ETS surplus permits between Phase 2 and Phase 3, as is
sector, 143Mt would be expected to be achieved clear from Article 13 of Directive that governs the ETS
through the Commission’s renewable-energy (Directive 2003/87/EC, 13 October 2003, available at
targets, leaving a gap of 223Mt to cover. http://europa.eu.int/comm/environment/_en.htm).
(ii) How many CERs/ERUs will be available to the ETS The relevant paragraphs of this article are 13.2 (which
sector? We assume that Member States will use relates to banking arrangements between Phases 1 and
106Mt of CERs/ERUs per year over 2008-12. Since 2), and 13.3 (which relates to banking arrangements
we have assumed a total annual CER/ERU limit of between Phases 2 and 3). The big difference in these
247Mt (Figure 5), this means that the remaining arrangements is that the Directive states that banking
amount available for the ETS sector on our of surplus Phase-1 permits into Phase 2 is at the
estimates would be 141Mt per year, Figure 6.

discretion of Member States between Phases 1 and 2, opportunities at the moment would allow for nearly
but is mandatory between Phases 2 and 3: 100Mt per year of emissions abatement per year.
Over time, however, as more gas plant is built across
Europe, this number will increase, so we would argue
“13§2. Four months after the beginning of the that it is reasonable to assume that the full residual
first five-year period referred to in Article 11(2), abatement required by the ETS sector over 2013-20 will
allowances which are no longer valid and have not be achievable via fuel switching.
been surrendered and cancelled in accordance
So what are the economics of fuel switching, and
with Article 12(3) shall be cancelled by the
hence the implications for carbon prices in the ETS over
competent authority. Member States may issue
Phase 3? To answer this question we make the
allowances to persons for the current period to
following assumptions on the key variables:
replace any allowances held by them which are
cancelled in accordance with the first (i) An average oil price over 2013-20 of
subparagraph. $60/boe, this being the long-term forecast
of DB’s Commodities Research team.
13§3. Four months after the beginning of each
(ii) A gas price of Euro 0.64/therm. At $60/boe
subsequent five year period referred to in Article
this represents the average of the thermal
11(2), allowances which are no longer valid and
equivalent gas price (Euro 0.72/therm) and
have not been surrendered and cancelled in
the Troll index price (Euro 0.56/therm).
accordance with Article 12(3) shall be cancelled by
the competent authority. Member States shall (iii) A coal price of $60/t with transportation
issue allowances to persons for the current period costs of $20/t
to replace any allowances held by them which are
(iv) A carbon price of EUR35/tonne
cancelled in accordance with the first
subparagraph.” (Our emphasis.) (v) Thermal efficiency of 57% for UK gas
plant, 37-43% for coal, and 37% for lignite
What this means is that we effectively need to
(vi) A Euro/$ exchange rate of 1.38, and a
consider the entire 13 years covered by Phases 2
and 3 as one period, and thus to average our £/Euro exchange rate of 1.48
projected annual deficit over 2008-20. This results in
On our assumption of a carbon price of EUR35/tonne,
a total expected residual abatement requirement in
we believe gas would start to look economic against
the ETS of 950Mt over the 13-year period, and
hence an average annual residual abatement coal in the UK, and fuel switching would therefore start
requirement over 2008-20 of 73Mt. to happen at this level.
We think a residual abatement requirement over this

period of 73Mt is a very material amount of emissions In short, our assumption that the ETS will have to
to be abated each year, and that it will largely have to achieve residual abatement of 30Mt per year over
be achieved via fuel switching in the power-generation 2008-12, and 80-100Mt per year over 2013-20 implies
sector. a price for 2008 EUA allowances of EUR35/tonne.
Adjusted for the cost of carry, we project the same
We estimate that the opportunities for large-scale fuel
price over the rest of Phases 2 and 3.
switching are limited in the EU at the moment to three
main markets:
(i) Germany, where we estimate that up to 40Mt
(4) The impact of including the aviation
per year of abatement can be achieved via
industry
switching to coal plant (and to, a lesser extent
to older gas plant) from lignite plant;
With emissions from aviation growing faster than those
(ii) The UK, where we estimate that up to 30Mt of any other industry in the EU, the European
th
per year of abatement can be achieved via Parliament voted on the 13 of November to tighten up
switching to gas plant from coal plant; the proposals made by the Commission to regulate the
industry.
(iii) Spain, where we estimate that up to 25Mt per
year of abatement can be achieved via
In reviewing the Commission’s draft legislation for the
switching to gas plant from coal plant.
Aviation Trading Scheme (ATS) that will exist in parallel
We have set out these estimates in much more detail in to the ETS from 2011, the EU Parliament has been very
a previous research report (What If? The risk of much radical. Most notably, it has voted to allocate European
higher carbon and power prices, 1 November 2005, see Aviation Allowances (EAAs) to the industry at only 90%
especially pages 35-41), the point being that switching of its average emissions over 2004-06 rather than

100%, and to cap the use not only of CERs/ERUs, but Trade Recommendation:
also of EUAs.
• We are bullish on Phase-2 EUAs, as they
currently trade at around E23.5/t for
We do not expect Parliament’s proposals to be
2008 delivery and we think they are
accepted in full, and assume in particular that the idea
worth Euro 35/t on fundamentals
of capping the use of EUAs in the ATS will be rejected.
On our estimates, the demand from airlines for EUAs
will increase the average annual residual abatement
requirement in the ETS over 2008-12 to 60Mt from
30Mt. Mark Lewis, (33) 1 4495 6761
mark-c.lewis@db.com
Moreover, with Parliament clearly signalling that
aviation’s emissions will have to be aggressively limited
over Phase 3 as well, we now assume an increase of
60Mt in the average annual abatement required within
the ETS over 2013-20, to 160Mt from 100Mt.
Overall, this means we now project an average

annual abatement requirement within the ETS over
2008-20 of 122Mt, compared with the 73Mt we
project for the other industries covered by the
scheme before taking aviation into account.
(5) Conclusion: Banking on higher prices
Expectations about a much tighter cap in Phase 3 will

make Phase-2 allowances more valuable given that they
can be carried over into Phase 3. In effect, the
bankability of Phase-2 EUAs means that the more
drastic shortage of EUAs foreseen by the market in
Phase 3 will already be anticipated in Phase 2.
In other words, bankability means that we have to

consider the expected residual abatement requirement
in Phases 2 and 3 together rather than separately. On
our assumptions, this results in a total expected
residual abatement requirement in the ETS of 1,580Mt
over the 13-year period 2008-20, and an average
abatement requirement of 122Mt per year.
We think this level of abatement implies that in the

short term the marginal cost of carbon will be set by
fuel switching to gas from coal in the UK, and, longer
term, by the carbon price required to incentivise new
gas and/or carbon-capture and storage (CCS) coal plant
to be built ahead of conventional coal. Based on our
assumptions for long-term oil, gas, and coal prices this
implies a carbon price of EUR35/tonne.

Bali Roadmap
#18 US Carbon Trading The Kyoto Protocol binds virtually every industrialized
country (but not the US due to its refusal to ratify) to
Climate Legislation Outlook reduce their collective emissions of greenhouse gases
by 5.2% compared to the year 1990. Kyoto expires in
• Despite the US failure to ratify the Kyoto
2012. The Bali meeting was intended to work out the
Protocol, and a recalcitrant role at the recent
details of an agreement with a goal of having a new
Bali Conference, a national system to regulate
protocol in place by 2009. Based on a recommendation
emissions of GHGs is likely to take effect in
in the IPCC synthesis report, the European Union
the US by the start of year 2012.
wanted reductions of 25% to 40% by 2020. The lack of
• The Lieberman-Warner (L-W) proposal for a US binding targets for developing countries persuaded
carbon cap-and-trade system is the likely representatives from the US, Canada, Australia and
template for final US legislation on this topic. Japan to object to text that included any direct
reference to the 25% to 40% reduction. Nevertheless,
• L-W was approved by a key US Senate
Bali marked the first such international negotiation at
committee in December 2007 and is likely to
which the US did not rule out accepting binding limits in
be scheduled for a full Senate vote in 2008. It
the future. Despite the continued foot-dragging of the
covers six primary GHGs: CO2, methane,
current Administration, the timetable for the negotiating
nitrous oxide, sulfur hexafluoride, as well as
process is set to culminate in 2009 when a new
hydro- and per-fluorocarbons
President will be sitting in the White House. The US
• L-W would set caps on CO2 equivalent did agree to language that approves "measurable,
emissions in the electric power, industrial, reportable and verifiable nationally appropriate
commercial, and transportation sectors, It mitigation commitments or actions" and calls for
provides for partial auctioning of entitlements, "quantified emission limitation and reduction objectives,
and allows some use of both domestic and by all developed country Parties".
international GHG allowances.
Spurs to US Action
• The consensus view in Washington is that In October 2007, former US vice president Al Gore and
“final” law on this topic is likely to be signed the IPCC were jointly awarded the Nobel Peace Prize.
by the new President in 2010. Gore’s documentary film An Inconvenient Truth
popularized the scientific message of the IPCC, and
• We believe that curbing CO2 emissions will
politicians in Washington and industry executives were
alter the energy mix, increase energy-related
taking note.
costs, and require reductions in demand
growth. Earlier in the year (April 2007), the US Supreme Court
ruled that “the harms associated with climate change
are serious and well recognized” in a case involving the
A political consensus is forming in the US around a
refusal of the US Environmental Protection Agency
central set of climate law provisions that include
(EPA) to regulate GHG emissions from motor vehicles.
federally-enforced caps on GHGs and “traded” markets
The Supreme Court found that GHGs fit well within the
in carbon dioxide (CO2) and equivalents (CO2e).
Clean Air Act’s definition of an “air pollutant” and that
Although the US never ratified the Kyoto Protocol,
the EPA has a statutory mandate to regulate such
public pressure for the US to actively participate in the
emissions from new motor vehicles.
UN Framework Convention on Climate Change
(UNFCCC) is growing rapidly. During the course of 2007, a number of state
governments began to implement their own individual
(and regional) GHG emission initiatives and the
During the course of 2007, the Intergovernmental Panel opposition of many industrial and commercial firms to
on Climate Change (IPCC) issued four reports that federal GHG regulation began to turn in favor of
assessed the scientific aspects of the climate system Congressional action in order to avoid the potential
and climate change, the vulnerability of economic, chaos of numerous and conflicting state mandates.
social and natural systems, and options for limiting or
Congressional Activity
mitigating GHGs. A synthesis report was published in
In August 2007, Senators Joseph Lieberman (I-CT) and
November 2007, in time to provide key conclusions for
John Warner (R-VA) released a detailed outline for a
policy makers attending the UNFCCC conference in Bali,
federal GHG cap-and-trade system. The Lieberman-
Indonesia.
Warner proposal drew ideas from other climate change
bills, including the Bingaman-Specter bill introduced
earlier in the year by Senators Jeff Bingaman (D-NM)
and Arlen Specter (R-PA). The Lieberman-Warner bill
was debated and fine-tuned over the course of

September and October, and on December 5 was The direct allocation provision of ACSA provides for
approved by the full Senate Committee on Environment issuance of allowances each year in a total amount
and Public Works (EPW), chaired by Senator Barbara that equals the cap for that year. Each year, a share
Boxer (D-CA). of the allowances are allocated, at no cost, for a number
of purposes, including a long and complicated list that
America’s Climate Security Act (“ACSA”), as the bill is
includes allocations for early adopters, individual states,
titled, is currently seen as the most likely vehicle for any
low-income electricity and natural gas consumers,
federal legislation on climate change in the US and the
carbon capture and sequestration, power plants,
preferred template for further Congressional action.
agricultural and forestry programs, energy intensive
According to attorneys at VanNess Feldman, ACSA
manufacturers (iron, steel, aluminum, pulp, paper,
would place a declining cap on US emissions of the six
cement, chemicals and such other products as EPA
primary greenhouse gases. A general cap applies to
may specify), landfill and coal mine methane reduction
certain emissions of CO2, methane, nitrous oxide, sulfur
projects.and others. The remainder are allocated to the
hexafluoride, perfluorocarbon, and certain byproduct
Climate Change Credit Corporation to be auctioned,
HFCs. A separate cap applies to HFCs produced in, or
with the proceeds to be devoted to funding energy
imported into, the United States. The cap is expressed
technology deployment, including advanced vehicle
in metric tons of CO2 equivalents (CO2e). In 2012, total
technologies and advanced coal and sequestration
emissions attributable to covered facilities would be
technologies; energy assistance to consumers; a
capped at 2005 levels. In 2020, the cap would be set at
Climate Change Worker Training Program; an adaptation
1990 levels. By 2050, the cap would drop to 70%
program, and sustainable energy programs.
below 2005 levels. Between 2012 and 2050, the cap
declines from 5.775 billion tons in 2012 to 1.732 billion
tons in 2050. During the 38 intervening years, the cap
ACSA provides for limited offsets and international
would decline by 106 million tons each year.
trading. “Domestic Offsets” under which a covered
ACSA provides for a combination of allocation and facility would be able to satisfy up to 15% of a given
auctions for distributing allowances. It would year’s compliance obligation with domestically
impose direct allowance surrender requirements on the generated offset allowances. The legislation provides
owners and operators of the following facilities and for “International Trading” via a mechanism to allow up
entities: to 15% of emission allowances to be obtained on a
foreign GHG emissions trading market certified by EPA.
(1) that uses more than 5,000 tons of coal in a year; (2)
This provision would foreclose use of credits from
that is a natural gas processing plant or that produces
project-based reductions from developing countries,
natural gas in the State of Alaska, or any entity that
including through the Clean Development Mechanism
imports natural gas (including liquefied natural gas; (3)
(CDM). According to experts at Van Ness Feldman, it
that in any year produces, or any entity that in any year
appears that only European Union (EU) allowances
imports, petroleum- or coal-based liquid or gaseous fuel;
would be eligible.
(4) that in any year produces for sale or distribution, or
any entity that in any year imports, more than 10,000
CO2 equivalents of chemicals that are GHGs; and (5)
Conclusions
that in any year emits as a byproduct of the production
The momentum behind US climate legislation has built
of hydrochlorofluorocarbons (HCFCs) more than 10,000
rapidly, although the consensus view in Washington is
CO2 equivalents of HFCs.
that “final” law on this topic is unlikely to be signed
Coal combustion is regulated downstream, based on ahead of the US elections in 2008. It is becoming
the CO2 emissions of the coal-burning facility. Natural increasingly likely that a national system to regulate
gas and petroleum fuels (and coal-based liquid or emissions of GHGs will take effect in the US by the
gaseous fuels) would be regulated upstream. start of year 2012, and the shape of that system is
being moulded now. We believe that curbing CO2
The bill would establish a Carbon Market Efficiency
emissions will alter the energy fuels mix in the US,
Board to oversee the carbon trading market and make
increase energy-related costs, and could require
adjustments to the emissions cap and borrowing terms
reductions in demand growth if carbon technology is
if the price of emission allowances exceeds
slow in being developed.
expectations. The legislation also directs the US EPA to
establish a clear legal and regulatory framework for
carbon capture and sequestration (CCS). Carbon
constraints could dramatically alter the energy mix – Adam Sieminski (1) 212 250 2928
favoring gas at the expense of coal – and CCS) is adam.sieminski@db.com
deemed necessary by virtually all economists to
preserve some balance in the existing global
infrastructure for energy supply and delivery.

supply will have to increasing become a greater source

#19 Uranium and there are several players in the market vying to take
that position.
More Excitement In 2008
The bulk of new mine supply will come from Canada
• Uranium delivered an unprecedented
and Kazakhstan. Cameco’s Cigar Lake project in
performance in 2007, with prices reaching an
Saskatchewan province in Canada was expected to fill a
all-time nominal high of USD136.00/lb in June.
large proportion of the gap from 2007 and ramp up to
Although prices have since fallen below
providing around 10% of total world mined production
USD100/lb, we believe market fundamentals
by 2008, but has fallen well behind schedule. In
in 2008 could provide another exciting price
October 2006, a rock fall caused the mine to flood and
performance and test the 2007 highs.
due to environmental sensitivities, the water has yet to
• In our view, supply-side developments be removed. There are also several other technical
represent the most significant sensitivity to assessments that need to be made before the company
uranium prices as production disruptions and receives regulatory approval to dewater the mine and
new mine delays have been the primary Cameco is targeting the second half of 2008 for
drivers of price volatility over the past two completion and does not expect Cigar Lake to begin
years. production until 2011 – at the earliest. Given the
multiple complexities surrounding this large-scale
• The global clamour over greenhouse gas
project, we expect more delays will be eventually
emissions has bred a mounting interest in
announced which will continue have a serious effect on
nuclear generated electricity which is likely to
the global market balance.
makeup an increasingly larger proportion of
new power capacity.
Producers in Kazakhstan have also faced difficulty
• Although spot volumes tend to be lower in the getting material to the market as scheduled. One of the
first quarter of the year and often pressure world’s top producers, Toronto-listed Uranium One, cut
prices lower, we expect discretionary its 2008 production estimate by 38%, citing a shortage
purchasing to become as robust as volumes in of sulfuric acid needed to process ore in Kazakhstan.
2007.
While we are forecasting the global market balance to
• In 2008 we are forecasting an average U3O8
revert to a surplus between 2009 and 2013, we are
spot price of USD119.00/lb and USD116/lb in
mindful of the potential of more delays to new mine
2009.
production and supply disruptions.
Supply: Production disruptions and delays remain Figure 2: New mines are coming – but will it be
the greatest risk enough?
Much like in 2006, production disruptions were one of
100 New M ines
the primary drivers of price volatility and dominated Other Secondary Supply
90 HEU Feed
uranium market headlines. In the first quarter of 2007, Prim ary m ine supply
80 Dem and
we estimated primary mine supply for the year to be at
70
47.7KtU (124.1Mlbs) but have now revised that figure
60
to 44.5Ktu (115.6Mlbs). In fact, due to producer
KtU
50
production revisions we have adjusted our primary mine
40
supply estimates every year.
30
20
Figure 1: Comparison of DB production estimates 10
in 2007 and 2008 0
tU 2007 2008 2009 2010 2011 2012 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Estimate in 200747,727 45,273 49,756 51,385 51,462 52,224 Source: WNA, UxC, DB Global Markets Research
Estimate in 200844,450 44,450 44,450 44,450 44,450 44,450
Difference tU -3,276 -823 -5,306 -6,935 -7,012 -7,774
Difference % -6.9% -1.8% -10.7% -13.5% -13.6% -14.9%
Source: WNA, UxC, Deutsche Bank Global Markets Research Demand – The growing popularity of nuclear power
Amid the global clamour over greenhouse gas
The strong demand outlook and sharp price appreciation
emissions, nuclear generated electricity – which emits
piloted a resurrection of the uranium mining sector.
almost none – is currently undergoing a resurgence in
Since the late 1980s, secondary supply (ie recycled
popularity. We expect that as the world progressively
material and downgraded highly enriched uranium) has
turns to placing a price on carbon emissions, more and
filled the gap between primary mined supply of U3O8
more energy policy makers will look to nuclear power
and demand. Given secondary supply is finite, mined
as an alternative. There are multiple economic, political,

social and environmental dimensions to this discourse Figure 5: Existing and projected nuclear power
and we believe that greater awareness of the effects of plants, 2007-2015
pollutants emitted from the traditional sources of 2015 Total
energy generation is a positive development for the Current New Reactor Capaci % Chg
MWe
prospects of greater uptake of nuclear generated reactors Builds Shutdown ty by MWe
electricity. Many studies (including our own) have s 2015
shown that in the absence of financial penalties for Asia
China 11 8828 16 0 24888
emitting pollutants, nuclear power plants are not
India 19 4183 5 0 8755
economically competitive to other electricity generating
Japan 55 47591 10 0 60099
technologies. However, given the increasing
Korea 20 17606 7 0 25456
acceptance and eventual adoption of carbon taxes and
Pakistan 2 425 1 0 725
international carbon trading schemes, we think nuclear 6 4884 2 4 10840
Taiwan
power will become more economically attractive. Total 113 83517 42 4 125166 50%
Currently, there are 95 new reactors with regulatory South America

approval scheduled to come on-line between now and Argentina 2 935 1 0 1635
2015 with dozens more planned and/or waiting for Brazil 2 1901 1 0 3125
approval. While North America and Europe have the South Africa 2 1842 5 0 2667
highest concentration of current installed capacity, the Total 6 4678 7 0 7427 59%
real growth story is in Eastern Europe and Asia,
particularly in China and India – as well as in the US. The Eastern Europe
growing popularity of nuclear power is highlighted by Armenia 1 376 0 1 752
the recent decision by Russian aluminium giant Rusal to Czech Rep 6 3472 2 0 3524
use two nuclear reactors to power a new aluminium Bulgaria 4 2722 2 2 5538
Hungary 4 1755 0 0 1755
smelter.
Lithuania 1 1185 1 1 3370
Romania 2 1361 0 0 1361
Figure 3: Distribution of current nuclear capacity Russia 31 21743 17 2 37530
Slovakia 6 2442 2 2 4098
Asia Slovenia 1 686 0 0 686
22%
North Am erica Ukraine 15 13330 3 0 16330
30% Total 71 49072 27 8 68514 40%
South Am erica &

Africa Western Europe
1% Belgium 7 5761 1 3 7508
Eastern Europe & Finland 4 2656 1 0 4256
Russia
13% France 59 63363 1 0 64963
Western Europe Germany 17 20384 0 7 28750
34% Netherlands 1 452 1 0 452
Spain 8 7430 1 1 7876
Sweden 10 8933 1 1 9700
Source: UxC, WNA, DB Global Markets Research
Switzerland 5 3220 0 0 3220
United Kingdom 23 12062 1 16 20286
Total 134 124261 7 28 108511 -13%
Figure 4: Distribution of nuclear power plant
new builds, 2008-2015 North America
Canada 18 12606 2 0 14144
North Am erica
10% Mexico 2 1364 2 0 1626
Western Europe
USA 104 100466 8 0 107246
4%
Total 124 114436 12 0 123016 7%
Global Total 448 375964 95 40 15%

Asia Source: DOE, EIA, Reuters, Bloomberg, Ux, WNA, Deutsche Bank432 634 Markets
Global
Eastern Europe
56% Research
& Russia
27%
In 2007, five reactors began commercial operation and

South Am erica &
ten started construction. Significantly, the US nuclear
Africa Regulatory Authority has received applications for new
3%
Source: UxC, WNA, DB Global Markets Research
builds. Before 2007, no company had applied to build a
new reactor in the USA since the Three Mile Island
nuclear accident in Pennsylvania in 1979. The Nuclear
Regulatory Commission says it expects to receive

applications for 25 more reactors from 13 additional Model review

companies by the end of 2009. American energy policy We have undertaken a detailed review of our supply
planners have created a very amenable environment for and demand model that has resulted in some significant
new nuclear power generation. Under the 2005 Energy changes to our global market balance and therefore to
Policy Act, the US Department of Energy will guarantee our price forecasts. The World Nuclear Association
the full amount of loans covering up to 80% of the cost (WNA) in September released its biennale Global Fuel
of new clean energy projects including nuclear power, a Market Report which provides the industry standard
program that was recently extended. The US Energy demand projections for all of the world’s nuclear
Information Administration's 2008 Outlook reference reactors.
case expects 20 GWe of newly-built US nuclear
capacity on line by 2030, almost half of it supported by In our model, we account for demand of U3O8 from
production tax credits at the same level as for wind utilities and investors. The exercise of forecasting
generation. This is 63% above previous estimates. In uranium demand is an exercise in estimating when,
addition, there is 2700 MWe in nuclear plant uprates, where and size of new builds over the outlook period,
offset by 4300 MWe retirements. and estimating when and where old reactors will be
decommissioned. Both of these tasks are subject to a
Investment demand significant degree of uncertainty, primarily caused by
Investor interest in the uranium market continues to volatile political situations. When evaluating the
gain momentum. So far, there are two Exchange prospects for nuclear power we have considered the
Traded Funds (ETFs) – Nufcor Uranium and Uranium following factors:
Participation Corporation – which provide an opportunity
for investors to leverage the uranium price. While the • The prospects for energy demand in the
two funds over the last three years secured around region;
3.5% of annual uranium consumption, there have been • Alternative energy sources available; and
other parties who have secured material to gain • Political atmosphere and public support.
exposure. Although financial investors can not obtain
the proper license requirements to actually hold
We have considered these factors on a country by
uranium, they have secured ownership rights of
country basis for the 31 countries currently using
material stored at licensed repositories in North
nuclear power or seriously considering new build in our
America and Europe, essentially exploiting legal
outlook period. We only assessed nuclear electricity
channels previously used only by utilities and suppliers.
programs in which reactors already existed, were under
Outside of the ETFs, most fund controlled material has
construction and/or guaranteed to be constructed. New
derived from the US DOE, which makes no distinction
build programs in provisional stages were not
between financial investors and end users when
considered, nor did we attempt to model probable
auctioning the fuel.
cases in our demand scenario, thus this category of
demand is only viewed as an upside risk to the market
While this new element of demand is difficult to
balance.
estimate, we think the growing popularity of
commodities as an asset class will only increase
The key assumption we have made to determine
investor interest in uranium, particularly given it has one
demand by tonnes of uranium was to take the total
of the most favourable market outlooks among the
wattage of all reactors in our database and use a
other mainstream commodities.
conversion factor to convert capacity into physical
volumes. That conversion factor is determined by
Figure 6: Nufcor NAV and implied uranium price calculating the ratio between an average of the WNA’s
5.00 140.00
reference and upper case scenarios in their annual
Im plied U3O8 price, USD/lb, (rhs)
M onth-end NU.L share price, GBP (lhs) projections of demand by MWe and tonnage. Although
130.00
NU.L NAV, GBP (lhs)
4.00 this assumption is broad, we believe this is a
120.00
reasonable estimate as it inherently accounts for every
110.00
3.00 reactor currently operating around the world.
100.00
2.00
90.00
The most significant change to our model during this
1.00
80.00 review is an expectation of a market surplus between
70.00 2009 and 2013. What tipped this estimation away from
0.00 60.00 our previously forecast deficit was a trimmed down
Aug-06 Dec-06 Apr-07 Aug-07 Dec-07
demand scenario by the WNA from their previous
Source: UxC, DB Global Markets Research projection in 2005. We note, however, that the WNA
consistently underestimates demand, even in their
upper case scenarios. Therefore we believe the risk in
this outlook lies to the upside.

Figure 7: DB U3O8 market balance vs price Figure 9: Prices will continue upward trajectory
7500 140.00 160 DB Forecast
140
3500 110.00
120
100
-500 80.00
80
60
-4500 50.00
M arket Balance, tU (lhs)
40 M onth-end spot, USD/lb
U3O8 Price, USD/lb (rhs)
20 M onth-end LT price, USD/lb
-8500 20.00
Linear (M onth-end spot, USD/lb)
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0
Dec-04 Dec-05 Dec-06 Dec-07 Dec-08
Source: WNA, UxC, DB Global Markets Research
Source: UxC, DB Global Markets Research
Price outlook
Akin to the past two years, production trends will
continue to have significant impact on prices in 2008. If Conclusion
the current primary mined supply comes to market as Given the profile of new reactor builds already
guided by the world’s producers, we are unlikely to see announced and the prospects for an even greater
a sharp move upward. However, if production again resurgence in atomic power’s popularity, the demand
ends up falling short of target in 2008 similar to the past for U3O8 will remain strong in the coming years. At the
two years, we expect spot prices could easily re-test same time, persistent delays on the supply-side will
the highs of 2007. keep the market balance tight. In the longer-term, we
expect that prices will eventually head back down
The uranium price certainly has the propensity to rise closer to long-term average as a result of increased
sharply, what remains to be seen is if the price can stay investment in exploration and production. However until
high for a longer period of time. We have argued in the then, prospects in the uranium market certainly remain
past that the last time prices tracked above the long- positive.
term real price average, it lasted for 10 years. If history
is to repeat itself, this cycle is only in its infancy, Figure Joel Crane (1) 212 250 5253
XX. joel.crane@db.com
We have moderately decreased our price forecast from

our previous update last September, dropping the 2008
expectation by 8% to USD119.00/lb and the 2009
forecast by 11% to USD116/lb.
Figure 8: Real vs nominal U3O8 prices, annual
160.00 USD/lb
Nom inal
Real (2006 constant)
140.00
LT Real Average Price
120.00
100.00
80.00 Period above LT Real Average Price
60.00
1974 - 1984 2006 - ????
40.00
20.00
-
1971 1975 1979 1983 1987 1991 1995 1999 2003 2007
Source: UxC, DB Global Markets Research

Figure 1: Iron ore and the base metal cycle

#20 Bulk Commodities
450 Base m etal index w eightings:
Al 42.6%, Cu 25.4%, Zn 16%, Pb 13.6%,
•
400 Ni 1.9%, Sn 0.5%.
Bulk commodities like iron ore, coking coal
350
and thermal coal are making new price highs 300
37 44 44 30
m onths m onths m onths m onths
driven by shortages in supply, infrastructure 250
bottlenecks and strong demand. This pattern 200
of rising bulk commodity even after the peak 150
in industrial metal prices may have been 100
reached has been evident in preceding cycles. 50
•
Aug-69 Feb-75 Jul-80 Jan-86 Jul-91 Dec-96 Jun-02 Dec-07
We believe the iron ore market will continue
to tighten over the next two years. We have Base M etal Index Australian iron ore fines
adjusted both short and medium term prices

Source: Datastream, TEX Report, CRU, Deutsche Bank estimates.
upwards to reflect both the tightness in the *Prices referenced to October 2001 (the base metal trough)
iron ore market, cost pressures and also
rising capital costs. We expect that JFY2010 We believe that this delay is driven by two key factors,
will be the year that the supply side catches 1) the bulk commodity contract prices are negotiated
up to demand and expect to see prices annually so this can lead to up a year lag and 2) The bulk
declining at that point, but, remaining at commodities are not screen traded like the base metals
elevated levels by historical standards. and not subject to as much speculation or anticipation.
That is, if the market anticipates a loosening in one of
• Coke prices are also on the rise reflecting the base metals, it will be sold off early (zinc is a prime
strong underlying demand for carbon units in example of this, in early 2007 the market expected that
key Asian markets. As a result of the 2008 would bring a surplus and the price decline right
continuing tightening in coking coal market through 2007 despite continued low inventory levels).
dynamics we are now forecasting a +60% The negotiated outcomes for the bulk commodities
increase for premium hard coking coal prices tend to more readily reflect the supply demand balance
in JFY 2008 (prev +25%) to USD150/t and for of the bulk commodities at the time of the negotiations
JFY2009. in our opinion.
The bulk commodities of iron ore and coal are taking In Figure 2 we track the value of the seaborne bulk
centre stage in this commodity review. While we commodity markets including the significant price
believe that base metal prices have generally seen the increases we have put through in this review. We
peak this cycle, bulk commodities like iron ore, coking expect that the continuing demand for the bulk
coal and thermal coal are making new price highs driven commodities combined with continuing impediments to
by shortages in supply, infrastructure bottlenecks and producer growth will mean that bulk consumers will
strong demand. This pattern of rising bulk commodity need to pay even more for the products over the
prices after peaks in base metal prices has been evident coming years. It is worth noting that these figures
in preceding cycles and we believe will also be the case perhaps understate the total value as we have assumed
in this cycle. The chart below highlights this case with all trades are priced on contract pricing terms.
the Australian fines iron ore price used as the example.
We see here that it took between 30 and 44 months
Figure 2: Global seaborne bulks market and
from the downturn in base metal prices to reach the
downturn in iron ore prices. value, 2000 -2009
180 US$bn
160
140
120
100
80
60
40
20
0
2000 2001 2002 2003 2004 2005 2006 2007E 2008E 2009E
Seaborne iron ore Seaborne metallurgical coal Seaborne thermal coal
Source: CRU, TEX, UNCTAD, McCloskey, AME, DB estimates

The spot/ short-term contract prices remain significantly Figure 4: Baltic capesize freight rates on key
above the 2007 term contract prices and provide a routes
ready barometer of the short-term supply demand
100
status for the markets…ie. A high pressure zone! This Australia to China
difference provides a positive bargaining chip for the Brazil to China
80 Freight Differential
producers in the current price negotiations. We expect
that the ongoing market tightness into the medium
60
term will mean that the steel producers and utilities will
USD/tonne
be required to pay up for raw materials in 2008 and into
40
2009.
20
Figure 3: Spot prices vs 2007 contract prices
0
200%
Jan-00 Jul-01 Jan-03 Jul-04 Jan-06 Jul-07
180%
160% Source: Reuters, Deutsche Bank estimates
140%
120% Direct tightness in shipping capacity is not the only
100% driver of the higher freight rates. Infrastructure
80%
congestion globally has meant that ships are often
60%
unable to be loaded in planned timetable resulting in
40%
20%
many ships being held up at port – reducing the
0% effective shipping capacity even further. The export coal
Iron ore fines Coking coal Thermal coal port of Newcastle in Australia is a prime example of the
impacts of infrastructure congestion with the vessel
Source: CRU, McCloskey, DB estimates queue reaching ~80 ships in June of 2007 and still well
above long-term levels with the queue sitting at 52
Shipping rates also continue to pressure prices. Bulk ships in mid December as shown in the chart below.
commodities are by definition “bulky” and require large
amounts of shipping capacity to move around. Figure 5: Newcastle vessel queue size
Increasing demand for bulk commodities globally and a
90
shipping industry that has not been able to increase
80
capacity as rapidly as needed has driven shipping rates
up by as much as 16x over the last 5 years as shown in 70
the chart below. In this decade, the capesize freight 60
rates from Brazil to China have risen from below US$6/t 50
in September 2001 to over US$95/t in November of 40
2007. These rates are comparable with the bulk 30

commodity prices themselves. 20
10
Increases in shipping rates have not been equal across 0
regions and has led to some key rate differential Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07
increases – in particular the freight rate differential

Source: Hunter Valley coal chain logistics team, Deutsche Bank estimates
between the Brazil/China route and the WA/China route,
which blew out to >US$55/t in November 2007 and has
Newcastle is not the only port seeing the tightness in
generated a significant landed price disparity between
the market. Richard’s Bay Coal Terminal (RBCT)
iron ore from Brazil and Iron ore from Australia that
exported its largest monthly volume of coal for the 2007
currently remains unresolved.
calendar year in December (6.77mt) but problems in the
interface between the rail and the port meant port
stocks had to be drawn down to the lowest level in 15
years and pushed short term steaming coal prices from
RBCT to USD99.35/t (compared with a 2007 contract
price of USD55/t)
Clearly we see upcoming price increases for the bulk

commodities and in the next section we review the
three major bulk commodity markets in more detail.

The iron ore market continues to tighten with recent We outline key points on this bullish assessment:
spot price movements again highlighting strong
demand while providing a positive lead for iron ore Spot iron ore prices into China from India have been
producers in the current contract negotiations. We have trending higher and are currently close to US$190/t CIF,
raised our price assumptions to +45% for lump and but slightly below the US$210/t recorded in November.
fines (prev +25%) for JFY 2008 and remain at +10% for Freight rates have remained at close to record highs in
JFY 2009, implying contract prices in 2009 will be December. By comparison Brazilian iron ore on a
around 60% higher than those being received currently. delivered contract basis (CIF) is selling for around
For pellets we assume a broadly similar profile. We USD137/t CIF and Australian production for around
maintain our previous view of the profile of price USD87/t. The FOB price for iron ore fines is around
declines from 2010-2012 but from a higher base. We USD50/t in JFY 2007. An increase of +45% in contract
expect that JFY2010 will be the year that the supply prices would lift the delivered price of Australian ore to
side catches up to demand and expect to see the prices around US$110/t and Brazilian to around US$150/t – still
declining from then but remaining at elevated levels by below the price being paid for iron ore from India at
historic standards. Our long term prices remain spot prices.
unchanged following the review in Q3 when we
increased our LT assumptions by around 58%. Figure 7:Spot iron ore prices go stratospheric
Figure 6: Iron ore price forecasts 220 China CiF (spot)

200 Australian CIF
2008 2009 2010 2011 2012 LT Brazilian CIF
180
Iron Ore Lump Australian 151.2 166.3 145.5 123.7 105.2 82.2
160
export (JFY) (USc/dlt)
USD/ tonne
140
US$/t (62% grade, 2% 91.9 101.1 88.4 75.2 63.9 49.9 120
moisture) 100
% Chg from previous year 45% 10% -13% -15% -15% 80
% Chg from previous forecast 16% 16% 13% 10% 10% 0% 60
Iron Ore Fines Australian export 118.5 130.3 114.0 96.9 82.4 63.9 40
(JFY) (USc/dltu) 20
May-04 Nov-04 May-05 Nov-05 May-06 Nov-06 May-07 Nov-07
US$/t (62% grade, 2% 72.0 79.2 69.3 58.9 50.1 38.8
moisture) Source: CRU, Reuters, Deutsche Bank estimates
% Chg from previous year 45% 10% -13% -15% -15%
% Chg from previous forecast 16% 16% 13% 10% 10% 0%
Source: IISI, UNCTAD, TEX, SSY Group, Deutsche Bank Global Markets
Spot iron ore sales have usually been a very small
Research component of the major iron ore producers’ portfolios
and have typically been used only as a pointer for iron
The benefits that such a re-based price delivers to ore demand in the negotiations – this position is
industry profitability have been partially offset by higher changing with the spot market becoming larger and a
assumed industry costs, both operating and capital. number of the majors announcing that they are looking
According to AME the industry’s total project pipeline to increase sales into this market. Rio Tinto recently
contains over 400Mt of new capacity to come on announced on 18 December it had sold 1Mt of iron ore
stream from 2007-2009. Despite this, Chinese domestic in the month of December 2007 at US$190/t CIF and
production remains constrained while its market that a similar amount had been sold for January
continues to require increasing volumes. Outside of shipment at a price of US$187/t. With the freight cost
China, shortages of skilled personnel and equipment are around US$35/t to China, Rio is netting around
continuing to limit the quantum of the supply response. US$150/t compared with ~US$50/t under contract sales
for fines! Rio Tinto also announced that it plans to sell
We acknowledge that the current iron prices are well up to 15Mt of iron ore on to the spot market during
above the inducement price as evidenced by the 2008. We believe this highlights the readiness of major
numerous small players attempting to bring production producers to extract higher price outcomes through the
to market and this is borne out in our long-term pricing spot market and signals a significant price increase in
assumptions (below current levels). However, we contract prices in JFY 2008.
believe that prices will continue to go up over the next
two years, before coming down again. The demand side continues to look robust. The most
recent IISI release for November showed global steel
production grew only 4% YoY in November, with YTD
at +7.7%. This was largely due to a slowdown in China
with steel production growth of only +4.3% YoY in
November and 16.7% YTD. However, strong iron ore
spot prices suggest reducing availability of domestic

iron ore. Furthermore, the slowing growth in steel Recent Chinese customs statistics on the iron ore and
production appears to be more a production steel side show no let up in demand for iron ore.
phenomenon than a drop in steel demand with steel China's iron ore imports rose 24% YoY in November to
prices continuing to rise. In our opinion, it will be 35.4Mt. YTD imports are +17% to 349Mt. We expect a
difficult for the key steel producers to “cry poor” in the strong finish to the year if supply is willing and still see
current iron ore price negations with steel prices around 385Mt of imports for 2007.
continuing to climb as shown in the chart below.
Domestic iron ore production in China is struggling to
Figure 8: CRU steel price index – Domestic HRC match demand and grades are declining. Production
prices during the January – October 2007 period increased
22% YoY to 566Mt, while in October output rose
900 13.6% YoY to 60Mt. We see domestic output
800 increasing to around 720Mt in 2007 and are forecasting
700
a further 11% increase in 2008.
600
500
400 Figure 10: Domestic iron ore production is
300 leveling out and grades are lower
200
Mt
100
1000
0
800
Japan China Germ any
600
Source: CRU
400
Currency movements will also be providing a spur for
producers at the negotiating table in the current price 200
negotiations in our opinion. Since the contract prices
were last agreed (24th December 2006) the 0
1998 2001 2004 2007E 2010E 2013E
movements in the relative currencies has meant that
Brazilian producers are now receiving 9% less for their Source: IISI, UNCTAD, TEX, SSY Group, Deutsche Bank Global Markets
Research
ore in the local currency (despite a 10% price rise in
April 2007!), Australian producers are receiving 2% less
while the Chinese and Japanese consumers are paying On the back of 12.5% growth in crude steel production
2% and 5% more respectively (not a bad outcome for in 2008 we expect imports to increase by 55Mt to
the consumers in a tightening iron ore price 440Mt. Beyond this, we expect China to continue to
environment). The chart below shows the relative price grow its imports by around 50-70mt pa between 2009
movements for contract iron ore fines in local and 2013. For this reason the major iron ore producers
currencies since the last price settlements (prices set to have announced capacity expansions with around
1 on 24th December 2006). 400Mt of capacity coming on stream between 2007-
2009, according to AME, with additional expansion
plans beyond this articulated.
Figure 9: Relative fines iron ore price movements
in varying currencies
Figure 11: Chinese iron ore imports, 1997-2007
1.20 Australia
Japan 400 50%
1.15 Brazil Mt
China 40%
1.10
300
30%
1.05
20%
1.00 200
10%
0.95
0%
100
0.90
-10%
0.85
0 -20%
Dec-06 M ar-07 Jun-07 Sep-07 Dec-07 Nov-97 Nov-99 Nov-01 Nov-03 Nov-05 Nov-07
Source: Datastream, Company data, Deutsche Bank estimates 12 month rolling total, Mt (lhs) % chg (rhs)
Source: Reuters

In the chart below we highlight the anticipated growth Figure 14: Chinese iron ore imports LT
in seaborne trade of iron ore primarily driven by the 800 Mt
strength of demand from China. 700
600
Figure 12: Iron ore seaborne trade vs benchmark
500
price (FOB), 2000-2010
400
Mt USc/Dmtu
1000 145
300
900 125 200
800 105 100
700 85 0
2000 2001 2002 2003 2004 2005 2006 2007E 2008E 2009E 2010E 2011E 2012E 2013E
600 65 Source: TEX, UNCTAD, Deutsche Bank Global Markets Research
500 45
The figure below has a summary version of our updated
400 25
2000 2002 2004 2006 2008E 2010E supply and demand model for iron ore.
Seaborne trade Iron Ore Fines Benchmark Price
Source: TEX, UNCTAD, Deutsche Bank Global Markets Research Figure 15: DB Iron Ore Supply/Demand Model
Mt 2005 2006 2007E 2008E 2009E 2010E
Our near-term forecasts continue to reflect the strength Apparent Demand
1545 1695 1830 1941 2062 2162
in the iron ore market. We have adjusted both short and for Iron Ore
medium term prices upwards to reflect both the Total World
1525 1789 1989 2159 2309 2423
tightness in the iron ore market, cost pressures and Production
also rising capital costs. Demand satisfied
703 750 828 893 964 1032
by Imports
Figure 13: Iron ore fines and lump prices Fines Prices -
Benchmark 62.7 74.6 81.7 122.6 134.8 118.0
200 Hamersley lump (USc/Dltu - FOB)
180 Hamersley fines Source: IISI, UNCTAD, TEX, SSY Group, Deutsche Bank Global Markets
160
Tubarao pellets Research
140
USc/Dltu - FOB
120 Since our Q3 review developments in hard coking coal

100 have continued to be very positive. Amid tightening
80 fundamentals, spot sales of premium hard coking coal
60 from Australia have risen toward USD180/t FOB
40 (>USD80/t above last year’s contract settlements) and
20 low vol PCI coal prices have risen to USD160/t,
0
according to CRU. The Chinese Government has
2000 2002 2004 2006 2008E 2010E 2012E
recently announced plans to increase export tariffs on
Source: TEX, UNCTAD, Deutsche Bank Global Markets Research coke to +25%. The continuing robust demand outlook
coupled with continued supply-side issues within the
In the chart below, we show our LT profile expectations industry set the scene for a tight market over the next
of Chinese iron ore imports. Our base case assumes 12-24 months.
continued growth to around 750Mt by 2013. If lower
grades are assumed with steel volumes higher than Aside from the continued strong Indian demand that is
currently factored in, numbers of >900Mt could be stretching suppliers in Australia, Canada and the US,
achievable, in our view. China continues to pull back from its position as an
exporter of coking coal. YTD (to November) China is a
net importer of coking coal of 3Mt versus a balanced
position during the same period last year.

Figure 16: Chinese metallurgical coal exports vs increase in metallurgical coal exports in 2007 was at the
price, 2003-2007 expense of growth in thermal coal exports.
Kt
1,600 Exports
Imports
Figure 18: Australian coal exports
1,400
1,200 140 Mt
1,000 120
800 100
600
80
400
60
200
40
0
Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 20
Source: Reuters, CRU
0
YE Jun 2000 2001 2002 2003 2004 2005 2006 2007
Coke prices are also on the rise reflecting strong Metallurgical Thermal
underlying demand for carbon units in key Asian Source: ABARE, Deutsche Bank estimates
markets. The tightness in the coke market is highlighted
below with Chinese export prices increasing by Australia remains the dominant supplier of metallurgical
US$150/t since our last quarterly review and are coal to the global markets as shown in the chart below
currently tracking close to US$400/t. Coke prices are – consequently Australia’s ability to grow its exports
expected to rise further due to the export tax. We through its infrastructure will be a key component in the
expect Chinese exports of metallurgical coke and semi- supply/demand mix for coking coal.
coke to exceed 15Mt in 2007, up around 6% YoY.
Figure 19: Australia – dominant in the premium
Figure 17: Chinese metallurgical coke exports vs hard coking coal market
price, 2002-2007
Poland Other
2,500 450
Kt US$/t 1% 5%
400
2,000 350 Canada
300
16%
1,500
250
200
1,000
150
USA
500 100
16% Australia
50
62%
- 0
Jan-02 Sep-02 M ay-03 Jan-04 Sep-04 M ay-05 Jan-06 Sep-06 M ay-07
Chinese coke exports (LHS) Chinese export coke price (RHS)
Source: Reuters
Source: Reuters
As a result of the continuing tightening in the coking

As with iron ore, there is a supply response underway coal market dynamics we are now forecasting a +60%
but it will continue to take time to filter into the system increase for premium hard coking coal prices in JFY
given ongoing infrastructure constraints (both rail and 2008 (prev +25%) to US$150/t and for JFY2009 a
port). This is particularly the case on the East coast of reduction of -5% to US$143/t, although still 28% higher
Australia. According to CRU Australian exports of coking than our previous assumption. We expect a similar
coal are expected to rise by around 10-12Mt next year, profile for standard hard coking coal.
although the majority of this (>80%) is expect to be in
the semi-hard and semi-soft coal category, which is For premium hard coking coal the demand outlook
likely to result in the premium in the hard coking coal continues to be robust for 2008. Indian imports are
market staying at elevated levels for longer than the expected to increase further (by 4-5Mt) while Ukrainian
lower quality coals. imports could also see significant growth. US coking
exports will partially offset this demand but we expect
Figure 18 shows the exports of coal from Australia over the market to remain acutely tight into 2009.
the last 8 Australian fiscal years as reported by the
Australian Bureau of Agriculture and Resource
Economics (ABARE). It is worth noting that the large

Figure 20: Metallurgical coal price profiles Figure 22: DB Metallurgical Coal Supply/Demand Model
Mt 2005 2006 2007E 2008E 2009E 2010E
160
Mt Total metallurgical coal
140 228 223 236 243 254 259
imports for coke making
120
Total seaborne
100 172 175 183 191 202 207
metallurgical coal trade
80
Surplus/Deficit in
60 -2.6 -2.9 -3.6 -4.6 -0.4 1.0
seaborne market
40
Premium hard coking
20 127 114 94 150 143 129
coal (JFY)(US$/t)
0
Standard hard coking
125 105 85 139 132 118
coal (JFY)(US$/t)
P remium hard co king co al Standard hard co king co al Semi-Soft Coking Coal
Semi-So ft Co king Co al Lo w Vo latilie P CI Co al 80 58 62 93 80 72
(US$/t)
Source: IISI, MCIS, TEX, WEFA, Deutsche Bank Global Markets Research
Low Volatilie PCI Coal
102 68 68 107 92 83
(US$/t)
In addition we have also made significant revisions Source: IISI, MCIS, TEX, WEFA, Deutsche Bank Global Markets Research
across the profile to semi-soft coking and low volatile
pci coal prices. We continue to see supply side issues,
particularly in Australia, and also strong demand for PCI
coals as steel makers look to increase injection rates Mined Energy
given the tight coke market. For semi-soft and low vol
PCI coals we do see increased supply during 2008/2009
which should translate into weaker but still elevated
Thermal Coal
prices during FY09.
A combination of positive Asian thermal coal market
developments, supply infrastructure issues and rising
Figure 21: Seaborne coking coal trade vs prices A$ and Rand through 2007 have been positive
250 160
influences on thermal coal prices with spot prices at
Mt record highs.
140
200
120
100
150 Congestion at the Port of Newcastle due to a shortage
80
of capacity in the Hunter Valley coal chain has continued
100
60 with few immediate signs of easing. The Australian
50
40 Corporate Regulator (ACCC) has approved a
20 continuation of the existing export quota system (CBS)
0 0 for 2008, rejecting the proposal by the terminal
2000 2001 2002 2003 2004 2005 2006 2007E 2008E 2009E 2010E
operators for a new system based on rail contracts. The
Seaborne coking im ports (LHS) Hard coking coal price (RHS)
continued use of the export quota system and the lack
Source: IISI, MCIS, TEX, WEFA, Deutsche Bank Global Markets Research of immediate capacity growth will limit thermal exports
in Australia to just 2.5% growth of 114Mt, in our view,
In the table below we show our revised supply demand which should help underpin coal prices into 2009.
model which incorporates some significant adjustments During 2007 shipping allocations in the port of
reflecting market developments in H207 and further Newcastle were cut by 9Mt to 82Mt and if achieved will
updates on actual traded volumes. represent only 2% grow over the year.
As highlighted in our review of the coking coal market,

our expectations of increasing demand for all types of
coking coal including PCI and semi-soft could see the
removal of some of the current thermal coal production
that can make the semi-soft coking coal grade
requirements.
The continuing strength of demand from China is

highlighted by the lower level of net exports in 2007
versus 2006, albeit producers are closely eyeing the
export market given the differential between spot and
contract prices. In China, according to McCloskey Coal,
Chinese domestic term contracts are due to be settled

shortly with but prediction that prices would be up by Price developments during 2007 were all one-way
($4- $7/t) which would mean a new QHD price for traffic. Key developments are highlighted below:
domestic coal in the mid-late 60s per tonne adjusted to
an export quality of 5,800kc NAR and while it would • In March contract negotiations between
seem logical to expect higher exports given the strong Japanese utilities and Australia suppliers were
Asian spot price at greater than US$90/t, strong settled +6% to US$55.7/t.
domestic demand and tightening rail capacity could
keep exports relatively constrained. Recent export • In May, China-Japan LT contracts for JFY2007
prices ex Qinhuangdao are being quoted in the US$96- were partially settled at a price of US$67.9/t,
98/t range. +28% on the previous year. Tonnage
allocations were also cut reflecting lower
Figure 23: Chinese thermal coal net exports, availability.
2002 - 2007
9000
• In October, Xstrata settled mid year contracts
Kt
with the JPU’s at US$78/t reflecting the
8000
continued run up in spot prices.
7000
6000
• In late 2007, AME highlighted Korea Western
5000
Power awarded contracts for 1Mt from
4000 Russian, Australian and Indonesian producers
3000 for 2008 deliveries with the Russian priced at
2000 US$80/t.
1000
0 Spot prices increased from around US$52/t in January

Jan-02 A ug-02 M ar-03 Oct-03 M ay-04 Dec-04 Jul-05 Feb-06 Sep-06 A pr-07
2007 to close the year at US$90/t ex Newcastle, and
Source: CRU, Reuters, Deutsche Bank Global Markets Research
US$96/t in Europe. Chinese export prices are currently
close to US$100/t.
We expect global import demand to grow by +3.7% in
2008 to just over 600Mt and by a further 3.9% in 2009. Asian tightness has fed through to European spot prices
This is being driven almost entirely by stronger Asian topping US$95/t, +87% over the year. Strong demand
demand growth with India, Japan, China, Thailand, from India in particular, a lack of meaningful Russian
Philippines all showing stronger demand. For India in supply growth and continued difficulties in getting
particular we see up to 15% YoY CAGR out to 2012 tonnes out of South Africa all pushed prices higher.
given coal shortages domestically. We highlight this South African exports, flat at around 67Mt, were again
trend in the chart below. In Europe we see little growth disappointing, despite a strong performance in
in demand, with only modest growth in North America. December. Late 2007/early 2008 has not started well,
according to McCloskey with >1Mt lost due to rail line
closures while RBCT coal stocks are only 1.1Mt.
Figure 24: Global Import demand growth driven
by Asia
Figure 25: Spot prices in Asia and Europe
500 Mt 12%
100 US$ /t
400
10% 90
300 80
8% 70
200 60
50
6%
100 40
30
0 4%
2000 2001 2002 2003 2004 2005 2006 2007 2008E 2009E
20
Jan-02 N o v-02 Sep-03 Jul-04 M ay-05 M ar-06 Jan-07 N o v-07
Asian import demand for thermal coal YoY % chg (RHS)
fo b - R ichards B ay fo b - N ewcastle
Source: CRU, Reuters, Deutsche Bank Global Markets Research
Source: Reuters

With tight conditions expected to continue into 2008

we have raised our contract price assumption forecast
for JFY2008 to USD85/t which is +53% YoY and 33%
higher than our previous assumption. For JFY 2009 we
lifted our forecast by 19% to USD74/t, yet lower as
supply conditions improve modestly. We make no
changes to our long term price forecast given the
adjustments made in the previous quarter when we
lifted our LT thermal coal price +32% to USD52.9/t.
The table below is a summarised version of our global

steam coal model following a full review and updated
trade statistics.
Figure 26: DB Thermal Coal Supply/Demand Model

Mt 2005 2006 2007E 2008E 2009E 2010E
Supply of
Internationally Traded 502 570 587 606 630 655
Coal
Demand for
Internationally Traded 512 558 582 604 628 651
Thermal Coal
Internationally Traded
-9.2 12.1 5.1 2.2 2.2 3.4
Market Balance
Newcastle Contract -
Japanese Guide Price
53 52 56 85 74 67
(US$/t - FOB shipment
port) (JFY)
Source: IISI, MCIS, TEX, WEFA, Deutsche Bank Global Markets Research
Tama Willis (44) 20 754 58170

tama.willis@db.com
Rob Clifford (44) 20 754 58339

robert.clifford@db.com

Commodities Chartbook
Commodity consumption around the world relative to per capita income
Figure 1: Oil consumption intensity Figure 2: Gold consumption intensity

6
3.0
Canada US
Gold fabrication demand (Kg per capita)

Oil consumption per capita (gallons per day)
5 Italy
2.5
South Korea Taiwan

2.0
4
Japan Australia
1.5 Germany Sweden 3

France
UK
Italy South Korea
1.0 Venezuela MexicoRussia 2
Taiwan
Thailand Thailand Japan
0.5 Brazil 1 India
Indonesia Indonesia Mexico Germany Canada US
China Ven UK
Russia France Aus
India China Sweden
0.0 0 Brazil
0 5 10 15 20 25 30 35 40 45 50 0 5 10 15 20 25 30 35 40 45 50
GDP per capita ('000 USD)
GDP per capita ('000)
Source: DB Global Markets Research, IMF, BP Yearbook (2006) Source: DB Global Markets Research, CPM Group, IMF (2006)
Figure 3: Aluminium consumption intensity Figure 4: Copper consumption intensity

30 30
Canada
Aluminium consumption (Kg per capita)
Copper consumption (Kg per capita)
Germany Taiwan
25 25
South Korea US
20 Taiwan Japan 20 Sweden
Korea
Italy Australia Germany
15 15
Italy
Sweden
France 10 Japan
10
Thailand Canada
France
China
Russia UK Thailand Russia US
5 China Australia
5 Venezuela
Brazil Indonesia Mexico UK
Indonesia India Brazil
India Mexico 0
0
0 10 20 30 40 50
0 5 10 15 20 25 30 35 40 45 50
Source: DB Global Markets Research, IMF, Brook Hunt (2006) Source: DB Global Markets Research, IMF, Brook Hunt (2006)
Figure 5: Nickel consumption intensity Figure 6: Zinc consumption intensity

2.0 14
Taiwan
1.8 South Korea
12 Australia
South Korea
Japan
Zinc consumption (Kg per capita)
1.6
Nickel consumption (Kg per capita)
10
1.4 Germany
1.2 8
Italy
Germany
1.0
6 Italy
0.8 Canada
Japan
0.6 France 4 France US

UK Sweden
US China Mexico
0.4
2 Thailand Russia
China Australia Brazil UK
0.2 India
Russia Canada Venezuela
India Indonesia
Brazil 0
0.0
0 5 10 15 20 25 30 35 40 45 50
0 5 10 15 20 25 30 35 40 45 50
Source: DB Global Markets Research, IMF, Brook Hunt (2006) Source: DB Global Markets Research, IMF, Brook Hunt (2006)

Commodity consumption around the world relative to per capita income
Figure 7: Iron ore consumption intensity Figure 8: Uranium consumption intensity

1200 14
Japan Taiwan
1000 12
South Korea South Korea
Iron Ore consumption (Kg per capita)
Uranium consumption (Kg per capita)

Australia
800
10
8
600 Russia Sweden
Venezuela Taiwan Germany
Germany 6
400 Canada
China Japan
Brazil Canada
Italy
UK 4 France US
France Sweden
200 US
2 Russia
India UK
Brazil
0 India
0 5 10 15 20 25 30 35 40 45 50 China
0
0 5 10 15 20 25 30 35 40 45 50
Source: DB Global Markets Research, Brook Hunt (2005), IMF Source: DB Global Markets Research, (2006)
Figure 9: Meat consumption intensity Figure 10: Sugar consumption intensity

45 60
US Brazil
40 Australia
Brazil Mexico
50
Meat consumption (Kg per capita)
35
Sugar consumption (Kg per capita)
Australia Canada
30 40 Canada
Russia
25 Mexico Venezuela Thailand
30 Taiwan US
20
Korea
15 Indonesia
20
Japan
10 South Korea India
Japan
China 10 China
5 Taiwan
India
0
0
0 10 20 30 40 50 0 5 10 15 20 25 30 35 40 45 50
GDP per capita ('000) GDP per capita ('000)
Source: DB Global Markets Research, USDA (2006), IMF Source: DB Global Markets Research USDA (2006), IMF
Figure 11: Corn consumption intensity Figure 12: Wheat consumption intensity
400
400
350 350 Australia

Canada
Wheat consumption (Kg per capita)
corn consumption (Kg per capita)
300 300
Mexico
Canada
250 250 Russia
Brazil
200 200
Taiwan
South Korea
150 150
Japan
China 100 China US
100 Venezuela
Venezuela
Mexico Korea
Thailand 50 India Japan
50 Brazil
Indonesia Thailand Taiwan
Russia Indonesia
India Australia 0
0
0 10 20 30 40 50
0 5 10 15 20 25 30 35 40
GDP per capita ('000) GDP per capita ('000)
Source: DB Global Markets Research, USDA (2006), IMF Source: DB Global Markets Research, USDA (2006), IMF

Commodities relative to G7 per capita income
Figure 1: Crude oil prices relative to per capita Figure 2: Gold & silver prices relative to per capita
income income
G7 per capita income divided by the price of oil 120 7000
G7 per capita income divided by precious metal prices
3000
Oil price decline helps to 100 Gold 6000
2500 boost the purchasing
Number of barrels of oil
power of a G7 consumer Silver 5000

80
2000
4000
Ounces
Ounces
1500 60
1970-2007 average
3000
`
1000 40
Higher oil prices cut 2000
the purchasing power
500 20
of a G7 consumer 1000
0
0 0
1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 1972 1977 1982 1987 1992 1997 2002 2007
Source: DB Global Markets Research, IMF Source: DB Global Markets Research, IMF
Figure 3: Industrial metal prices relative to per Figure 4: Lead & tin prices relative to per capita
capita income income
45 G7 per capita income divided by respective metal prices 7 9 G7 per capita income divided by 80
40 Copper 8 lead and tin prices
6 70
35 Zinc 7 Tin
60
5
Number of tonnes
Number of tonnes
Aluminium Lead
30 6
Nickel (rhs) 50
25 4 5
40
20 3 4
30
15 3
2
10 2 20
1 10
5 1
0 0 0 0
1970 1975 1980 1985 1990 1995 2000 2005 1970 1975 1980 1985 1990 1995 2000 2005

Figure 5: Grain prices relative to per capita income Figure 6: Coal prices relative to per capita income
20000 1200 G7 per capita income divided by coal

G7 per capita income divided by grain prices
18000
Corn 1000
16000
14000
Wheat
Number of bushels
800
12000
Tonnes
10000 Corn: 1970-2007 avg 600

1970-2007 average
8000 `
400
6000
Wheat: 1970-2007 avg
4000
200
2000
0 0
1972 1977 1982 1987 1992 1997 2002 2007 1970 1975 1980 1985 1990 1995 2000 2005
Source: DB Global Markets Research, IMF Source: DB Global Markets Research, IMF

Commodity inventory-to-use ratios
Figure 1: Crude oil Figure 2: Aluminium stock-to-consumption ratio
US crude inventory cover of refinery runs (days) 6000 Kt Total com m ercial stocks (lhs) Weeks 16
27
Stock to consum ption ratio (rhs) 14
5000
25 Long-term equillibrium ratio (rhs)
12
4000
23 10
3000 8
21
6
2000
19 4
1000
17 2
0 0
15 3Q87 3Q89 3Q91 3Q93 3Q95 3Q97 3Q99 3Q01 3Q03 3Q05 3Q07
1995 1997 1999 2001 2003 2005 2007
Source: DB Global Markets Research, EIA Source: Reuters, WBMS, DB Global Markets Research
Figure 3: Copper stock-to-consumption ratio Figure 4: Nickel stock-to-consumption ratio
2500 Kt Total com m ercial stocks (lhs) Weeks 12 300.0 Kt Total com m ercial stocks (lhs) Weeks 20
Long-term equillibrium ratio (rhs)
Stock to consum ption ratio (rhs)
250.0 Stock to consum ption ratio (rhs)
10
2000 Long-term equillibrium ratio (rhs) 16
8 200.0
1500 12
6 150.0
1000 8
100.0
4
4
500 50.0
2
0.0 0
0 0
3Q87 3Q89 3Q91 3Q93 3Q95 3Q97 3Q99 3Q01 3Q03 3Q05 3Q07
3Q87 3Q89 3Q91 3Q93 3Q95 3Q97 3Q99 3Q01 3Q03 3Q05 3Q07
Source: Reuters, ICSG, DB Global Markets Research Source: Reuters, INSG, DB Global Markets Research
Figure 5: Zinc stock-to-consumption ratio Figure 6: Corn, soybeans & wheat
Weeks Corn stock-to-use ratio Total available stocks

2000 Kt 18 180 divided by daily consumption
Wheat stock-to-use ratio
Total comm ercial stocks (lhs)
160 Soybean stock-to-use ratio
Stock to consumption ratio (rhs) 15
1600
Long-term equillibrium ratio (rhs) 140
12
120
1200
Days of use
100
9
800 80
6 60
400 40
3
20
0 0
0
3Q87 3Q89 3Q91 3Q93 3Q95 3Q97 3Q99 3Q01 3Q03 3Q05 3Q07 1965 1970 1975 1980 1985 1990 1995 2000 2005
Source: Reuters, ILZSG, DB Global Markets Research Source: DB Global Markets Research, USDA

Commodities prices in real terms
Figure 1: Crude oil prices in real terms Figure 2: Precious metal prices in real terms
90 Deflated by US PPI 1400 Deflated by US PPI 80

Real crude oil price (2005 US dollars) Real gold price (2005
US dollars, lhs)
80 1200 70
70 Real silver price (2005

US dollars, rhs) 60
1000
60
50
800
50
40
40 600
30
30
400
20
20
200 10
10
0 0 0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006
Source: DB Global Markets Research, IMF, Bloomberg Source: DB Global Markets Research, IMF, Bloomberg
Figure 3: Aluminium & zinc prices in real terms Figure 4: Copper & nickel prices in real terms
6000 Deflated by US PPI Real copper price 50000 Deflated by US PPI

(2005 US dollars) Real copper price
(2005 US dollars)
5000 Real nickel price
(2005 US dollars) 40000 Real nickel price
(2005 US dollars)
4000
30000
3000
20000
2000
10000
1000
0 0
1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008
Figure 5: Lead & tin prices in real terms Figure 6: Corn & wheat prices in real terms
4000 Deflated by US PPI Real lead price (2005 35000 Wheat price in real terms
20 Deflated by US PPI
US dollars, rhs) (2005 US dollars)
30000
Real tin price (2005 Corn price in real terms
3000 US dollars, lhs) (2005 US dollars)
25000 15
USD bushel
20000
2000
15000 10
`
10000
1000
5
5000
0 0
0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

Commodity Forward Curves
Figure 1: WTI crude oil forward curve Figure 2: Aluminium forward curve
January 2008
January 2008
June 2007
September 2007
June 2007
September 2007
Figure 3: Copper forward curve Figure 4: Nickel forward curve
January 2008
June 2007
September 2007
January 2008
June 2007
September 2007
Figure 5: Zinc forward curve Figure 6: Wheat forward curve

950
Wheat forward curve
900
850 Jan 2008
800
750
June 2007
700 Dec 2007
650
September 2007 600

January 2008
550
Sep 2007
500
Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09

Credit Focus: Energy
Crude oil price vs. CDS spreads US natural gas price vs. CDS spreads
Figure 1: Occidental Petroleum CDS spreads and Figure 3: Burlington Resources, Inc. CDS spreads
the WTI crude oil price and the US natural gas price
80 5Y CDS spread (bp, lhs) 15 5Y CDS spread (bp, lhs)
70 2
Oil prices (WTI USD/bbl, inverted rhs)
US natural gas price (USD/mmBtu, inverted rhs)
70 25
60 4
35
60
50 6
45
50
55 40 8
40
65 30 10
30
75
20 12
20
85
10 14
10 95
0 105 0 16
Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08
Figure 2: Conoco Phillips CDS spreads and the WTI Figure 4: Devon Energy Corporation-CDS spreads
crude oil price and the US natural gas price
70 5Y CDS spread (bp, lhs) 15 110 0
5Y CDS spread (bp, lhs)
Oil prices (WTI USD/bbl, inverted rhs) 100
25 US natural gas price (USD/mmBtu, inverted rhs) 2
60
90
35
4
50 80
45
70 6
40 55
60
8
30 65 50
40 10
75
20
30
85 12
10 20
95 14
10
0 105
0 16
Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07
Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07
* A credit default swap allows one party to “buy” protection from another party for losses that might be incurred as a result of default
by a specified reference credit (or credits). The “buyer” of protection pays a premium for the protection, and the “seller” of protection
agrees to make a payment to compensate the buyer for losses incurred upon the occurrence of any one of several specified “credit
events.” Source: Moody’s

Credit Focus: Metals & Mining
Metals Commodity Prices vs. CDS Spreads
Figure 1: Alcoa CDS spreads and the LME Figure 3: Phelps Dodge CDS spreads and the LME
aluminium spot price copper spot price
80 1,050 286 1,000
Alcoa 5Y CDS spread (bp, lhs)
Phelps Dodge 5Y CDS spread (bp, lhs)
Aluminium spot price (USD/metric ton, inverted rhs) 1,300 256 2,000
70 Copper spot price (USD/metric ton, inverted rhs)
1,550 226 3,000
60
1,800 196
4,000
50 2,050 166
5,000
2,300 136
40 6,000
2,550 106
30 7,000
2,800 76
3,050 8,000
20 46
3,300 9,000
16
10 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07
Source: DB Global Markets Research, LME Source: DB Global Markets Research, LME
Figure 2: Inco CDS spreads and the LME nickel Figure 4: Barrick Gold CDS spreads and the gold
spot price spot price
140 Inco 5Y CDS spread (bp, lhs) 2,000 55 Barrick Gold 5Y CDS spread (bp, lhs) 320
Gold spot price (US$/troy ounce, inverted rhs)
Nickel spot price (USD/metric ton, inverted rhs) 50
120 10,000
420
45
18,000
100 40
520
26,000 35
80
30 620
34,000
60 25
42,000 720
20
40
50,000 15 820
20 10
Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07
Source: DB Global Markets Research, LME Source: DB Global Markets Research, LME
* A credit default swap allows one party to “buy” protection from another party for losses that might be incurred as a result of default
by a specified reference credit (or credits). The “buyer” of protection pays a premium for the protection, and the “seller” of protection
agrees to make a payment to compensate the buyer for losses incurred upon the occurrence of any one of several specified “credit
events.” Source: Moody’s

Equity Focus: Metals & Mining
Metals’ commodity prices versus stock market price
Figure 1: Alcoa stock price and the LME aluminium Figure 4: Freeport McMoRan stock price and the
spot price LME copper spot price
55 Alcoa share price (USD, lhs) 3500 130 Freeport McMoran share price (USD, lhs) 11000
Aluminium spot price (USD/tonne, rhs) 120 Copper spot price (USD/tonne, rhs)
50 10000
3200 110
100 9000
45
2900 90 8000
40 80
2600 70 7000
35
60 6000
30 2300 50
5000
40
25 2000
30 4000
Jan-06 Jul-06 Jan-07 Jul-07
Figure 2: CVRD stock price and the LME nickel spot Figure 5: Newmont Mining stock price and the gold
price spot price
50 CVRD share price (USD, lhs) 70000 80 900
Newmont share price (lhs)
45 Nickel spot price (USD/tonne, rhs) 75
60000
Gold price (USD/oz, rhs)
40 70 800
35 50000 65
30 60 700
40000
25 55
20 30000 50 600
45
15
20000 40 500
10
35
5 10000
30 400
Figure 3: Lonmin stock price and the platinum spot Figure 6: Xstrata stock price and spot thermal coal
price prices (Asia & Europe)
100 Lonmin share price (USD) 1650 90 Xstrata share price (lhs) 130
API#2 Coal price (Cal 07, USD/tonne, rhs)
90 Platinum price (USD/oz, rhs) 1550 80 120
API#4 Coal price (Cal 07, USD/tonne, rhs)
70 110
80 1450
100
70 1350 60
90
60 1250 50
80
50 1150 40
70
40 1050 30 60
30 950 20 50
20 850 10 40
Jan-06 Jul-06 Jan-07 Jul-07 Jan-06 Jul-06 Jan-07 Jul-07

Price Forecasts
Energy Price Forecasts
USD/barrel Q108 Q208 Q308 Q408 2007 2008 2009 2010 2011 2012 LT
WTI 90 80 85 85 72.4 85.00 80.00 75.00 77.00 79.00 81.00
Brent 90 80 85 85 72.7 85.00 80.00 75.00 79.00 79.00 81.00

Spreads
(USD/barrel) Q307 Q407 Q108 Q208 2007 2008 2009 2010 2011 2012 LT
WTI-Brent 0.00 0.00 0.00 0.00 -0.70 0.00 0.00 0.00 0.00 0.00 0.00
WTI-Maya 10.00 10.00 10.00 10.00 10.75 10.00 10.00 10.00 10.00 10.00 10.00
Brent-Dubai 4.00 4.00 4.00 4.00 3.75 4.00 3.50 4.00 4.00 4.00 4.00
USD/mmBtu Q108 Q208 Q308 Q408 2007 2008 2009 2010 2011 2012 LT
Natural gas 8.00 7.50 7.75 7.75 7.26 7.75 8.00 8.75 9.50 9.75 10.00
U308 USD/lb Q108 Q208 Q308 Q408 2007 2008 2009 2010 2011 2012 LT
Uranium 105.0 120.0 125.0 125.0 97.8 119.0 116.0 95.0 75.0 65.0 46.0
Figures are period average; Source: DB Global Markets Research forecasts
US Refining Margins
USD/barrel Q108 Q208 Q308 Q408 2007 2008 2009 2010 2011 2012 LT
East Coast 2-1-1 9.00 14.00 12.00 10.00 13.5 11.000 10.00 11.00 - - -
Midcontinent 10.00 19.00 14.00 9.00 18.9 13.00 12.00 13.00 - - -
Gulf Coast 8.00 15.00 11.00 6.00 15.1 10.00 9.00 10.00 - - -
US GC Complex 16.00 23.00 21.00 15.00 21.5 18.00 16.00 18.00 - - -
West Coast 5-3-2 18.00 28.00 22.00 16.00 23.70 18.00 21.00 21.00 - - -
Precious Metals’ Price Forecasts

USD/oz Q108 Q208 Q308 Q408 2007 2008 2009 2010 2011 2012 LT
Gold 850 900 925 965 698 909 863 780 650 600 525
Silver 15.50 16.20 16.60 16.80 13.4 16.28 15.7 14.2 12.0 10.7 9.00
Platinum 1560 1600 1630 1700 1305 1623 1540 1400 1210 1150 1081
Palladium 380 400 420 440 356 410 405 410 420 405 400

Price Forecasts
Industrial Metals’ Price Forecasts
Q108 Q208 Q308 Q408 2007 2008 2009 2010 2011 2012 LT
Aluminium
US cents/lb 114.0 120.0 125.0 127.0 119.8 121.5 121.8 110.0 105.0 100.0 98.0
USD/tonne 2513 2646 2756 2800 2641 2679 2684 2425 2315 2205 2161
Price revision -10% -7% -2% 2% -4% 11% 5% 2% 0% 0%
Copper
US cents/lb 315.0 320.0 335.0 330.0 321.6 325.0 306.3 250.0 230.0 200.0 150.0
USD/tonne 6945 7055 7385 7275 7091 7165 6752 5512 5071 4409 3307
Price revision -11% -9% 5% 8% -2% 12% 19% 15% 11% 0%
Lead
US cents/lb 115.0 108.0 102.0 97.0 117.2 105.5 76.8 65.0 55.0 50.0 45.0
USD/tonne 2535 2381 2249 2138 2583 2326 1692 1433 1213 1102 992
Price revision 0% -2% 7% 8% 3% 0% 0% 0% 0% 0%
Nickel
US cents/lb 1300.0 1350.0 1400.0 1325.0 1681.0 1343.8 1265.0 1110.0 1050.0 1000.0 800.0
USD/tonne 28660 29762 30865 29211 37060 29625 27888 24471 23149 22046 17637
Price revision -15% -10% -5% -9% -10% -2% 23% 35% 39% 0%
Tin
US cents/lb 730.0 690.0 650.0 600.0 655.7 667.5 452.5 400.0 380.0 375.0 350.0
USD/tonne 16094 15212 14330 13228 14456 14716 9976 8818 8378 8267 7716
Price revision 22% 20% 23% 18% 21% 7% 0% 0% 0% 0%
Zinc
US cents/lb 110.0 105.0 103.0 100.0 147.9 104.5 95.5 105.0 107.0 110.0 82.0
USD/tonne 2425 2315 2271 2205 3262 2304 2105 2315 2359 2425 1808
Price revision -21% -22% -21% -20% -21% -7% 14% 22% 29% 0%
Figures are period average and relate to the spot price; Source: DB Global Markets Research forecasts
Steel Making Raw Materials, Minor Metals & Mineral Sands

Q108 Q208 Q308 Q408 2007 2008 2009 2010 2011 2012 LT
Iron ore lump
Australian export 104 151 151 151 102.02 151 166 146 124 105 82
(JFY) (USc/dlt) 9.5% 45% 45% 45% 45% 10% -12.5% -15% -15% -22%
Price change
Iron ore fines
Australian export 82 118 118 118 79.94 118 130 114 97 82 64
(JFY) (USc/dlt) 9.5% 45% 45% 45% 45% 10% -12.5% -15% -15% -22%
Price change
Premium hard
coking coal (JFY) 94 150 150 150 99.50 150 143 129 113 98 84
(USD/tonne) -19% 60% 60% 60% 60% -5% -10% -12.5% -12.5% -15%
Price change
Standard hard
coking coal (JFY) 85 139 139 139 90.00 139 132 118 104 91 79
(USD/tonne) -19% 63% 63% 63% 63% -5% -10% -12.5% -12.5% -13%
Price change
Figures are period average; Source: DB Global Markets Research

Global Economic Indicators

Growth of real GDP (% yoy) Inflation, CPI (% yoy) Current Account (% of GDP)
2006 2007F 2008F 2009F 2006 2007F 2008F 2009F 2006 2007F 2008F 2009F
US 2.9 2.2 2.2 2.6 3.2 2.8 3.3 2.5 -6.2 -4.9 -4.1 -3.9
Japan 2.4 1.6 1.2 2.4 0.2 0.0 0.6 0.7 3.9 4.9 5.4 5.8
Euroland 2.9 2.6 1.6 1.9 2.2 2.1 2.3 1.8 -0.2 0.3 0.4 0.2
Germany 3.1 2.6 1.7 2.2 1.8 2.3 2.3 1.8 4.9 5.2 4.7 4.9
France 2.2 1.9 1.6 2.2 1.9 1.5 2.0 1.8 -1.5 -1.2 -1.0 -1.2
Italy 1.9 1.8 1.3 1.5 2.2 1.8 2.3 2.3 -2.6 -2.4 -2.6 -2.6
Spain 3.9 3.8 2.3 2.4 3.6 2.8 3.4 3.2 -8.7 -9.4 -10.1 -9.8
Netherlands 3.0 3.1 2.5 2.3 1.7 1.6 2.0 2.6 8.3 7.0 6.8 6.8
Belgium 2.9 2.6 1.8 2.0 2.3 1.5 1.7 1.5 2.0 2.2 2.4 2.3
Austria 3.3 3.3 2.4 2.4 1.7 2.1 2.3 1.9 3.2 3.9 3.7 3.6
Finland 4.9 4.3 2.7 3.1 1.3 1.6 2.3 2.0 5.2 5.8 5.6 5.8
Greece 4.3 4.0 3.5 3.3 3.3 3.0 3.3 3.1 -11.1 -12.8 -13.0 -12.8
Portugal 1.3 1.8 1.7 1.7 3.0 2.4 2.2 2.2 -9.9 -9.4 -9.2 -9.2
Ireland 5.7 4.5 3.0 3.5 2.7 2.7 2.8 2.5 -4.2 -3.3 -3.0 -3.2
Other Industrial Countries
United Kingdom 2.8 3.1 1.8 2.1 2.3 2.3 2.1 1.8 -3.2 -3.0 -3.0 -3.3
Denmark 3.5 1.7 1.7 2.1 1.9 1.7 2.1 2.0 2.6 1.3 1.0 1.2
Norway 2.2 3.0 3.0 2.7 0.8 1.4 1.7 1.9 16.4 15.0 14.0 13.8
Sweden 4.1 2.7 2.7 2.9 1.2 1.2 1.8 2.0 7.0 6.5 6.0 6.0
Switzerland 3.2 2.8 2.1 2.2 1.1 0.7 1.5 1.2 15.1 16.0 15.0 14.5
Czech Republic 6.1 6.2 4.9 4.8 2.5 2.8 5.0 3.1 -4.2 -3.4 -3.8 -4.4
Hungary 3.9 1.5 2.3 3.2 3.9 8.0 5.2 3.4 -6.5 -5.0 -4.9 -4.8
Poland 6.2 6.5 5.0 5.0 1.0 2.5 3.7 2.8 -3.2 -4.4 -4.9 -5.6
Slovak Republic 8.5 9.0 7.7 6.8 4.5 2.7 3.2 3.3 -8.1 -4.4 -3.8 -3.4
Canada 2.8 2.6 2.3 2.7 2.0 2.2 2.1 2.0 1.3 0.3 0.2 n.a.
Australia 2.8 3.9 3.5 3.3 3.5 2.3 3.2 3.0 -5.5 -5.9 -5.2 -5.2
New Zealand 1.6 3.0 1.9 3.0 3.4 2.3 3.2 3.2 -8.6 -7.7 -6.0 -6.4
Emerging Europe/Africa
Egypt 6.8 7.1 6.5 5.7 12.3 7.4 5.2 5.7 1.6 2.1 1.7 0.5
Israel 5.1 5.1 4.2 4.6 -0.1 2.3 2.6 2.5 5.7 3.4 2.2 2.2
Kasakhstan 10.6 8.3 6.0 6.5 8.4 17.3 7.9 7.6 -2.2 -4.5 -2.2 -0.1
Romania 7.7 5.7 4.2 4.6 4.9 6.3 4.9 4.9 -10.3 -13.5 -13.0 -12.6
Russia 6.7 7.5 7.4 7.4 9.1 11.3 10.4 9.4 9.6 7.1 3.7 2.3
Turkey 6.1 5.0 5.5 6.0 9.7 8.5 6.0 4.5 -8.2 -7.6 -8.1 -7.3
Ukraine 7.1 7.3 6.7 6.3 11.6 14.1 10.8 9.1 -1.5 -2.6 -2.1 -4.9
South Africa 5.0 4.7 4.7 4.8 4.6 9.0 5.0 5.0 -6.5 -7.0 -8.0 -7.5
Asia (ex-Japan)
China 11.0 11.5 10.4 10.0 1.5 4.7 4.0 3.2 9.4 9.5 9.2 8.6
Hong Kong 6.8 6.0 5.0 6.5 2.0 2.0 2.8 2.0 10.8 13.6 13.5 14.3
India 9.7 9.0 8.2 8.6 5.2 4.6 4.5 4.3 -1.0 -0.8 -1.2 -0.9
Indonesia 5.5 6.1 6.5 6.5 13.3 6.5 6.5 6.5 2.6 2.7 1.2 1.3
Korea 5.0 4.8 3.9 4.0 2.2 2.5 2.9 2.8 0.7 0.8 -0.1 -0.2
Malaysia 5.9 6.0 5.2 5.5 3.6 2.0 2.7 2.8 16.3 14.7 11.2 6.2
Pakistan 6.6 7.0 6.5 6.2 7.9 7.9 7.9 7.9 -3.9 -4.9 -5.1 -5.3
Philippines 5.4 6.7 6.3 6.3 6.3 2.8 4.5 4.5 4.7 5.2 5.8 4.1
Singapore 7.9 8.0 7.1 7.2 1.0 2.2 4.3 2.0 28.8 31.4 25.6 25.6
Taiwan 5.0 5.2 3.9 4.0 0.6 1.8 2.1 2.0 6.7 8.0 7.2 7.6
Thailand 5.1 4.6 4.0 4.8 4.7 2.3 3.0 2.0 1.6 6.0 4.4 3.5
Vietnam 8.2 8.3 7.5 7.9 7.5 7.9 7.7 7.6 -0.3 -4.0 -4.5 -3.4
Latin America
Argentina 8.5 8.1 5.1 3.6 10.0 17.0 16.3 13.6 3.9 2.6 1.6 0.7
Brazil 3.8 5.3 4.6 4.5 3.1 4.2 4.0 4.2 1.3 0.5 -0.2 -0.7
Chile 4.0 5.3 5.0 5.0 2.6 7.4 3.8 3.4 3.6 4.6 2.5 0.3
Colombia 6.8 6.5 5.5 5.3 4.5 5.3 4.2 3.7 -2.1 -4.0 -4.3 -3.8
Mexico 4.8 3.1 3.4 3.9 4.0 3.9 3.7 3.4 -0.2 -1.0 -1.3 -1.4
Venezuela 10.3 8.4 5.4 4.0 17.0 21.0 23.0 25.0 15.4 7.4 5.6 1.1
World 5.4 5.2 4.6 4.8 3.1 3.6 3.6 3.1
QUARTERLY GDP
(% qoq annualised)
Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008
US 4.8 2.4 1.1 2.1 0.6 3.8 4.9 0.5 1.7 2.0 2.4 2.4
Japan 1.8 3.2 -0.4 5.3 3.3 -1.8 1.5 -2.2 2.0 2.9 2.5 2.4
Euroland 3.6 3.9 2.3 3.3 3.2 1.2 2.9 1.5 1.0 1.4 1.7 2.0
Germany 3.5 5.4 3.0 4.0 2.2 1.0 2.8 1.1 1.2 1.7 2.2 2.4
France 2.9 3.8 -0.2 1.9 2.3 1.4 2.9 1.5 1.0 1.5 2.0 2.0
Italy 3.1 2.4 1.3 4.4 1.3 0.2 1.7 2.0 -0.4 2.8 1.6 1.2
Spain 3.8 4.3 3.6 4.5 4.1 3.8 2.7 2.0 2.3 2.1 2.1 2.2
United Kingdom 3.3 3.3 2.7 3.3 3.2 3.3 3.0 2.1 1.3 1.3 1.4 1.8
Dollar Bloc
Canada 3.4 1.5 1.3 1.5 3.5 3.8 2.9 1.3 1.9 2.1 3.0 3.2
Australia 2.4 2.3 1.9 4.8 5.4 2.8 4.1 3.9 3.1 2.9 3.6 4.5
New Zealand 3.5 0.1 1.6 3.3 4.9 3.0 2.2 2.2 1.5 1.6 1.7 2.5
Sources: Deutsche Bank Global Markets Research, National Statistical Authorities

Long Term Forecasts

GDP growth, % yoy CPI inflation, % yoy
2006 2007F 2008F 2009F 2010F 2011F 2012F 2006 2007F 2008F 2009F 2010F 2011F 2012F
Industrial countries
USA 2.9 2.2 2.2 2.6 2.7 2.7 2.7 3.2 2.8 3.3 2.5 2.4 2.3 2.3
Japan 2.2 1.6 1.4 2.4 1.7 2.5 2.5 0.2 0.0 0.6 0.7 2.1 0.8 1.0
Euroland 2.9 2.6 1.6 1.9 2.0 2.0 2.0 2.2 2.1 2.3 1.8 2.0 2.0 2.0
Germany 3.1 2.6 1.7 2.2 1.4 1.4 1.4 1.8 2.3 2.3 1.8 1.3 1.3 1.3
France 2.2 1.9 1.6 2.2 1.8 2.0 2.0 1.9 1.5 2.0 1.8 1.8 2.0 1.8
Italy 1.9 1.8 1.3 1.5 1.5 1.5 n.a. 2.2 1.8 2.3 2.3 2.0 2.0 0.0
United Kingdom 2.8 3.1 1.8 2.1 2.8 2.8 2.8 2.3 2.3 2.1 1.8 2.0 2.0 2.0
Switzerland 3.2 2.8 2.1 2.2 2.0 1.8 1.8 1.1 0.7 1.5 1.2 1.0 1.0 1.0
Canada 2.8 2.6 2.3 2.7 n.a. n.a. n.a. 2.0 2.2 2.1 2.0 n.a. n.a. n.a.
Australia 2.8 3.9 3.5 3.3 3.3 3.3 3.3 3.5 2.3 3.2 3.0 2.7 2.5 2.5
Emerging Markets
Russia 6.7 7.5 7.4 7.4 7.3 7.1 7.1 9.1 11.3 10.4 9.4 8.8 7.7 7.0
South Africa 5.0 4.7 4.7 4.8 5.0 5.0 5.0 4.6 9.0 5.0 5.0 4.5 4.5 4.5
China 11.0 11.4 10.2 10.0 9.5 9.2 9.0 1.5 4.5 3.8 3.2 3.0 3.0 3.0
India 9.7 9.0 8.2 8.6 8.2 8.5 n.a. 7.1 6.6 4.5 4.5 4.5 4.5 n.a.
Indonesia 5.5 6.1 6.5 6.5 6.0 6.0 6.0 13.3 6.5 6.5 6.5 5.0 4.0 4.0
Brasil 2.3 4.8 4.4 4.0 4.0 4.0 n.a. 3.1 4.2 3.7 4.2 4.2 4.0 n.a.
Mexico 4.8 3.1 3.4 3.0 3.0 3.0 n.a. 4.0 3.9 3.7 3.3 3.3 3.3 n.a.
GDP per head, % yoy Population growth, % yoy
2006 2007F 2008F 2009F 2010F 2011F 2012F 2006 2007F 2008F 2009F 2010F 2011F 2012F
USA 1.9 1.2 1.2 1.6 1.7 1.7 1.7 1.0 1.0 1.0 1.0 1.0 1.0 1.0
Japan 2.1 1.7 1.5 2.5 1.9 2.7 2.7 0.0 -0.1 -0.1 -0.1 -0.2 -0.2 -0.2
Euroland 2.4 2.1 1.0 1.4 1.5 1.5 1.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5
Germany 3.2 2.7 1.8 2.3 1.5 1.5 1.5 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1
France 1.8 1.6 1.3 1.9 1.5 1.7 1.7 0.4 0.3 0.3 0.3 0.3 0.3 0.3
Italy 1.7 1.6 1.1 1.4 1.4 1.4 n.a. 0.2 0.2 0.2 0.2 0.1 0.1 n.a.
United Kingdom 2.5 2.8 1.5 1.8 2.4 2.4 2.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3
Switzerland 2.6 2.2 1.4 1.5 1.5 1.2 1.2 0.7 0.7 0.6 0.6 0.5 0.5 0.5
Australia 1.3 2.3 2.0 1.9 2.1 2.1 2.2 1.5 1.5 1.4 1.3 1.2 1.2 1.2
Emerging Markets
Russia 7.1 8.0 7.8 7.8 7.7 7.5 7.6 -0.4 -0.4 -0.4 -0.4 -0.4 -0.4 -0.5
South Africa 3.4 3.4 3.6 3.6 3.8 3.8 3.8 1.5 1.3 1.1 1.2 1.2 1.2 1.2
China 10.2 10.6 9.4 9.2 8.7 8.5 8.3 0.8 0.8 0.8 0.8 0.7 0.7 0.7
India 8.3 7.6 6.8 7.2 6.9 7.2 n.a. 1.4 1.4 1.4 1.4 1.3 1.3 n.a.
Indonesia 4.2 4.8 5.3 5.3 4.8 4.8 4.8 1.3 1.3 1.3 1.3 1.2 1.2 1.2
Brasil 1.0 3.5 3.1 2.5 2.7 2.7 n.a. 1.3 1.3 1.3 1.3 1.3 1.3 n.a.
Mexico 3.4 1.7 2.0 1.6 1.6 1.6 n.a. 1.4 1.4 1.4 1.4 1.4 1.4 n.a.
Key official interest rate, % (eop) 10Y bond yields (eop)
2006 2007F 2008F 2009F 2010F 2011F 2012F 2006 2007F 2008F 2009F 2010F 2011F 2012F
USA 5.25 4.25 3.75 4.25 4.75 4.75 4.75 4.40 4.25 4.50 5.00 5.25 5.50 5.50
Japan 0.25 0.50 1.00 1.50 2.25 3.00 3.50 1.68 1.60 2.00 2.60 2.90 3.50 3.75
Euroland 3.50 4.00 3.50 4.00 4.00 4.00 4.00 3.92 4.30 4.20 4.75 4.75 4.75 4.75
Germany 3.50 4.00 3.50 4.00 4.00 4.00 4.00 3.92 4.30 4.20 4.75 4.75 4.75 4.75
France 3.50 4.00 3.50 4.00 4.00 4.00 4.00 3.95 4.30 4.20 4.75 4.75 4.75 4.75
Italy 3.50 4.00 3.50 4.00 4.00 4.00 4.00 4.22 4.55 4.45 5.00 5.00 5.00 5.00
United Kingdom 5.00 5.50 5.00 5.25 5.25 5.25 5.25 4.74 4.80 4.80 5.50 5.50 5.50 5.50
Switzerland 2.00 2.75 2.50 2.50 2.50 2.50 2.50 2.48 3.10 3.05 3.55 3.55 3.55 3.55
Canada 4.25 4.25 4.00 n.a. n.a. n.a. n.a. 4.09 4.25 5.50 n.a. n.a. n.a. n.a.
Australia 6.25 6.75 7.00 6.00 5.75 5.75 5.75 5.71 6.00 6.50 6.25 6.25 6.25 6.25
Emerging Markets
Russia 11.00 11.00 10.00 9.00 9.00 9.00 9.00 7.60 6.50 6.50 6.50 6.50 6.50 6.50
South Africa 9.00 11.00 10.00 8.50 8.00 8.00 8.00 8.00 8.25 8.25 8.00 8.00 8.00 8.00
China 2.52 4.14 4.41 4.41 4.41 4.41 4.41 n.a. n.a. n.a. n.a. n.a. n.a. n.a.
India 7.25 7.75 6.75 6.00 6.00 6.00 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.
Indonesia 9.75 8.25 8.50 8.25 7.75 7.00 7.00 9.94 9.90 10.80 10.00 9.50 9.00 8.50
Brasil 13.00 11.25 10.75 10.25 10.25 10.00 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.
Mexico 7.00 7.00 6.75 6.75 6.75 6.75 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.
FX rate vs. USD (eop) FX rate vs. EUR (eop)
2006 2007F 2008F 2009F 2010F 2011F 2012F 2006 2007F 2008F 2009F 2010F 2011F 2012F
USA 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.32 1.45 1.40 1.35 n.a. n.a. n.a.
Japan 119 115 96 85 90 n.a. n.a. 157 167 134 115 n.a. n.a. n.a.
Euroland 1.32 1.45 1.40 1.35 n.a. n.a. n.a. 1.00 1.00 1.00 1.00 1.00 1.00 1.00
United Kingdom 1.96 2.05 1.88 1.78 n.a. n.a. n.a. 0.67 0.71 0.74 0.76 n.a. n.a. n.a.
Switzerland 1.22 1.11 1.12 1.16 n.a. n.a. n.a. 1.61 1.61 1.57 1.57 n.a. n.a. n.a.
Australia 0.79 0.90 0.78 0.76 0.76 n.a. n.a. 1.68 1.61 1.79 1.78 n.a. n.a. n.a.
Emerging Markets
Russia 26.33 24.50 24.50 24.19 24.19 24.01 23.90 34.68 35.53 34.30 32.66 n.a. n.a. n.a.
South Africa 6.95 7.50 8.00 8.25 8.50 8.75 9.00 9.15 10.88 11.20 11.14 n.a. n.a. n.a.
China 7.86 7.36 6.92 6.56 6.23 5.98 5.80 10.35 10.67 9.69 8.85 n.a. n.a. n.a.
India 44.40 39.40 40.50 43.00 44.20 46.00 n.a. 58.47 57.13 56.70 58.05 n.a. n.a. n.a.
Indonesia 9020 9300 9000 8800 8500 8200 8000 11879 13485 12600 n.a. n.a. n.a. n.a.
Brasil 2.14 1.70 1.75 2.10 2.20 2.24 n.a. 2.82 2.47 2.45 2.84 n.a. n.a. n.a.
Mexico 10.85 11.05 11.05 11.40 11.57 11.68 n.a. 14.29 16.02 15.47 15.38 n.a. n.a. n.a.
Sources: National authorities, DB Global Markets Research

DOE: US Department of Energy. Often used as synonym

Glossary for its EIA arm. EIA: Energy Information Administration.
API: American Petroleum Institute – sets standards for Statistical arm of the US DOE, which releases weekly and
specific gravity of crude oil. monthly data.
API#2 – TFS API#2 ® average price index for coal delivered FOB: Free on Board – denotes commodity price loaded and
CIF ARA. cleared for export at load port, e.g. coal FOB Richards Bay,
South Africa.
API#4 – TFS API#4 ® average price index for coal loading
FOB Richards Bay, South Africa. Fuel oil (FO) – Dense refined oil product used to fuel ships
and generating stations.
ARA: Amsterdam-Rotterdam-Antwerp – major delivery hub
for cargo entering Northwest Europe. German Dark Spread: The spread between German
power and coal -- Dark Spread = German power –
Backwardation – Market condition in which forward coal/(2.65*EURUSD)
prices decline as tenor increases.
HDD: Heating degree day – deficit of daily average
Barrel (bbl): liquid measure of 42 US gallons. temperature below 65°F in US, 18°C elsewhere.
Bcf: Billion cubic feet – macro measure of natural gas Henry Hub: Louisiana delivery point for NYMEX natural
volume. gas.
Bpd: Barrels per day – measure for oil production or use. HSFO: High sulphur fuel oil.
Bunkers – Fuel oil used to power ships. LNG: Liquefied natural gas – can be shipped on special-
CAT: Cumulative average temperature. The sum of daily purpose tankers.
high + low)/2, usually over a month or season. mmBtu: million British Thermal Units – Natural gas heat-
CDD: Cooling degree day – excess of daily average content measure, approx. 1000 cubic feet.
temperature over 65°F; usually cumulated over time. PADD: Petroleum Area of Defense District – US regions
CIF: Cost, Insurance, and Freight – denotes commodity for petroleum market data, defined approximately as:
price delivered to destination, e.g. fuel oil CIF Rotterdam. PADD1 – East coast
Clean Spread: The spark spread minus the cost of PADD2 – Midwest
emissions.
PADD3 – Gulf coast
Contango – Market condition in which forward prices
increase as tenor increases. PADD4 – Inter-mountain west
Crack – Price spread between crude oil and refined PADD5 – West coast
product (after the refining process of “cracking” large Spark Spread: Price spread between electricity and the
molecules to make smaller). fuel (see also UK Spark Spread and German Dark Spread).
DBLCI: Deutsche Bank Liquid Commodities Index – tracks UK Spark Spread: The spark spread represents the
six commodities, rolling positions in crude oil and heating marginal value of selling UK electricity and buying UK
oil monthly, and in gold, aluminum, corn and wheat once natural gas for a gas fired power station. Market standard
per year. Reuters: DBLCI. Bloomberg: DBCM. DBLCI-MR: UK Spark Spread = UK power – UK Natural Gas * 0.6944
DBLCI-Mean-reverting – rule-based variant of the above;
under-weights those commodities amongst the six which Therm: 100,000 British Thermal Units, or 0.1 mmBtu
are expensive relative to their long-term average, and over- WTI: West Texas Intermediate – benchmark US crude oil;
weights those which are relatively cheap. for NYMEX futures, delivered Cushing, Oklahoma.
Distillate: Class of refined oil products including heating oil
(aka gasoil) and diesel, and usually jet fuel and burning
kerosene.
Contacts
Name Title Telephone Email Location
Head of Commodity Sales,
Richard Jefferson Europe, Asia 44 20 7547-7689 richard.jefferson@db.com London
Global Head of Commodities
Louise Kitchen Structuring & Sales 44 20 7547-5395 louise.kitchen@db.com London

Correlation Matrix
Page 100
Commodities Correlation Matrix
11 January 2008
Commodities Outlook
Source: Deutsche Bank
This Pearson moment correlation matrix is calculated from the daily returns of the 60 most recent business days’ data. For most, the first nearby futures contract is used. A roll adjustment is made by back-creating
the price series according to the daily return of the prompt contract on the roll date. This avoids severe consequences for those commodities with significant term structure, where rolls introduce spurious jumps,
which lower correlations. The shading scheme is as follows: numbers in interval [-0.4, 0.4] are unshaded; numbers in [-0.85, -0.4] and [0.4,0.85] have a light grey background; the highly correlated pairs (with a
magnitude >=0.85) are shown with the darker grey.
Deutsche Bank AG/London

Appendix 1
Important Disclosures
Additional information available upon request
Special Disclosures
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Global

Deutsche Bank AG/London

Brent 95.54 -2.35% 1.80% 51.70 97.84 52.40

Heating oil 2.64 -3.80% -0.31% 1.47 2.74 1.50

Gasoline (RBOB/gallon) 2.47 -3.70% -0.08% 1.36 2.57 1.54

US natural gas (/mmBtu) 7.97 1.49% 6.47% 5.43 8.64 6.97

Coal (API#2/tonne) 130.00 4.84% 4.84% 65.80 133.00 65.66

Uranium (/lb) 90.00 0.00% 0.00% 72.00 138.00 41.02

EUR Emissions Cal'10 24.48 2.01% 4.85% 12.92 26.01 20.98

Gold 879.05 2.58% 5.52% 607.92 879.05 505.54

Silver 15.49 3.72% 4.91% 11.67 15.82 8.79

Platinum 1550.00 0.62% 1.57% 1117.50 1550.00 979.88

Palladium 376.25 0.87% 1.28% 320.75 386.00 262.79

Copper 7230 7.03% 8.31% 5340 8320 4394

Lead 2660 1.72% 4.31% 1550 3890 1237

Nickel 29895 9.91% 13.67% 25100 51600 19512

Tin 16500 0.76% 0.46% 10100 17575 8807

Zinc 2580 5.26% 8.86% 2220 4170 1966

Cotton 0.68 0.80% 2.09% 0.46 0.69 0.55 Agriculture

Soybeans 12.67 1.46% 5.67% 6.65 12.68 6.91

Sugar 0.11 5.96% 5.08% 0.08 0.11 0.10

Source: DB Global Markets Research, Bloomberg (Prices as of close of business Tuesday)

Page 2 Deutsche Bank AG/London

Like the sirens in Greek mythology, commodities have

China (Year 0 = 1995)

• We believe the run-up in oil prices during the 5,000

Deutsche Bank AG/London Page 3

2004 1992 1998 2000 2008 1996

Steel 0.13 150

Source: China Statistical Bureau

Page 4 Deutsche Bank AG/London

The role of the US

For those investors concerned towards a potential

Consequently, alongside tight supply-demand

Michael Lewis, (44) 20 7545 2166

Deutsche Bank AG/London Page 5

Index • Long DBLCI-MR • Long DBLCI-MR vs. short S&PGSCI

• Long DBLCI-MR “Plus” • Long DBLCI-CL vs. short DBLCI-OY-CL

• Long Commodities Booster Fund • Long DBLCI-OY-NG vs. short SPGSCI-NG

Grains • Long grains basket • Long corn curve backwardation

Source: DB Global Markets Research

Page 6 Deutsche Bank AG/London

Oct 5 2007 Playing Grains Seasonality: Long Mar’08 Corn

Sep 14 2007 Wheat Term Structure Trade

Source: DB Global Markets Research, Bloomberg

Deutsche Bank AG/London Page 7

July 20 2007 RV Oil Index vs. Oil Equities

July 20 2007 WTI Curve Play: Backwardation To Stay

Feb 16 2007 Bullish Back-end Copper

Page 8 Deutsche Bank AG/London

certain commodity markets, for example gold, is

Deutsche Bank AG/London Page 9

DBLCI All others: annual Annual Feb-03 70%

DJ-AIG Six times per annum Annual Jul-98 60%

RJ/CRB Monthly Monthly Jun-05 30%

RICI Monthly Annual Jul-98 20%

This has seen the energy allocation collapse to 5% by

Page 10 Deutsche Bank AG/London

aluminium exports since September 2006 such that net

100K tonnes. Moreover, in 2008 steps to discourage

Figure 5: China’s move to become a net

Figure 7: Expected composition of returns for the

Source: DB Global Markets Research, CEIC