Commodities Forecast Update: The Return of Fundamentals

25 June 2013 Securities Research & Analytics http://www.credit-suisse.com/researchandanalytics Commodities’ Forecast Update: The Return of “Fundament...
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25 June 2013 Securities Research & Analytics http://www.credit-suisse.com/researchandanalytics

Commodities’ Forecast Update: The Return of “Fundamentals” Connection Series

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Supply is the Word… In our April Forecast Update (The Setting of the Sun), we suggested that the commodity complex would come under increasing pressure during Q2. In particular, we noted that in a world of tepid growth, supply dynamics were likely to drive differences between individual commodity performances. Fast forward three months and it is clear that, if anything, we were too optimistic, with the market now beginning to recognize the structural nature and magnitude of the Chinese growth slowdown. Within the generalized weakness, however, it is evident to us that supply divergences are playing an increasing role at a time when the high correlation between asset classes and commodities seen since Lehman has begun to break down. In many ways, we are seeing the return of fundamentals. With global growth likely to remain subdued over the second half of 2013, and Chinese activity apparently slowing as we enter Q3, the commodity complex is likely to remain under pressure. Within the general trend, however, the pace of supply growth is likely to remain the key factor driving inter-commodity variation. • Copper and iron ore prices are likely to continue to decline as increased supply outpaces demand; • In contrast, Brent oil is likely to be supported around the current level by subdued supply growth. • Nickel, thermal coal, and aluminum prices should begin to stabilize over the course of H2 2013 as price bites deeper into the cost curve. With core PCE inflation in the US still slowing, and the Fed openly contemplating tapering its asset purchase program, gold is also likely to come under substantial further pressure.

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25 June 2013

Table of Contents Editor’s Summary: “The Return of Fundamentals”

4

Supply is the word

4

And then there was gold

5

Correlation – Slowly reverting to “normal”

6

Summary of the outlook for individual commodities

7

Macro Outlook: Still Subdued

13

Global growth remains tepid at best

13

Europe – Lead in the global saddlebag…

14

In the US we must trust

15

China: Reality bites

16

The great Japanese experiment

19

Petroleum: Steady as she goes

22

… But what’s next in terms of oil price ranges?

22

Downside to oil prices in the longer run

22

Supply growth, yes; supply shock, not likely

23

Price effects and what makes oil demand so sticky

25

Near term: Fairly firm support

29

Supply-side support

32

How oil is trading

33

Brent-WTI

35

Natural Gas:

39

Global LNG

39

US: Raising our forecast (modestly) to balance storage

42

UK (NBP)

50

Steel:

53 Struggling for traction

Bulk Commodities

53 58

Iron Ore – Surplus begins now

58

Metallurgical Coal – From hero to zero

65

Thermal Coal – Stagnation

70

Commodities’ Forecast Update: The Return of “Fundamentals”

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Base Metals: Life in the slow lane

77

Downside price risks come to the fore

77

Copper – At home on the (lower) range

78

Aluminum – All pain and no gain

87

Alumina – Looking gloomy

93

Zinc – Lock, stock and barrel

108

Lead – Heavyweight still on its feet … just

113

Tin – Temporary headwinds

119

Gold & Silver:

123

Gold – Further falls ahead as investors capitulate

123

Silver – Is relative stability too much to hope for?

135

Forecasts:

139

Platinum Group Metals

140

Platinum – Great expectations (of disruption)

140

Palladium – Delayed gratification

144

Mineral Sands

150

High grade TiO2 feedstocks

151

Chinese ilmenite market

155

Zircon demand moving into a restock

156

Normalised zircon sales volumes

157

Uranium: Nuclear regulations in Japan a positive step Uranium price forecasts Financial Flows 2Q 2013 summary of commodity-linked flows

163 163 169 169

Technical Analysis

172

Contributors

175

Commodities’ Forecast Update: The Return of “Fundamentals”

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Editor’s Summary: “The Return of Fundamentals” RESEARCH ANALYST Commodities Research Ric Deverell [email protected] +44 20 7883 2523

Supply is the word In our April Forecast Update (The Setting of the Sun), we suggested that the commodity complex would come under pressure during Q2. In particular, we noted that supply growth was likely to become increasingly important, with those commodities where supply is set to improve likely to fall the most. Fast forward three months and it is clear that we were too optimistic, with the market beginning to recognize the structural nature and magnitude of the Chinese growth slowdown (see macro section). Our economists expect growth to remain tepid over H2 (Global Economics Quarterly), suggesting that the broad based downward pressure is likely to continue. In particular, the recent data from China suggest that, if anything, growth there is continuing to slow, adding to the pressure on basic materials. Within this broad trend, however, supply growth is likely to remain the key driver of differentiation among individual commodities.

Exhibit 1: Supply growth over the next 12 months – iron ore leads the pack…

Exhibit 2: Iron ore and copper will likely experience big supply improvements on recent years Percentage point difference between supply growth in year to Q3 2014 and that seen over 2010 and 2011.

20%

Raw % growth rate (next 12 months)

10%

Fcst vs 2010-2011 avg supply growth rate

18% 5%

16% 14%

0%

12% 10%

-5%

8% -10%

6% 4%

-15%

2% 0%

-20%

Source: Credit Suisse Commodities Research

Source: Credit Suisse Commodities Research

• With supply likely to recover substantially over the next 12 months, iron ore and copper prices are likely to come under further (possibly substantial) pressure; • On the other hand, continued subdued supply growth should support the price of oil at around the current level. • After strong growth in recent years, low prices are beginning to curtail the expansion of nickel, thermal coal and aluminum supply which in turn should reduce downward pressure. For aluminium in particular, however, it may take until 2014 before we start to see prices stage a sustainable recovery. − As we highlighted in (Marginal Cost: Less Support Than Many Think), while production costs can provide some price support, prices can “undershoot” for a time; costs themselves are more dynamic than most analysts suggest (they tend to fall when prices are falling).

Commodities’ Forecast Update: The Return of “Fundamentals”

4

25 June 2013

Exhibit 3: 3Q 2014 Credit Suisse commodity forecasts vs. current front month Credit Suisse 3Q14 quarter average forecast price vs. front month at 08:45 GMT on 24/06/13

20% 15% 10% 5% 0% -5% -10% -15% -20% -25%

U.K. Nat Gas

Palladium

Platinum

Nickel

Brent

Aluminium

Thermal Coal

WTI

Silver

U.S. Nat Gas

Zinc

Tin

Lead

Copper

Gold

Iron Ore

Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service

And then there was gold Of course the commodity that experienced the largest fall in 2Q was gold, the commodity with the least tangible “fundamental” support. Indeed, while the workhorse of forecasting industrial commodities remains detailed supply and demand analysis, for gold, pricing is far more ephemeral, with the precious metal in many ways trading more like a currency (an alternative store of value) than an input into the industrial process. Having highlighted the downside risks to the price of gold in Gold: The Beginning of the End of an Era), we remain bearish, targeting $1,150/oz in 12 months’ time. While there are many moving parts in the gold equation (see page 129), to us the risk-reward of owning gold has fundamentally changed, for both technical and “fundamental” reasons. On the technical side, it is clear that after steadily moving higher for 10 years, the upward trend has decisively broken over recent months, shattering the confidence of those who thought gold would continue to chart new highs indefinitely. More importantly, the “fundamental justifications” for holding gold have substantially diminished, in our view. • Following Dr. Draghi’s famous speech last year, the risk of a financial cataclysm has reduced, with markets pricing risk much more efficiently as the broad risk-on risk-off period has subsided. The substantial reduction in this “Planet of the Apes risk – a world where the financial system fails”, is a key factor reducing the need for investors to hold gold as tail-risk insurance. • The second key reason cited by many to hold gold over the past five years has been the near religious faith among bulls that QE must relatively quickly lead to a substantial increase in inflation, with many fearing hyperinflation. In reality, five years after the Fed commenced its program of quantitative easing – and 12 years after Japan began “printing money” – global inflation continues to fall, with core US PCE deflator inflation falling to the lowest level seen since the series was first calculated in the 1960s. • Finally, the recent increase in US yields has shown that at some point in the not-toodistant future it is probable that the Fed will begin the long process of normalizing monetary policy. In a world of higher rates, the opportunity cost of holding zero coupon gold is increasingly likely to become an issue. With the need for tail risk protection and the need for inflation protection substantially reduced, it remains hard to see where the marginal buyer for gold will come from.

Commodities’ Forecast Update: The Return of “Fundamentals”

5

25 June 2013

Correlation – Slowly reverting to “normal” As we discussed in (Commodities as an Asset Class: Correlation Has Peaked), over the past 100 years risk assets have tended to become highly correlated during substantial macro-economic shocks (e.g., the depression, the oil shocks/break up of Bretton Woods, the great recession). While at the time, it feels like this increased correlation will persist for ever, history suggests that it tends to unwind at a relatively predictable rate (Exhibit 5). This general pattern appears to be well underway in the current episode, no doubt aided by the Draghi “the ECB will save the euro” speech last July. • With the current unwind well underway, we expect commodities once again to begin to provide diversification benefits to many portfolios, as the return of fundamentals continues.

Exhibit 4: Commodity correlation is reverting to more “normal” levels

Exhibit 5: Indeed the pace of “normalization” is very much in line with the historical experience

Commodities vs. US equities, rolling 36-Month correlation

Commodities vs. US Bond Total Return Index, rolling 36-month correlation 80%

90% 70%

Max - Jun 2011

t = Mar'56

t = Mar'81

t = Jun'11

60%

50%

40% 30%

20% 10%

0% -10% -30%

-20%

-50% 1915 1925 1935 1945 1955 1965 1975 1985 1995 2005

-40%

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, RBA, Shiller

Commodities’ Forecast Update: The Return of “Fundamentals”

t-45 t-36 t-27 t-18

t-9

t

t+9

t+18 t+27 t+36 t+45 t+54

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, RBA

6

25 June 2013

Summary of the outlook for individual commodities Relative to futures pricing we remain most bullish the PGMs and oil, and bearish most of the China intensive basic materials, with iron ore and copper likely to see the largest underperformance relative to current market expectations. We are also far more bearish than current market pricing on gold. Nickel’s performance reflects an expected modest rebound after falling more sharply than most LME commodities.

Exhibit 6: 3Q 2014 Credit Suisse commodity forecasts vs. futures Credit Suisse 3Q14 quarter average forecast price vs. 3Q14 future at 08:45 GMT on 24/06/13

20% 15% 10% 5% 0% -5% -10% -15%

Palladium

Platinum

Brent

WTI

Nickel

Thermal Coal

Silver

U.K. Nat Gas

Aluminium

U.S. Nat Gas

Tin

Lead

Zinc

Copper

Gold

Iron Ore

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Relative to the Bloomberg consensus we remain most bearish on the precious metals and basic materials, with oil the only commodity where we are more constructive than the consensus of analysts.

Exhibit 7: 3Q 14 Credit Suisse commodity forecasts vs. consensus forecasts Credit Suisse 3Q14 quarter average forecast price vs. 3Q14 Bloomberg consensus mean at 08:45 GMT on 24/06/13

5% 0% -5% -10% -15% -20% -25% -30%

Brent

WTI

Thermal Coal

U.S. Nat Gas

Aluminium

Palladium

Nickel

Platinum

Iron Ore

Copper

Zinc

Lead

Tin

Gold

Silver

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Crude Oil – Minor revision down for near-term prices Oil prices have remained remarkably resilient in the face of a bearish consensus and highly uncertain world. As of yet, we do not see a strong enough shift in the fundamentals to knock prices out of their $100-$120 per barrel quarterly average Brent range. That

Commodities’ Forecast Update: The Return of “Fundamentals”

7

25 June 2013

being said, rising risks to emerging market economies, the engines that drive oil demand growth, mean that we are less confident oil consumption will rise by more than 1% in the second half of 2013. As such, we are marking to market our second quarter Brent price, which traded ~6% short of our $110/b forecast, and shaving $5/b off our price projections for the second half of the year. Supply/demand data for oil (through April and in many instances May) were on track with our out-of-consensus bullish projections for 2013. On the demand side, year-to-date growth comes to ~1.5% yoy, in raw, unadjusted terms. But when adjusted for seasonality levels look flat, and down in a few key places, and momentum is not strong. Better price support keeps coming from the supply side. Industry-led production outside the US is still underperforming, while flows from sovereign producers remain well below expectations.

Global Gas: Global gas markets remain fundamentally disconnected, the more so since ‘spot’ liquefied natural gas tankers are almost all pulled to Asia, which has consistently remained short after the Fukushima tragedy of March 2011. On the other side, the North American market remains over-supplied but its low-cost molecules remain in splendid isolation until the first LNG export terminal cranks up in 4Q 2015. Somewhere in the middle (see Exhibit 73), floats Europe. Its low import demand is mostly fed by pipelines. Also, its power-markets remain in thrall of renewables and cheap imported coal and thus uncompetitive for LNG.

North American Gas – Near-term increase to forecast The big picture of US natural gas markets remains one of abundant supply. Despite market expectations to the contrary, the multi-year uptrend of US dry-gas production has still not turned – and we think it will not do so in our forecast time-frame. That said we are raising our near-term price outlook, mostly because an unusually long winter created a deep inventory deficit versus five-year norms. We forecast 2H 2013 prices to average $4.20/MMBtu on the basis that lower storage levels will require higher gas prices relative to coal to adequately loosen the summer supply/demand balances. Our updated supply model points towards annual dry gas growth of +1.1 Bcf/d yoy (up 300 MMcf/d from last quarter). We have also factored in losing ~3 Bcf/d in gas power demand though the summer. We now target $4 average prices in 2014, a downward revision of 20 cents. Substantial gas processing additions within the Utica and Eagle Ford shale and the second wave of the Marcellus pipeline late in 2013 will add substantial supply to the market, leaving little upside to next year’s natural gas prices.

UK (NBP) Gas – Outlook unchanged NBP (National Balancing Point) natural gas prices have come off their highs from late March as the bleak late winter storage situation has steadily improved. Indeed, it is somewhat remarkable that just three months ago, the UK balance looked terribly short supply with inventories nearing total exhaustion, since then storage is already almost sufficiently full ahead of next winter. It does validate our slightly more bearish April view and we leave our price forecasts unchanged.

Bulk Commodities: Iron Ore – Near-term downward revision Iron ore markets should register a small surplus in H2 of this year before 2014 heralds the more obvious arrival of the much-vaunted wall of supply – Rio Tinto, FMG, BHP Billiton and Vale are all projected to deliver significant growth tonnage over the next 18 months. In addition, we believe that China’s steel production is likely to slow in the second half of the year as credit, construction and infrastructure cycles all appear to be turning down. As a

Commodities’ Forecast Update: The Return of “Fundamentals”

8

25 June 2013

consequence we have cut our 2013 average price forecast to US$120/t (CFR China) and to $96/t for 2014. From 2Q of next year we expect iron ore to head back towards our longrun real estimate of $90/t but with the risk that, for significant periods, it may need to trade below this level in order to remove unwanted tonnes from the market.

Metallurgical Coal – Prices revised lower Metallurgical coal markets have gone from bad to worse over the past three months as the steel-making raw material faces both cyclical and structural headwinds. Almost no producers are profitable at current prices but it will take time for production curtailments to alter the market balance. We have consequently downgraded our 2013 average price to $159/t. In addition, we have cut out our long-run real price forecast to $165/t as we expect a diminished call on supply growth over the coming years.

Thermal Coal – Near-term downward revision Thermal coal has underperformed even our bearish expectations over the past quarter and we again revise prices lower, now forecasting a 2013 average of $86 for FOB Newcastle. From 2014 on, supply growth is set to slow and should offer demand the opportunity to catch up but this is still likely to be a slow, drawn out, affair. The market looks set to remain in surplus for some time, albeit a diminishing surfeit, and any recovery should therefore be relatively muted.

Base Metals – Downward price revisions Copper stands out as being the most overvalued of the LME metals, in our view. Inevitably, we think prices must come under further downward pressure soon. Although we question strict faith in short-term cost support – prices almost always under- or over-shoot when supply and demand swing – the price today sits more than US$1,500/t above the short-run marginal cash cost of supply. Within the next 6-12 months we expect LME prices to be tracking at the bottom of the US$6,000-9,000/t range in which the metal has traded since 2006. We believe that underlying aluminium prices will need to fall further to trigger meaningful smelter responses in a market awash with excessive supply. We have not been surprised to see the US$1,800 level broken in recent days. In the absence of wholesale setbacks to nickel projects, which now seem unlikely, prospects for price rises for this metal look bleak in 2H 2013; surpluses will likely exceed 50 kt this year and there are risks of further falls, perhaps into the US$13,000-14,000 range for spells ahead. However, nickel has fallen furthest in the LME complex and a moderate rebound is a possibility in 2014. Meanwhile, we have also trimmed our forecasts for both zinc and lead, taking the view that while supply constraints are a feature over coming years, demand is simply too soft to create much of an updraft any time soon. Further ahead an end to cash-and-carry warehousing trade could one day severely dent zinc and aluminium prices but probably beyond 2014.

Gold and Silver: Gold – Still more downside risk; forecast prices cut sharply We remain bearish gold and have cut our price forecasts again. We do not expect equilibrium between physical demand/falling supply and investor liquidation to be found until the price drops to around $1,150/oz – note that is only around 12% below where spot is trading at the time of writing. We project it may take until 2H 2014 to get to that point but would not be surprised to see the metal get there sooner.

Commodities’ Forecast Update: The Return of “Fundamentals”

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We retain a negative outlook on gold as we continue to believe that: • Inflation in the developed world will remain largely static while nominal yields will move up, pushing real yields higher and increasing the opportunity cost of holding gold; • Monetary policy in the US will get less easy – the beginning of QE tapering will signal a more robust US economy and will reinforce the credibility of the Fed with respect to its price stability mandate; • “Fear trades” will continue to be unwound as tail risks (systemic financial collapse, US rating downgrade, etc.) diminish further; • And, notwithstanding its recent decline, gold remains an expensive hedge, both in real historical terms and relative to other assets. However, given the significant structural shifts that the gold market underwent from 1999 to 2007, and the fact that over an extended period price-elastic jewelry demand and (arguably) declining mine supply should provide some support, we have retained our longterm real price forecast of $1,300/oz.

Silver – Forecasts trimmed but outlook more stable We think that in terms of future price performance the worst may just be over for silver. Fund positioning in derivatives is almost as neutral as it has been for 15 years, while holders of physical metal seem content (so far) to retain their longs. And if the economic forecasts of a modestly improved and relatively stable trajectory for global growth come good then the more “industrial” precious metal should outperform gold. We have trimmed our price deck from our last quarterly report to account for our lower gold forecasts but do not project much downside beyond 4Q this year. Naturally, with a commodity such as silver that is prone to substantial bouts of volatility, there are still some sizeable risks to that view but we believe the outlook is certainly better than it was a year ago.

Platinum Group Metals – Nearby bullishness tempered Questions about the future rate of supply growth from South Africa have been at the forefront of investors’ minds for some time. At the start of the year, the potential for heightened disruption to supply from industrial disputes was a key driver of investment flows and price. Expectations of significant production losses, however, have not been met – yet – and the platinum price has come off the boil. However, in our view, the necessary supply response to weaker metal prices and thin to negative margins has only been deferred, not abandoned. On the demand side of the coin the European auto-catalyst industry remains very weak but may now at least be in the process of bottoming. Lower prices have also provided a fillip to Chinese jewelry demand, the largest single sector of consumption. We also retain our long-term bullish outlook for palladium but, given a slowing China and high level of speculative and investor positioning, we have trimmed our forecasts. Demand for the metal should continue to be driven by emerging market car sales (China is still growing, just less quickly) and emissions legislation, while supply growth is likely to be muted and dependent on South African and Zimbabwean projects. Consequently, we see annual deficits persisting through to 2016, which should steadily tighten the market.

For trading recommendations related to this note, please see Trading Recommendations: The Return of Fundamentals.

Commodities’ Forecast Update: The Return of “Fundamentals”

10

Commodities’ Forecast Update: The Return of “Fundamentals”

Exhibit 8: Global commodities forecast research price forecast summary (units as stated) 2012 Yr Avg (f)

2013 Q1 (f)

Q2 (f)

Q3 (f)

2014 Q4 (f)

Yr Avg (f)

Q1 (f)

Q2 (f)

Q3 (f)

Q4 (f)

Yr Avg (f)

2015

2016

2017

LT

Yr Avg (f)

Yr Avg (f)

Yr Avg (f)

(real)

Energy Brent (US$/bbl)



previous

WTI (US$/bbl)



previous

U.S. Natural Gas (US$/MMBtu)

113

103

105

110

108

115

110

110

105

110

100

95

95

111.64

113.19

110.00

110.00

115.00

112.00

115.00

110.00

110.00

105.00

110.00

100.00

95

95

90 90

94.11

94

94

97

102

97

105

100

100

95

100

90

85

85

80

94.11

94.33

95.00

98.00

105.00

98.00

105.00

100.00

100.00

95.00

100.00

90.00

85

85

80



2.83

3.35

4.09

4.20

4.20

4.00

4.10

3.90

4.00

4.10

4.00

4.40

4.70

4.60

4.50

2.83

3.35

3.65

3.80

4.00

3.70

4.20

3.90

4.20

4.40

4.20

4.25

5

5

5

-

58.49

67

68

62

68

66

72

65

64

70

68

67

66

65

61

58.49

67.21

64.00

62.00

68.00

65.00

72.00

65.00

64.00

70.00

68.00

67.00

66

65

61

128

148

125

105

100

120

105

95

95

90

96

90

90

90

90

128

148

125

115

110

125

105

100

100

95

100

90

90

95

90

206

239

202

169

161

193

169

153

153

145

155

145

145

145

145

206

210

202

185

177

194

169

161

161

153

161

145

N/A

N/A

145

210

165

172

147

150

159

160

160

165

165

163

173

180

185

165



210

165

172

175

175

172

175

175

180

180

178

183

188

190

170

139

116

120

103

105

111

112

112

116

116

114

121

126

130

125



139

116

120

123

123

120

123

123

126

126

124

128

132

133

125

154

124

141

110

113

122

120

120

124

124

122

129

135

139

130

154

124

141

131

131

132

131

131

135

135

133

137

141

143

130

95

91

87

80

85

86

90

90

90

95

91

100

102

105

100



95

91

87

90

90

90

90

90

95

95

93

100

102

105

100

92

86

80

77

82

81

89

89

89

94

90

99

101

104

100

92

86

80

85

89

85

89

89

94

94

92

99

101

104

100



93

85

80

78

82

81

88

88

88

93

89

98

100

103

100

93

85

80

84

88

84

88

88

93

93

91

98

100

103

100

49

43

40

43

45

43

48

52

56

60

54

65

70

65

65

49

43

45

48

50

46

56

56

56

56

56

65

70

65

65

previous

U. K. NBP (GBp/Therm)

111.64

previous

Iron Ore Iron ore fines - 62% (China CFR) US$/t



previous

Iron ore fines - (China CFR) US¢/dmtu



previous

Coking Coal (contract) Hard coking coal (US$/t) previous

Semi soft coal (US$/t) previous

PCI coal (US$/t)



previous

Thermal Coal Thermal Coal (Newcastle FOB) US$/t previous

Thermal Coal (ARA CIF) US$/t



previous

Thermal Coal (RBCT FOB) US$/t previous

Uranium Uranium spot (US$/lb) previous



Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

25 June 2013

11

Commodities’ Forecast Update: The Return of “Fundamentals”

Exhibit 9: Global commodities forecast research price forecast summary (units as stated) 2015

2,016

2,017

LT

Yr Avg (f)

2012 Q1 (f)

Q2 (f)

Q3 (f)

2013 Q4 (f)

Yr Avg (f)

Q1 (f)

Q2 (f)

2014 Q3 (f)

Q4 (f)

Yr Avg (f)

Yr Avg (f)

Yr Avg (f)

Yr Avg (f)

(real)

7,971

7,958

7,200

7,000

6,800

7,240

6,600

6,300

6,100

5,900

6,225

6,750

7,250

7,750

7,971

7,927

7,700

7,300

7,000

7,482

6,900

6,800

6,600

6,400

6,675

6,200

6,300

6,800

6,600

2,030

2,040

1,875

1,800

1,750

1,866

1,800

1,850

1,900

1,900

1,863

2,000

2,100

2,200

2,250

2,030

2,011

2,000

1,950

2,000

1,990

2,050

2,050

2,050

2,050

2,050

2,000

1,900

2,000

2,250

319

340

330

340

340

338

350

350

350

350

350

360

400

400

400

319

340

350

350

350

348

350

350

350

350

350

360

400

400

400

17,548

17,376

15,250

14,500

14,000

15,282

14,500

15,000

15,500

16,000

15,250

17,000

18,000

20,000

20,000

17,548

17,291

16,500

16,500

17,000

16,823

17,000

17,000

17,000

17,000

17,000

18,500

20,000

21,000

20,000

2,064

2,307

2,050

1,950

1,900

2,052

1,900

1,900

1,900

1,950

1,913

2,200

2,300

2,500

2,000



2,064

2,299

2,250

2,300

2,450

2,325

2,600

2,650

2,700

2,800

2,688

3,000

2,800

2,400

2,000

1,954

2,054

1,850

1,800

1,750

1,864

1,800

1,800

1,750

1,700

1,763

1,900

2,000

2,200

1,900

1,954

2,034

2,050

2,050

2,150

2,071

2,250

2,300

2,350

2,450

2,338

2,600

2,500

2,200

1,900

-

21,047

23,230

20,500

19,000

18,500

20,308

19,000

19,000

19,000

20,000

19,250

23,000

25,000

25,000

20,000

21,047

24,060

21,500

21,500

22,500

22,390

23,000

23,000

23,000

23,000

23,000

24,000

25,000

26,000

20,000

1,670

1,630

1,410

1,310

1,250

1,400

1,220

1,190

1,150

1,150

1,180

1,200

1,250

1,340

1,300

1,670

1,630

1,580

1,570

1,540

1,580

1,520

1,520

1,480

1,470

1,500

1,420

1,400

1,380

1,300

31.30

30.10

23.40

22.20

21.20

24.20

21.40

21.60

20.90

21.30

21.30

22.60

23.10

24.40

22.80

31.30

30.10

28.70

28.00

27.00

28.50

27.10

27.60

26.90

27.20

27.20

26.80

25.90

25.10

22.80

640

745

730

720

750

740

760

780

780

820

790

850

870

900

850



640

745

760

770

800

770

840

870

900

910

880

950

980

900

900

1,560

1,630

1,490

1,500

1,540

1,540

1,550

1,580

1,580

1,630

1,585

1,700

1,770

1,850

1,800



1,560

1,630

1,630

1,660

1,700

1,655

1,720

1,750

1,830

1,870

1,790

1,880

1,850

1,820

1,800

1,320

1,200

1,130

1,150

1,350

1,210

1,600

1,700

1,800

1,900

1,750

2,080

2,300

2,500

2,500

1,320

1,200

1,350

1,450

1,650

1,410

1,900

2,000

2,200

2,200

2,080

2,280

2,600

2,800

2,500

2,250

1,230

1,250

1,500

1,500

1,370

1,700

1,700

1,700

1,700

1,700

1,650

1,650

1,625

1,500

2250

1,150

1,250

1,500

1,500

1,350

1,700

1,700

1,700

1,700

1,700

1,650

1,650

1,625

1,500

-

2,333

1,450

1,450

1,450

1,500

1,463

1,550

1,550

1,350

1,350

1,450

1,175

1,100

1,075

1,000

2333

1,450

1,450

1,550

1,550

1,500

1,350

1,350

1,350

1,350

1,350

1,175

1,100

1,075

1,000

-

1,659

1,300

1,300

1,300

1,350

1,313

1,450

1,450

1,250

1,250

1,350

1,075

1,000

975

890

1659

1,300

1,300

1,400

1,400

1,350

1,250

1,250

1,250

1,250

1,250

1,075

1,000

975

890

-

313

285

275

225

250

259

250

250

250

250

250

225

225

225

200

313

250

250

300

300

275

250

250

250

250

250

225

225

225

200

-

1,688

1,150

1,150

1,250

1,250

1,200

1,100

1,100

1,100

1,100

1,100

925

850

825

760

1688

1,150

1,150

1,250

1,250

1,200

1,100

1,100

1,100

1,100

1,100

925

850

825

760

Base Metals Copper (US$/t) previous

Aluminium (US$/t) previous

Alumina spot (US$/t) previous

Nickel (US$/t) previous

Lead (US$/t) previous

Zinc (US$/t)

▼ ▼ ▼ ▼ ▼

previous

Tin (US$/t) previous

6,600

Precious Metals Gold (US$/oz) previous

Silver (US$/oz) previous

Palladium (US$/oz) previous

Platinum (US$/oz) previous

Rhodium (US$/oz)

▼ ▼ ▼

previous

Minerals Zircon bulk (US$/t)

-

previous

Rutile bulk (US$/t) previous

Synthetic Rutile (US$/t) previous

Ilmentite - sulphate 54% (US$/t) previous

Titanium Slag - SA Chlor 86% (US$/t) previous

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

25 June 2013

12

25 June 2013

Macro Outlook: Still Subdued RESEARCH ANALYST Commodities Research Ric Deverell [email protected] +44 20 7883 2523

Global growth remains tepid at best At a global level GDP growth remains sluggish as we enter 2H. Chinese growth in particular has continued to disappoint market expectations as it has become increasingly apparent that this time the moderation is structural in nature and that the prospect of a substantial new stimulus is remote. • After growing by 2.5% saar in 1Q, our economists expect global GDP growth to have been 3.4% in 2Q, with a modest rebound to 3.8% saar for 2H.

Exhibit 10: Global GDP – modest rebound in prospect but merely “average” QoQ % annualised

8

30 year avg. 3.5%

6 4 2 0

Forecast

-2 -4 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: Credit Suisse

In terms of the near-term cycle, global IP growth looks to have moderated over 2Q, with growth relatively unsynchronized across the major regions. While it is likely that the latest slowdown scare is in the course of coming to an end, looking through the extreme IP volatility seen in recent years it is notable that trend IP growth at a global level is yet to clearly find a floor.

Exhibit 11: Global PMI NO vs. global IP 3MMA – IP yet to find a floor? Monthly, SA, 3MMA (lhs); index (rhs)

1.5%

Global IP

65

Global PMI New Orders (rhs)

1.0%

60

0.5%

55

0.0%

50

-0.5%

45

-1.0% 2005

40 2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

13

25 June 2013

While there are many factors underpinning this slowdown, the main drag on the global economy has been the substantial contraction in European final domestic demand, with global trade growth having slowed dramatically post Lehman as the challenges in Europe have weighed. • In many ways the virtuous cycle of increased trade and globalization during the 2000s moved into reverse, with trend global export growth slowing from 7.6% CAGR in the years up until Lehman to the current disappointing 1.8%.

Exhibit 12: Global trade – Europe acting as a real drag World exports, monthly, natural log 4.9

Jan11-Mar13: 1.8%

4.8

CAGR (Jan02-Dec07): 7.6%

4.7

Jan08-Apr09: -17.8%

May09-Dec10: 15.6%

4.6

4.5

4.4

4.3 02

03

04

05

06

07

08

09

10

11

12

13

Source: Credit Suisse

Europe – Lead in the global saddlebag… As discussed above, the main weight on global growth remains Europe. While GDP has only contracted modestly in recent years, final domestic demand on the continent has been in free fall, contracting by ~3.5% since early 2011, a similar fall to that seen during the “Great Recession”. With European exports holding up reasonably over this period, this has seen a dramatic increase in the European trade balance, with Europe effectively “stealing” growth from the rest of the world and Asian and emerging market countries in general particularly hard hit.

Exhibit 13: Euro trade balance – Europe “stealing” growth from other regions

Exhibit 14: Regional final demand – Europe in the doldrums, even if the slide is close to an end

Percent of GDP

Index, Q1 2008 = 100

102

3 2

101

Euro area

100

US

1

99

0

98

Japan

97

-1

96

-2 -3 1980

95

1985

1990

1995

2000

2005

Source: Credit Suisse, Eurostat

Commodities’ Forecast Update: The Return of “Fundamentals”

2010

94 2008

2009

2010

2011

2012

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

14

25 June 2013

There are signs that the contraction in European industrial production is coming to an end but, in large part, this reflects continued growth in the rest of the world, with much of the production for export. While it is also likely that the contraction in domestic demand begins to moderate over the coming year as financial conditions continue to ease, fiscal contraction slows and the US economy continues to strengthen, the road to recovery in Europe is likely to be gradual and there could be many setbacks along the way. • From a global perspective, it is difficult to see rapid growth returning until the structural problems in Europe are closer to resolution and it once again begins contributing to final demand.

Exhibit 15: Eurozone manufacturing – PMI new orders – beefier improvement requires solutions to structural problems Index

65 60 55 50 45 40 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, Markit

In the US we must trust Thankfully, the US has continued to demonstrate its relative resilience, with growth likely to pick up pace over the coming year as the current pronounced fiscal headwinds fade. US industrial production has followed the rest of the world lower in recent months but the labor market has proven relatively robust and the all-important housing sector continues to heal. • With the recovery continuing, the Fed has begun to discuss the possibility of tapering its asset purchases. Our economists expect the first steps in September but, following more hawkish than expected comments in last week’s FOMC statement, highlight the risk that July is Now in Play. • While initially markets are likely to react negatively to the possibility that the pace of QE will slow, ultimately a full blown US recovery will be a good thing for the global economy and commodity demand.

Commodities’ Forecast Update: The Return of “Fundamentals”

15

25 June 2013

Exhibit 16: US payrolls growth solid

Exhibit 17: US IP versus PMI – timing of the “tapering” impacting current mood

Thousand jobs

Percentage change (lhs); index (rhs)

500

US IP 3MMA

400 300 200 100

1.5%

Average Markit and ISM new orders (rhs) 65

1.0%

60

0.5%

55

0.0%

50

-0.5%

45

0 -100 -200 -300 -400 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

-1.0% 2008

40 2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, Markit

Exhibit 18: US housing is recovering… Percentage change (lhs), index (rhs)

20%

100

S&P/Case-Shiller 20 City Home Index YoY U. of Michigan Consumer Confidence (rhs)

15%

95 90

10%

85

5%

80

0%

75

-5%

70 65

-10%

60

-15% -20% 2005

55 50 2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

China: Reality bites The data flow from the past few months has confirmed our long-held belief that China has entered a period of substantially weaker growth, with the most recent partial data (for the month of May) suggesting that, if anything, growth has continued to slow as we approach the middle of the year. • GDP growth in 1Q was a (for Chinese standards) mediocre 6.6% saar; • IP growth remains tepid, with the 3mma of monthly change through to May a weak 7.7% saar – dramatically lower than the 17% seen between 2002 and 2008. Note that the recent information suggests that if anything IP growth is slowing further as we enter H2; • Anecdotally, we are picking up reports of weaker orders in key manufacturing sectors (e.g., home appliances) for 3Q onwards after 2Q’s seasonal strength.

Commodities’ Forecast Update: The Return of “Fundamentals”

16

25 June 2013

Exhibit 19: Chinese GDP growth remains weak …

Exhibit 20: … with IP growing at less than half the pace of the 2000s

Percentage change

Percentage change, 3MMA

13%

China Real GDP QoQ SA, annualised

China Real GDP YoY

35%

12%

30%

11%

25%

10%

20%

9%

15%

8%

10%

7%

5%

6%

0%

5% 2000

2002

2004

2006

2008

2010

2012

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, China NBS

-5% 2005

China Industrial Production

2006

2007

2008

2009

2010

Pre-2008 Average

2011

2012

2013

Source: Credit Suisse, PBOC

While many cite the numerous structural challenges in China as the proximate cause for the slowdown, with the implicit assumption that with further “reform” growth can return to its previous pace, we continue to feel that the main reason for the slowdown is the dramatic deceleration in exports since Lehman. • In the years running up to 2008, Chinese real exports grew at a 23.7% CAGR%; • Since 2010 the pace has slowed to 6.9%, with the recent “correction” to the data showing that over the past year exports have essentially stagnated.

Exhibit 21: Chinese export growth has slowed dramatically … Natural log, real USD billions, monthly, SA. China exports

5.0 4.8 4.6

CAGR: 6.9%

4.4 4.2 4.0

CAGR: 23.7%

3.8 3.6 3.4 3.2 3.0 2003

2005

2007

2009

2011

2013

Source: Credit Suisse, Markit

The main near-term catalyst for the export weakness has been the implosion in European final domestic demand – recall that Europe accounts for roughly 20% of Chinese exports. This suggests that an export rebound is unlikely until European growth begins to recover, something that in our view is some way off. This is supported by recent discussions with manufacturers expecting flat export activity in 4Q 2013 and 1Q 2014, for which orders are imminently being set.

Commodities’ Forecast Update: The Return of “Fundamentals”

17

25 June 2013

That said, part of the slowdown is structural, with the one-off level shift seen after China joined the WTO in 2002 having run its course. Given that the export/investment model of growth that has dominated over the past few decades was underpinned by the assumption that exports would continue to grow (they grew by more than 20% in the years up to Lehman), continued weak exports is in our view the key factor behind the growth slowdown, with little sign of a turnaround. • We expect the 6.6% saar pace of GDP growth seen in 1Q to be broadly replicated over 2H; • We note, however, that the downside risks to growth are building, with the transition to a slower pace seldom smooth. The authorities were able to pump up growth in 2009-10 through a massive build in infrastructure and credit but they are very reluctant to do this again – remember that a stimulus is really only designed to fill the hole until growth returns. Nearly six years on from the collapse of Lehman, export growth has not returned, partly because of cyclical reasons, but also because the rapid growth post WTO membership was a once off, with those market share gains unlikely to be repeated.

The stimulus is beginning to fade As we have suggested for some time, the boost from infrastructure spending and housing is likely to soften as we move into 2H. • Infrastructure fixed asset investment growth looks to have peaked at a similar pace to that seen in the previous cycle, with growth likely to slow further over the course of the year. • Government efforts to cool the housing sector are also beginning to take effect (Exhibit 23). As we postulated two months ago (China – Reality Bites), mild 1Q sector strength appears to have been due to buyers hastening to complete transactions before the imposition of new restrictions, rather than a signal of underlying improvement. − Availability and affordability of housing are the name of the government’s game and they will do the best they can to curb prices without stifling construction. In this context, we expect construction activity to trend sideways, with little positive momentum until price appreciation appears to be more firmly under control. − As long as house prices remain firm we anticipate little in the way of policy relaxation. − In terms of the May data specifically, sales and starts declined by 2.9% and 8.5% mom sa respectively, whilst completions gained 2.4% on the month, recovering a degree of their recent decline. Finally, it is becoming clear to us that the new leadership is firmly intent on addressing a range of pressing “social” challenges, not least of which are removing over-capacity and industrial renewal, controlling severe pollution and improving food safety and both urban and rural living standards. In the past, the authorities have fallen short of targets on these goals but the rhetoric this time points to a stronger likelihood of tangible and firm action. Greater control of credit creation via the shadow banking sector has also come to the fore in recent weeks. The impression we get when talking to policy advisors is that the newly-installed leaders are aware that time is limited and that the longer reforms are delayed, the harder it will be to reshape China’s “unbalanced” economy. For swathes of heavy industry and commodity-intensive activity, this alone spells slower growth in the years ahead.

Commodities’ Forecast Update: The Return of “Fundamentals”

18

25 June 2013

Exhibit 22: Infrastructure FAI growth has peaked …

Exhibit 23: … along with housing construction

Percentage change

Trend monthly change in seasonally adjusted construction activity

5%

Real China Infrastructure FAI, Monthly SA, Trend Change

15%

Sales

Completions

Starts

12%

4%

9%

3%

6%

2% 3%

1% 0%

0% -3%

-1% 2005

2006

2007

2008

2009

2010

2011

2012

2013

-6% 2007

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, China NBS

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, China NBSw

The great Japanese experiment The early evidence suggests that “Abe economics” is having a positive impact on the Japanese economy, with GDP increasing by 4.1% saar in Q1, and our economists expecting 2.4% over the remainder of the year. However, it will be some time before we are able to accurately gauge the success of the measure but, in the near term, it is clear that after being a substantial drag last year, Japan is contributing to global activity as we enter 2H.

Exhibit 24: Japanese GDP is beginning to recover Percentage change

8%

JPN GDP QoQ

JPN GDP YoY

6% 4% 2% 0% -2% -4% -6% -8% -10% 1995

Forecast 1997

1999

2001

2003

2005

2007

2009

2011

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

EM: The tide has turned After leading the recovery from the “Great Recession” in late 2009 and 2010, growth in the emerging market economies has disappointed over the past year, with aggregate growth remaining well below average as we exit 2Q. While there are many moving parts, in simple terms there have been four phases to EM growth over the past six years. Commodities’ Forecast Update: The Return of “Fundamentals”

19

25 June 2013

• The first was the US-led “Great Recession”; • The second, the largest stimulus in history, which worked very well in the EM, with growth returning to well above average in the second half of 2009 and through 2010; • Note that the developed economies only managed average growth in 2010 despite the massive stimulus – not surprising given that it was a “North Atlantic”, rather than global, financial crisis; • Third came the draining of the stimulus as EM economies began to overheat in 2011; and • Finally, over the past year the “hangover” has set in as it has become clear that the EM countries cannot sustain above-average growth while the North Atlantic continues to struggle. That is not to say that they cannot grow without strong exports but rather that they cannot grow as strongly in that environment. − This hangover has been exacerbated recently by the possibility that the Fed begins to taper its asset purchase program, with the inflows to EM countries in recent years beginning to reverse – in many cases sharply.

Exhibit 25: EM growth has disappointed over the past year Emerging market GDP growth, % qoq saar

12 10 8

Avg

6 4 2 0 -2 -4 -6 Jan-00

Apr-02

Jul-04

Oct-06

Jan-09

Apr-11

Source: Credit Suisse

With exports still relatively subdued and EM policy moving to support domestic growth again, the collective current account balance of the EM world (if there is such a thing) has also deteriorated markedly, with the large current account surpluses of earlier years giving way to a broadly balanced external position in early 2013 1.

1

We note that while this change will have an impact on currencies, it is less clear that it is a bad thing for the global economy. Or to put it another way, it was always a little odd that capital on balance was flowing from the world’s fastest growing economies to the old world.

Commodities’ Forecast Update: The Return of “Fundamentals”

20

25 June 2013

Exhibit 26: The EM current account balance has deteriorated substantially Percentage share of GDP

4.0%

EM current account, quarterly, %GDP

3.5% EM current account, 4Q sum, %GDP

3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Source: the BLOOMBERG PROFESSIONAL™ service

Notably, the main “culprit” in this process has been Europe, where domestic demand has collapsed once again. • While domestic demand in Japan and the US has recovered over recent years, in Europe it has fallen at a similar rate as seen in the first half of 2009 as the “Great Recession” was in full swing. • Using China as an example, after growing at 35% a year up until Lehman, exports to the EU are currently falling – note that the EU remains China’s largest trading partner.

Commodities’ Forecast Update: The Return of “Fundamentals”

21

25 June 2013

Petroleum: Steady as she goes RESEARCH ANALYSTS Commodities Research Jan Stuart [email protected] +1 212 325 1013 Johannes Van Der Tuin [email protected] +1 212 325 4556 Supply Model Contributors Equity Research Edward Westlake [email protected] +1 212 325 6751 David Hewitt [email protected] +65 6212 3064

The commodity price forecasts mentioned in this section have been provided by the Commodities Research analysts above.

… But what’s next in terms of oil price ranges? The remarkable thing about oil is that its price has remained as range-bound as it has in a highly uncertain world. One more quarter has gone by in which oil prices did not bow to consensus and collapse. Nor do we as yet see a significant turn in fundamentals this year or next that would tip prices out of their $100-$120 per barrel Brent range. We are, however, shaving $5/b off our benchmark projection for the second half of 2013. Mostly we are marking to market from a second quarter in which Brent oil prices traded ~6% short of our $110 forecast and traded in a very narrow, $5 channel near the bottom of their multi-year range. In addition, the adjustment reflects that we are less confident of our expectations for oil consumption to rise by more than 1% in the second half – what with rising risks to growth across EM and a US recovery that still feels fragile, especially in oil demand terms. Nor, of course, is it helpful that the best we can say about Europe’s oil economy is that things are not getting worse. That said, the supply/demand data of oil (through April and in many instances May) are on track with our out-of-consensus bullish projections for 2013. • On the demand side, year-to-date growth comes to ~1.5% yoy, in raw, unadjusted terms. But SA levels look flat and down in a few key places and momentum is not strong either. • Stronger price support keeps coming from the supply side. Industry-led production outside the US still underperforms, while flows from sovereign producers remain well below expectations, see Oil Sense: Middle East in the (Supply) Balance.

Exhibit 27: Credit Suisse versus the IEA on demand

Exhibit 28: Credit Suisse versus the IEA on supply

Mb/d

Mb/d

2.0

Credit Suisse

1.9

Consensus (IEA)

1.5

Credit Suisse

Consensus (IEA)

1.4

1.0

0.9

0.5

0.4

0.0

(0.1)

(0.5)

(0.6)

2013 Global

OECD

Non-OECD

Source: Credit Suisse, IEA

Non-Opec

Call on Opec crude + inventory

Source: Credit Suisse, IEA

While all of that is fine and good, and we’ll discuss it in more detail below, our headline “steady as she goes” in part reflects on the apparent complacency in oil markets as well.

Downside to oil prices in the longer run There will be blood “There will be blood” – the title of a film depicting the early days of the US oil industry in California – resonates on a number of levels when thinking about oil markets today. When looking further out, even optimists such as us have to acknowledge that oil use in developed economies began to decline a while ago. And a similar down-turn of long-run oil consumption trends may be less than a decade away for emerging market economies:

Commodities’ Forecast Update: The Return of “Fundamentals”

22

25 June 2013

• In a few emerging markets oil prices have already eroded demand growth, while substitution and technology are only beginning to compound down-ward pressure. As the current oil price paradigm eventually shifts, there will be blood – metaphorically on trading floors at least. There is an obvious case to be made that oil prices eventually come down. After all, supplies in the longer-run should prove plentiful and the costs of producing oil can go down as well (costs are not static or ever-rising). • That supply-side case is amply illustrated by the US shale revolution, or more broadly by the simple fact that in the last 20-odd years the liberal application of money and the many advances in technology and expertise have moved the boundaries of oil exploration and in so doing raised the best estimates of how much more oil can still be produced globally at least three-fold. The clear implication is that in a slower-growth world, still fraught with uncertainty, plentiful supplies eventually bring down oil prices. • That is also one reason why longer-dated futures prices have, since the Great Recession repeatedly failed to hold above $90-$95 per barrel Brent, and that we have kept our own long run, or normalized price target at a constant dollar $90/b.

Exhibit 29: Long-range oil price (2-year-out Brent)…

Exhibit 30: …is range bound at low-ish level

$/b

$/b $130

$160

$140

$120

Last Price

UBB (2)

BollMA (200)

LBB (2)

$120

$110 $100

$100

$80

$60

$90

$40

$80 $20

$70

$J-03

J-04

J-05

J-06

J-07

J-08

J-09

J-10

J-11

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

J-12

J-13

J-11

A-11

J-11

O-11

J-12

A-12

J-12

O-12

J-13

A-13

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

In this chapter we will frame and discuss what can drive oil prices down and out of their current range, and of course also highlight the upside price risks around a common-sense, longer-range outlook. We obviously don’t have all the answers, but want to initiate the discussion more formally and expect to pick up the story frequently in future.

Supply growth, yes; supply shock, not likely “The cure for high prices is high prices”, US oil production growth The old saying looks to be working, most visibly, in the case of the US tight oil ‘revolution’, for which the single most important requirement was and is high prices. We have reported before on the extensive, granular work we do with our equity-research colleagues to keep abreast of the oil supply impact of the US Shale, see Commodity Forecasts: The Setting of the Sun…. Looking out to the end of the decade, we put US oil production growth into a global context to show that while it is transformative for US energy trade and policy; on a global scale that growth pales in significance and is highly unlikely to become a gamechanger for oil later this decade.

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In our view many things need to go right and/or need to “normalize” for global supply to keep on growing at a pace that exceeds demand. From a base of 85 million barrels per day of global capacity in 2012 (see Exhibit 31). In this “waterfall” chart the base of oil production capacity excludes bio-fuels and processing gains. It consists of more than 6,000 oilfields and adds up to ~86 million barrels per day in 2012. From that base: • We conservatively projected cumulative declines in that portion of the existing base of oil production already in decline (based on 10-year historical performance); • And added growth from newer fields already in production; • Then comes the increment from US shale and tight oil formations, out to 2019, another ~4 Mb/d; • Then comes a stack of new field developments and a few other “optimistic” assumptions, including the following: − large slices of growth (~1.8-2.1 Mb/d) each from Canada, and Brazil; − big offshore additions also come from the US GoM; Angola and Norway; − new and large shale developments in Argentina and Russia; − A return to significant growth in Venezuela; − Growth from Iraq, and Saudi Arabia; − as well as a return to pre-crises production in Sudan, Syria, Yemen and Egypt; − and lastly the plethora of ongoing industry developments.

Exhibit 31: Outlook for end-decade global oil supply growth (+1.4 Mb/d pa through 2019) kb/d 100000

90000

US GoMexico

810

Saudi Arabia

896

Iraq

910

Venezuela

939

Norway

80000

991

Russia

1160

Angola

1232

Canada

1848

Brazil

2165

Other

3700

70000

60000

50000

40000

2012

Less Decline

Plus Growth on Existing Fields

Plus US shale

Plus New Fields (incl Russia/Arg/Canada Shale)

Other

2019

Source: Credit Suisse

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25 June 2013

All told, global oil capacity growth should be running at an average annual pace near ~1.4 Mb/d, 1.5% – which is roughly equivalent to the pace of oil demand growth in EM, but more on that latter point below. Risks to this medium-term supply-side outlook run both ways. − The technology of shale could continue to surprise and its adaptation and scaling up could proliferate faster; − Conversely sovereign producers (e.g. in MENA) may find still more reasons to inhibit investment and oil developments; − Or as cannot be ignored, at some point Saudi Arabia may adopt a longer-term view and switch to a ‘low-price’ strategy to frustrate competition and ensure market-share. In this point-forecast, however, we simply projected a path along reasonable, higher probability and granular, estimates. This serves two purposes: • One, it’s a reminder that a supply shock is likely not expected in the next 3-5 years, and prices should stay relatively well supported unless demand collapses. • Two, this exercise also frames the broader issue: Namely that incremental and costly private sector-driven supply growth has limitations. Far bigger price-effects, true supply shocks if you will, are more likely to come from key sovereigns changing policy. Most critical in that regard are political developments (and attendant changes in the investment climates) of Iraq; Venezuela; Kuwait; and eventually Saudi Arabia. These countries are not coincidentally at the top of anyone’s listing of oil reserves. Not surprisingly then, we think that the demand side is more likely to drive oil prices out of their current comfort zone.

Price effects and what makes oil demand so sticky Simply assuming that demand for oil will swiftly follow the path of demand for other commodities, we think would be mistaken. Oil products often are consumer goods, whereas base metals and bulks more often correlate with industry and investment. Typically consumption of base and bulk commodities grows fastest as economies industrialize/urbanize. Oil consumption, by contrast, grows less fast in that phase, especially if coal is available domestically and oil is imported. But oil demand then gets an added push as per capita wealth effects prompt more travel – work and discretionary. In addition, ongoing urbanization requires still more transport of goods and raw-materials. That said, high and rising prices are eroding oil consumption in absolute and especially in relative terms (Exhibit 32). And perhaps surprisingly, through 2012, that effect is greatest across emerging markets.

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Exhibit 32: Oil’s share of global primary energy use

Exhibit 33: Shares of fossil fuels across EM

% share of primary energy demand (BP definitions)

% share of primary energy demand non-OECD, ex former Soviet Union

50%

100% 45%

20%

Oil

Oil Coal Natural Gas (rhs)

Fossil Fuels 45%

95%

40%

90%

35%

85%

30%

42%

17%

39%

14%

36%

11%

33%

8%

80% 1965

1970

1975

1980

1985

1990

1995

2000

2005

2010 30%

5% 1985

Source: BP Statistical Review of World Energy, 2013, Credit Suisse

1990

1995

2000

2005

2010

Source: BP Statistical Review of World Energy, 2013, Credit Suisse

In a big historical picture, the share of oil in total primary energy demand peaked in 1973, then collapsed as oil prices first quadrupled (1974) and then tripled (1979-80). Things stabilized more or less from 1985-1999. Then oil began to lose ground fast, again, from 2002 onward, coinciding with another near quintupling of prices to ~$110/b Brent. • While fossil fuels as a whole lost considerable ground in the 70s and 80s (thanks mostly to hydro and nuclear making inroads into the power-sector) since the early 1990s their share has stabilized around 87%. And renewables reached only a ~2.5% share in 2012. The best illustration of the effect of high and rising prices on oil demand is its loss relative to other primary energy across the most dynamic economies.

Exhibit 34: Oil hangs on in North America

Exhibit 35: Oil demand, change by country, 2007-‘12

Share of primary energy demand of fossil fuels and share of oil forPE and FF

Kb/d, total change, annual average 2012 v 2007s

oil share of PE

60%

100%

oil share of fossil fuels fossil fuel share of primary energy (rhs) 50%

95%

40%

90%

30%

85%

20%

80% 1965

1975

1985

1995

2005

Source: Credit Suisse, Exxon

US 48 Italy France UK Germany Iran Canada Mexico South Korea Chile Australia Japan South Africa Venezuela Egypt Argentina Thailand FSU Brazil India Saudi Arabia China -3000

-2000

-1000

0

1000

2000

3000

4000

Source: Credit Suisse

Oil has lost ground across EM. Excluding the former Soviet Union, oil lost -8.8 percentage points from 39.9% in 1999, to 31.1% of total primary energy demand in 2012, see Exhibit 33. Put differently, while across EM (ex FSU) the CAGR of primary energy use from 2002 to 2012 was 5.8%, the CAGR for oil reached only 3.6%.

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The relative performance of oil in North America is less clear-cut. There seem to be limits to price effects. Oil demand as a share of total primary energy consumption lost 2.5 percentage points since 2005 (it went from 39.8% in 2005 to 37.3% last year). But since 2008, it has lost no ground within the complex of fossil fuels, despite a widening price gap versus both coal and natural gas. Having illustrated that oil demand growth in a relative sense, at least, is eroding, the question becomes, where is oil use rising still? All oil demand growth in the last five years has come from emerging markets (Exhibit 35). Aggregate EM oil demand should overtake DE oil use this year, in raw numbers probably in 2Q.

Broad drivers of oil demand growth Econometric studies have shown that while per capita wealth was the biggest driver of oil demand growth in the five years ending in 2010 (Exhibit 36). Slowing population growth in most regions and accelerating gains in oil intensity have begun to decelerate growth, even in China, already last decade. Indeed across the OECD, oil use began to contract by nearly 2% p.a. thanks to compounding effects of efficiencies and slow GDP growth.

Exhibit 36: Rising living standards are the main demand driver in EM

Source: Credit Suisse, OECD

However, in China, oil demand growth, while materially decelerating as intensities of GDP improve fast, still had high residuals near 6% p.a. And going forward, much will depend on what progresses faster: per capita wealth or the twin headwinds to oil demand of substitutions and efficiency gains. And in Emerging Markets ex-China, the wealth effect appears to have entered on a steeper growth path. That is the one slice of global oil consumption (roughly one third of the global total) that still features accelerating growth.

How much more can be expected? How much more oil demand growth can be expected depends in the main on: • how fast emerging markets continue to grow; • and how fast oil demand falls away in developed economies. On a sector basis, one long-term view, that of ExxonMobil, sees material oil demand growth, despite efficiency gains, particularly in industry and transportation (see Exhibits 37 and 38). From 2000 to 2010 the compound average oil demand growth rate for industrial and transportation usage were 1.29% and 1.75%, respectively.

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Again, rising living standards are a powerful driver of oil demand growth. Industrialization, rising wealth and the development of more mobile consumer societies have pushed up oil demand across the non-OECD. Going forward, even with incremental improvements in energy efficiency, breaking the strong link between development and oil demand growth would likely require massive technological breakthroughs.

Exhibit 37: In Exxon’s 25-year outlook for the world’s energy balance, storing energy is key and oil consumption grows in its two biggest sectors

Exhibit 38: But even the biggest commercial stakeholders see “energy efficiency” as the larger supply wedge in their long run forecasts

Mb/d

Quadrillion BTUs

Primary

Residential/Commercial

Industrial

Transportation Total

CAGR = 1.04%

120 100 80 60 40 20 0

2025

2010 Source: Credit Suisse, Exxon

Source: Exxon

Nor is it clear that the cycle of growth in EM has turned yet – in China or elsewhere. • China of course is special in oil as well. Coal fueled much of the phenomenal pace of its industrializing/urbanizing since the early 1980s. Oil’s share of that activity was comparatively small and all along was mostly confined to transportation.

Exhibit 39: Chinese diesel demand

Exhibit 40: Chinese gasoline demand

Kb/d

Kb/d

3,750

120%

2,500

100%

3,500

100%

2,250

80%

3,250

80%

2,000

60%

3,000

60%

1,750

40%

2,750

40%

1,500

20%

2,500

20%

1,250

0%

2,250

0%

2,000 Jan-07

-20% Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Source: Credit Suisse, NBS, the BLOOMBERG PROFESSIONAL™ service

Jan-13

1,000 Jan-07

-20% Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Source: Credit Suisse, NBS, the BLOOMBERG PROFESSIONAL™ service

While gasoline use continues to expand relatively fast (trend near 10% p.a.), the use of diesel, which tracks IP and GDP growth better historically, has begun to lag. And as we said before, much about the medium-term pace of oil demand growth will continue to depend most heavily on global growth, not yet some substitution and/or efficiency effect. Commodities’ Forecast Update: The Return of “Fundamentals”

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Near term: Fairly firm support Over the much shorter term, we remain persuaded that fundamentals stay reasonably supportive, which should allow Saudi Arabia to continue to manage supply and broadly guide against prices falling (or rising) out of their comfort zone, $110-120/b Brent.

Exhibit 41: Saudi Arabia’s oil production balances s/d $/b (lhs); kb/d (rhs) $150

Saudi Production (kb/d, right axis)

Brent front month ($/b)

$110 mark

$140 $130 $120

Oct'12, a particularly well timed output cut

Lower production in the wake of the GFC , when oil was under $100

10,500

10,000

9,500

$110

9,000

$100

8,500

$90

Increased output to compensate for disruptions from first Libya and then Iran ... and when Brent price reaches over $110/b

$80

8,000

7,500

$70 $60 Jan-10

7,000 Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

As for oil prices in 2013, we think that fundamentals improve incrementally through the balance of the year. Global crude oil markets have just come out of a spring soft patch and appear to be entering a more supportive 3Q, with caveats. Unlike the consensus (read IEA), we believe that oil markets will require a rising call on Opec and inventories through the balance of 2013 (see Exhibit 42).

Exhibit 42: CS balance, call on Opec ‘delta’ stays positive

Exhibit 43: The burden on Saudi Arabia becomes easier to manage

Mb/d

Mb/d

1.0

Credit Suisse

2.0

Consensus (IEA)

Opec

0.5

SA

1.5

0.0

1.0

(0.5)

0.5

(1.0) 0.0

(1.5) 1Q

2Q 3Q Call on Opec crude + Inventory

Source: Credit Suisse, IEA

4Q

(0.5) 2Q 2013

3Q 2013

4Q 2013

Source: Credit Suisse, IEA

With the majority of Opec producing at capacity, western sanctions on Iran and faltering Iraqi production, it should become easier for Saudi Arabia to manage the markets. The most recently available data shows the Kingdom with ~2.5 Mb/d of spare capacity, making the task of raising production when price starts to reach north of $110 and cutting production in the face of weaker demand much easier (see Exhibit 41). And in truth, the call on Opec has really become the call-on-Saudi Arabia (see Exhibit 43). Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Demand side uncertainty Markets may need every bit of Saudi support they can get. In aggregate, thus far global oil demand growth has held close to our forecasts, coming in at ~1.5% yoy growth in 1Q 2013 and ~1.1% yoy in 2Q 2013 (Exhibit 44 and 45). However, its components and distribution yield little confidence about the trajectory through the end of the year and into 2014.

Exhibit 44: Global demand holds on to gains

Exhibit 45: Momentum of growth has faded

Global demand SA, ln scale

Yoy and qoq % oil demand growth SA

11.45 6%

11.40

qoq growth

yoy growth

4% April 2013 2%

11.35 0%

11.30

-2%

-4% 2006

2007

2008

2009

2010

2011

2012

2013

11.25 J-08

J-09

J-10

J-11

J-12

J-13

J-14

Source: Credit Suisse, IEA, JODI, EIA, NBS, ANP

Source: Credit Suisse, IEA, JODI, EIA, NBS, ANP

As of April, global oil demand growth yoy was down sequentially, from 1.71% to just 0.85%(see Exhibit 45).

Exhibit 46: OECD demand seems to find a floor

Exhibit 47: But it remains fragile at best

OECD demand SA, ln scale

Yoy and qoq % oil demand growth SA

10.90 4%

qoq growth

yoy growth April 2013

10.85 2%

10.80

0%

10.75

-2% -4%

10.70

-6% 2006

10.65 J-08

J-09

J-10

J-11

J-12

J-13

Source: Credit Suisse, IEA, EIA

2007

2008

2009

2010

2011

2012

2013

J-14 Source: Credit Suisse, IEA, EIA

On the bright side, OECD oil demand growth has become incrementally less bad. After three straight quarters of qoq demand declines, OECD demand picked up by ~0.22% in April (see Exhibit 47). Now, a less than 0.3% gain in qoq oil demand growth is by no means a panacea, and yoy demand oil demand is still significantly down, but it does appear as if OECD demand declines have found a floor; for the time being (see Exhibit 46).

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Exhibit 48: EM oil demand tracks higher, but we worry about the second half …

Exhibit 49: … and here too, momentum is not great

EM demand SA, ln scale

Yoy and qoq % oil demand growth SA

10.80 10%

10.75

qoq growth

yoy growth

8%

10.70

6%

10.65

April 2013

4%

10.60

2%

10.55

0%

10.50

-2%

10.45

-4%

10.40 J-08

J-09

J-10

J-11

J-12

J-13

2006

J-14

Source: Credit Suisse, IEA, JODI, NBS, ANP

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, IEA, JODI, NBS, ANP

At the moment, what really makes us twitchy is EM oil demand. As discussed above, with the exception of the financial crisis, developing economies have seen steady trend oil demand growth of ~3.3%-3.4% yoy for quite some time (see Exhibit 48). Simply put, EM demand growth has been the engine of global demand growth. Unfortunately, after eight straight quarters of positive qoq growth, oil demand has fallen in April by -0.23% when compared with 1Q. Declines of that level, however small, have not happened since 4Q 2008 (see Exhibit 49).

Exhibit 50: China’s oil demand wobbles

Exhibit 51: April-May momentum, a blip?

China demand SA, ln scale

Yoy and qoq % oil demand growth SA

9.4 25%

9.3

qoq growth

yoy growth

20%

9.2 15%

9.1

April/May 2013

10%

9.0

5%

8.9

0%

8.8

-5%

8.7

-10% 2006

2007

2008

2009

2010

2011

2012

2013

8.6 J-08

J-09

J-10

J-11

J-12

J-13

Source: Credit Suisse, NBS

J-14 Source: Credit Suisse, NBS

Currently, the main source of EM demand declines is China. Several factors have undermined “apparent” oil demand growth in April and May (see Exhibits 50 and 51). In particular, weak IP and, possibly as a consequence, diesel demand, have been a drag on China’s oil demand. Whether or not weakness will continue into 3Q, especially with what should be seasonal demand increases is unclear and one of the key reason why we are not confident of growth in 2H and have taken $5 off of our price forecast.

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25 June 2013

Exhibit 52: US oil demand may yet surprise

Exhibit 53: Momentum looks encouraging

US demand SA, ln scale

Yoy and qoq % oil demand growth SA

10.0 6%

qoq growth

yoy growth April/May 2013

4% 2%

9.9

0% -2% -4%

9.8

-6% -8% -10% 2006

9.7 J-08

J-09

J-10

J-11

J-12

J-13

2007

2008

2009

2010

2011

2012

2013

J-14

Source: Credit Suisse, EIA

Source: Credit Suisse, EIA

On the upside, US oil demand may surprise us yet. At the moment, we’ve penciled in a mere 0.7% yoy demand growth forecast for the US in 2013, powered mostly by a dramatic supply driven increase in LPG demand. In seasonally adjusted terms though, both 1Q and 2Q momentum look encouraging and leave us somewhat hopeful. The large qualification being, the weekly US DoE data that we use to construct our monthly April and May data points have proved sadly unreliable of late.

Supply-side support Despite what has been an issue with decline rates in oil fields outside the US and Opec, global production, ex-Saudi Arabia, would begin to gradually ramp up towards the end of 2H 2013 (see Exhibit 54). Of course, the big driver of global production increases will remain the US (see Exhibit 55).

Exhibit 54: Global production (ex – Saudi Arabia)

Exhibit 55: The big driver is US production

Global supply SA, ln scale

US supply SA, ln scale

85000

14000

82000

12000

79000

10000

76000

8000

73000

6000 J-08

J-09

J-10

J-11

J-12

J-13

Source: Credit Suisse

J-14

J-08

J-09

J-10

J-11

J-12

J-13

J-14

Source: Credit Suisse

For non-Opec ex-US the picture remains somewhat dim. Non-Opec (ex-US) production has declined considerably since 2H 2010 (see Exhibit 56). Granted the majority of that decline was the result of supply disruptions in Sudan, Syria and Yemen, take those countries out of the mix and non-Opec supply has remained relatively stable over the last couple of years (see Exhibit 57). Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 56: Non-Opec (ex-US) production

Exhibit 57: Non-Opec (ex-US, Sudan, Syria, and Yemen) production

Non-Opec supply SA, ln scale

Non-Opec (ex-US, Sudan, Syria and Yemen) supply SA, ln scale

43000

42000

42000

41000

41000

40000

40000

39000

39000 J-08

J-10

J-09

J-11

J-12

J-13

J-14

Source: Credit Suisse

38000 J-08

J-09

J-10

J-11

J-12

J-13

J-14

Source: Credit Suisse

Unfortunately though, over the last couple of years the threat of supply disruptions has become increasingly dispersed. Large MENA supply disruptions have continued to hover at ~2.0 Mb/d, even rising in May to a new high of ~2.15 Mb/d, see Exhibit 58. Outside of the MENA region production has disappointed in the North Sea, Nigeria and Brazil, for just a few examples, which is why, unfortunately, our forecasts for non-Opec supply have repeatedly been too optimistic (see Exhibit 59).

Exhibit 58: Big MENA disruptions persist (rising?)

Exhibit 59: US growth dominates yoy quarterly pattern,elsewhere our forecast again too optimistic

Kb/d

Kb/d

2500

Libya

Iran

Sudan

Egypt

Syria

Yemen

kb/d

Non-Opec ex. USA

USA

Non-Opec

kb/d

1600

1600

1200

1200

800

800

400

400

2000

1500

1000

0 500

0

-400

(400)

-800 0 Jan-11

(800) Q1-'12

May-11

Sep-11

Jan-12

May-12

Sep-12

Jan-13

Q2-'12

Q3-'12

Q4-'12

Q1-'13

Q2-'13E Q3-'13E Q4-'13E

May-13

Source: Credit Suisse

Source: Credit Suisse, IEA

How oil is trading With economies struggling to reach “escape velocity” growth rates, government stimulus remains more life-blood than inflationary and any shift in expectations about its duration takes on correspondingly greater significance. Most markets therefore simply seem to be trading news and oil is no exception (see Exhibit 60). That being said, a strong fundamentals link remains. As the availability of oil in the prompt month continues to push flat price up or down, shaping the futures curve and maintaining a strong correlation between near term time spreads and flat price (see Exhibit 61). Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 60: Intraday gyrations in a narrow channel

Exhibit 61: Brent structure supports price

$/b

$/b flat price (lhs); $/b futures contracts 1-6 (rhs)

$140

$130

$130

Testing the top (then the bottome) of the range

$8 $7

Brent front month price ($/b)

$6

$120 $5

$120

$4 $110

$110

$3 $2

$100 From a bounce to a sideways grind

$1 $100

$90

$80 J-11

M-11

S-11

J-12

M-12

S-12

J-13

M-13

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

$0

Brent futures 1-6: positive means backwardation, negative means contango

Brent weakens significantly

-$1

$90 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13

-$2

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Clearly investors are longer than they were in March/April (see Exhibits 62 and 63) but confidence, let alone euphoria is still some ways off. Conversely, should the macro picture begin to wobble, than the risk of a sell off could be significant.

Exhibit 62: High open interest

Exhibit 63: Fairly long positioning of investors

Thousands of contracts

Managed money net length vs. Brent open interest % (lhs); Brent price $/b (rhs) 16%

2000

3600

MM Futures Net Length

$150

Brent Price

14%

3400

1800

12%

3200

1600

3000

Current

1400

2800

Hi

8%

1200

2600

Low

6%

2400

Average

1000

2%

2000 Brent OI (contracts)

WTI OI (contracts)

$100

4%

2200

800

$125

10%

Total Crude OI (contracts)

Source: Credit Suisse, CFTC, the BLOOMBERG PROFESSIONAL™ service

0% J-12

$75 A-12

J-12

O-12

J-13

A-13

Source: Credit Suisse, ICE, the BLOOMBERG PROFESSIONAL™ service

Partially for that reason, as well as worries about weak end user demand, we have lowered our Brent and WTI price forecasts for the balance of 2013 (see Exhibits 64 and 65).

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 64: Brent futures base case

Exhibit 65: WTI futures base case

$/b, period averages of front-month futures

$/b, period averages of front-month futures

Period FY11 (a) 1Q12 (a) 2Q12 (a) 3Q12 (a) 4Q12 (a) FY12 (a) 1Q13 (a) 2Q13 (a) 3Q13 4Q13 FY13E 1Q14 2Q14 3Q14 4Q14 FY14E 1Q15 2Q15 3Q15 4Q15 FY15E FY16E FY17E Long-Term

New Forecast** $ 109.97 $ 118.28 $ 108.99 $ 109.42 $ 110.11 $ 111.70 $ 112.57 $ 103.35 $ 105.00 $ 110.00 $ 107.73 $ 115.00 $ 110.00 $ 110.00 $ 105.00 $ 110.00 $ 105.00 $ 100.00 $ 100.00 $ 95.00 $ 100.00 $ 95.00 $ 95.00 $ 90.00

Previous Forecast

$ $ $ $

110.00 110.00 115.00 115.00

Futures

$ $ $ $ $ $ $ $ $ $ $ $ $ $ $

105.34 104.23 107.38 103.13 102.02 100.85 99.65 101.41 98.60 97.67 96.74 95.85 97.21 94.01 91.76

BBG Concensus*

$ $ $ $ $

107.82 107.52 108.42 107.18 106.04

$

107.52

$ $

112.63 105.71

New Period Forecast** FY11 (a) $ 90.70 1Q12 (a) $ 102.91 2Q12 (a) $ 93.47 3Q12 (a) $ 92.20 4Q12 (a) $ 88.22 FY12 (a) $ 94.20 1Q13 (a) $ 94.41 2Q13 (a) $ 93.53 3Q13 $ 97.00 4Q13 $ 102.00 FY13E $ 96.74 1Q14 $ 105.00 2Q14 $ 100.00 3Q14 $ 100.00 4Q14 $ 95.00 FY14E $ 100.00 1Q15 $ 95.00 2Q15 $ 90.00 3Q15 $ 90.00 4Q15 $ 85.00 FY15E $ 90.00 FY16E $ 85.00 FY17E $ 85.00 Long-Term $ 80.00

Previous Forecast

$ 95.00 $ 98.00 $ $ 105.00 $ $ 102.75 $ $ $ $ $ $ $ $ $ $ $ $ $

Futures

97.66 96.22 96.10 94.54 93.18 91.87 90.72 92.58 89.45 88.43 87.57 86.91 88.09 85.29 83.68

BBG Concensus*

$ $ $ $ $

94.52 95.54 95.15 95.15 94.84

$

98.00

$ $

106.15 101.96

*Bloom berg forecasts from previous three m onths only Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service

Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service

Brent-WTI A final word on the Brent-WTI spread: We moderated the outlook for the spread a little since clearly a narrower than $10 differential has been in place for a month or so already, and much more infrastructure has yet to be completed (see Exhibit 66).

Exhibit 66: The Brent-WTI differential has narrowed to a more sustainable level $/b

un-anticipated bottlenecks

$25

more refiner demand and infrastructure

$20

$15

Seaway anticipation

$10

$5 S-12

O-12

N-12

D-12

J-13

F-13

M-13

A-13

M-13

J-13

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Commodities’ Forecast Update: The Return of “Fundamentals”

35

25 June 2013

In the main we expect: • A relatively narrow differential as more infrastructure is built out in 2H 2013 and 1Q 2014; • The differential widens to roughly $10/b as more low-sulfur, light oil accumulates on the Gulf Coast – and near LLS – and further reduces import requirements.

Exhibit 67: Brent forecast comparison

Exhibit 68: Brent historical price and forecast

US$/t

US$/t

$120

CS Forecast

Forward Curve

$160

Bloomberg Forecast Mean

$115

$140

$110

$120

$105

Brent front month

Quarterly avg forecasts

$100

$100

$80 $95

$60

$90

$40

$85 $80 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

$20 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 69: WTI forecast comparison

Exhibit 70: WTI historical price and forecast

US$/t

US$/t

$110

CS Forecast

Forward Curve

Bloomberg Forecast Mean

$160

WTI front month

Quarterly avg forecasts

$140

$105 $100

$120

$95

$100 $90

$80 $85

$60

$80

$40

$75 $70 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Commodities’ Forecast Update: The Return of “Fundamentals”

$20 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

36

25 June 2013

Exhibit 71: Global oil demand, implied and reported inventory changes, data, and forecasts Mb/d, unless otherwise specified

Demand

2010

2011

Q1-'12

Q2-'12

Q3-'12

Q4-'12

2012

Q1-'13

Q2-'13E

Q3-'13E

Q4-'13E

2013E

2014E

Global

88.3

89.4

89.2

89.8

90.8

91.6

90.36

90.6

90.8

92.1

92.7

91.5

92.8

3.2

1.0

0.4

1.5

0.6

1.5

1.0

1.4

1.0

1.3

1.0

1.2

1.3

3.8%

1.2%

0.4%

1.7%

0.7%

1.7%

1.1%

1.5%

1.1%

1.4%

1.1%

1.3%

1.4%

46.9

46.6

46.4

45.7

46.1

46.4

46.1

45.9

45.4

45.9

46.2

45.9

45.6

0.6

-0.3

-0.7

0.2

-0.9

-0.4

-0.4

-0.6

-0.3

-0.2

-0.1

-0.3

-0.2

1.3%

-0.7%

-1.4%

0.5%

-2.0%

-0.9%

-1.0%

-1.2%

-0.7%

-0.4%

-0.3%

-0.6%

-0.5%

24.1

24.0

23.4

23.7

23.8

23.8

23.7

23.6

23.8

23.8

24.0

23.8

23.8

0.5

-0.1

-0.8

-0.1

-0.4

-0.2

-0.3

0.2

0.1

0.0

0.2

0.1

0.0

2.0%

-0.4%

-3.1%

-0.4%

-1.5%

-0.7%

-1.4%

0.9%

0.4%

0.0%

0.6%

0.5%

0.1%

14.9

14.6

14.0

14.1

14.2

13.9

14.1

13.4

13.7

14.0

13.8

13.8

13.6

0.0

-0.3

-0.5

-0.3

-0.9

-0.5

-0.5

-0.6

-0.4

-0.1

-0.1

-0.3

-0.1

-0.1%

-2.3%

-3.3%

-2.2%

-5.8%

-3.2%

-3.6%

-4.2%

-2.7%

-0.8%

-0.8%

-2.1%

-0.9%

YoY Grow th, net mb/d YoY Grow th, % OECD YoY Grow th, net mb/d YoY Grow th, % Americas YoY Grow th, net mb/d YoY Grow th, % Europe YoY Grow th, net mb/d YoY Grow th, % Asia Pacific YoY Grow th, net mb/d YoY Grow th, % Non-OECD YoY Grow th, net mb/d YoY Grow th, % Former Soviet Union

7.9

8.0

9.0

7.9

8.1

8.6

8.4

8.8

7.9

8.0

8.4

8.3

8.2

0.1

0.1

0.6

0.6

0.3

0.2

0.4

-0.2

0.0

-0.1

-0.2

-0.1

-0.1

1.8%

1.4%

6.6%

8.8%

3.8%

2.7%

5.4%

-2.0%

-0.3%

-0.9%

-2.2%

-1.4%

-1.6%

41.4

42.8

42.8

44.1

44.7

45.2

44.2

44.7

45.4

46.2

46.4

45.7

47.2

2.6

1.4

1.0

1.3

1.5

1.9

1.4

1.9

1.3

1.5

1.2

1.5

1.5

6.8%

3.3%

2.5%

3.0%

3.6%

4.4%

3.4%

4.5%

3.0%

3.3%

2.6%

3.4%

3.3%

4.2

4.3

4.3

4.4

4.6

4.3

4.4

4.6

4.6

4.7

4.4

4.6

4.7

0.1

0.1

0.2

0.1

0.1

0.1

0.1

0.2

0.1

0.1

0.1

0.2

0.1

3.1%

2.9%

4.0%

3.5%

1.2%

3.0%

2.9%

5.7%

3.1%

3.1%

3.1%

3.7%

3.1%

9.3

9.7

9.8

9.9

10.0

10.7

10.1

10.4

10.3

10.5

10.9

10.5

10.9

1.1

0.5

0.2

0.1

0.4

0.8

0.4

0.5

0.4

0.4

0.2

0.4

0.4

14.0%

4.9%

2.4%

1.2%

3.6%

8.0%

3.8%

5.5%

3.7%

4.4%

1.7%

3.8%

4.1%

10.6

11.0

11.2

11.4

11.2

11.7

11.4

11.7

11.8

11.6

12.1

11.8

12.2

0.5

0.4

0.3

0.3

0.5

0.4

0.4

0.5

0.4

0.4

0.4

0.4

0.4

4.6%

3.9%

2.9%

3.0%

5.1%

3.5%

3.6%

4.3%

3.5%

3.3%

3.4%

3.6%

3.2%

6.1

6.4

6.3

6.5

6.7

6.8

6.6

6.5

6.7

6.9

7.0

6.8

6.9

0.4

0.3

0.2

0.2

0.1

0.3

0.2

0.2

0.1

0.2

0.2

0.2

0.2

6.9%

4.3%

2.9%

3.5%

1.0%

4.3%

2.9%

2.9%

1.8%

3.4%

2.6%

2.7%

2.4%

7.1

7.3

6.9

7.6

8.0

7.3

7.5

7.2

7.9

8.2

7.6

7.7

8.1

0.4

0.2

0.1

0.4

0.3

0.0

0.2

0.3

0.2

0.3

0.3

0.3

0.4

5.8%

2.8%

2.0%

4.8%

4.4%

0.1%

2.8%

4.3%

2.9%

3.2%

3.9%

3.6%

4.9%

3.5

3.4

3.6

3.5

3.5

3.7

3.6

3.8

3.6

3.5

3.8

3.7

3.7

0.1

-0.1

0.0

0.1

0.2

0.3

0.2

0.2

0.1

0.0

0.0

0.1

0.0

3.8%

-2.7%

0.7%

3.6%

5.8%

9.3%

4.9%

5.1%

3.0%

0.7%

0.7%

2.3%

0.8%

Balance, stocks

2010

2011

Q1-'12

Q2-'12

Q3-'12

Q4-'12

2012

Q1-'13

Q2-'13E

Q3-'13E

Q4-'13E

2013E

2014E

Implied inventory change

-0.5

-0.6

1.5

0.7

-0.7

-0.6

0.2

-0.2

0.1

-0.6

-0.6

-0.4

0.0

YoY Grow th, net mb/d YoY Grow th, % China YoY Grow th, net mb/d YoY Grow th, % Other emerging Asia YoY Grow th, net mb/d YoY Grow th, % South America YoY Grow th, net mb/d YoY Grow th, % Mideast YoY Grow th, net mb/d YoY Grow th, % Africa YoY Grow th, net mb/d YoY Grow th, %

Reported oil inventory: OECD stock change

0.0

-0.2

0.5

0.4

0.4

-0.7

0.2

0.0

-0.1

-0.4

-0.6

-0.3

OECD inv entory (billion barrels)

2.67

2.60

2.64

2.68

2.72

2.66

2.66

2.65

2.64

2.61

2.55

2.55

Cov er, day s demand

56.6

55.9

57.9

58.1

58.6

57.9

57.9

58.5

57.5

56.4

55.6

55.6

'Call on Opec & stocks"

30.3

30.9

29.9

31.2

32.2

31.6

31.2

30.7

30.9

32.2

32.1

31.5

1.5

0.5

-0.1

0.9

0.1

0.4

0.3

0.8

-0.2

0.0

0.5

0.3

0.1

5.3%

1.8%

-0.5%

3.0%

0.3%

1.4%

1.0%

2.7%

-0.7%

0.1%

1.4%

0.9%

0.2%

YoY Grow th, net mb/d YoY Grow th, %

31.6

Source: Credit Suisse Commodities Research, IEA, JODI, EIA

Commodities’ Forecast Update: The Return of “Fundamentals”

37

25 June 2013

Exhibit 72: Global supply data and forecast Mb/d, unless otherwise specified

Supply

2010

2011

Q1-'12

Q2-'12

Q3-'12

Q4-'12

2012

Q1-'13

Q2-'13E

Q3-'13E

Q4-'13E

2013E

2014E

Global

87.8

88.8

90.7

90.4

90.1

91.0

90.6

90.4

90.9

91.4

92.0

91.2

92.9

YoY Grow th, net mb/d

2.4

1.0

1.7

2.4

1.8

1.2

1.8

-0.2

0.4

1.3

1.0

0.6

1.7

YoY Grow th, %

2.8%

1.1%

1.9%

2.8%

2.1%

1.3%

2.0%

-0.3%

0.5%

1.4%

1.1%

0.7%

1.8%

50.2

50.4

51.2

50.4

50.3

51.8

51.0

51.8

51.6

51.4

52.2

51.7

52.8

1.2

0.2

0.5

0.6

0.3

1.0

0.6

0.6

1.2

1.0

0.4

0.8

1.0

2.5%

0.3%

1.0%

1.1%

0.6%

1.9%

1.2%

1.2%

2.3%

2.0%

0.7%

1.6%

2.0%

14.9

15.5

16.5

16.4

16.6

17.5

16.7

17.6

17.6

17.8

18.3

17.8

18.8

0.6

0.6

1.2

1.2

1.2

1.3

1.2

1.1

1.2

1.2

0.8

1.1

1.0

4.3%

3.9%

8.2%

8.1%

7.5%

8.3%

8.0%

6.9%

7.4%

7.3%

4.7%

6.5%

5.6%

Non OPEC YoY Grow th, net mb/d YoY Grow th, % North America YoY Grow th, net mb/d YoY Grow th, % South America

4.5

4.6

4.7

4.5

4.5

4.6

4.6

4.5

4.6

4.7

4.7

4.6

4.8

0.2

0.1

0.1

0.0

-0.1

-0.1

0.0

-0.1

0.1

0.2

0.1

0.1

0.1

5.2%

1.4%

1.5%

-0.2%

-2.5%

-2.1%

-0.8%

-3.2%

2.1%

5.0%

1.8%

1.4%

3.1%

4.5

4.2

4.2

4.1

3.7

3.8

3.9

3.8

3.7

3.4

3.5

3.6

3.4

-0.3

-0.4

-0.2

-0.1

-0.3

-0.4

-0.3

-0.4

-0.3

-0.3

-0.3

-0.3

-0.2

-6.8%

-7.7%

-4.7%

-2.2%

-7.3%

-9.7%

-6.0%

-9.0%

-7.9%

-7.3%

-8.1%

-8.1%

-6.8%

13.3

13.5

13.6

13.5

13.5

13.7

13.6

13.8

13.7

13.5

13.7

13.7

13.8

0.3

0.2

0.1

0.0

0.0

0.3

0.1

0.2

0.2

0.0

0.0

0.1

0.1

2.5%

1.4%

0.8%

-0.1%

-0.1%

2.0%

0.7%

1.3%

1.2%

0.1%

-0.2%

0.6%

1.0%

10.3

10.5

10.6

10.6

10.6

10.8

10.6

10.8

10.7

10.7

10.8

10.7

10.8

0.3

0.3

0.2

0.0

0.0

0.2

0.1

0.1

0.1

0.1

0.0

0.1

0.0

3.2%

2.7%

1.7%

0.4%

0.2%

1.8%

1.0%

1.3%

1.2%

0.8%

0.0%

0.8%

0.3% 2.1

YoY Grow th, net mb/d YoY Grow th, % Europe YoY Grow th, net mb/d YoY Grow th, % FSU YoY Grow th, net mb/d YoY Grow th, % Russia YoY Grow th, net mb/d YoY Grow th, % Africa

2.6

2.6

2.3

2.2

2.2

2.2

2.2

2.1

2.1

2.1

2.1

2.1

0.0

-0.1

-0.3

-0.3

-0.4

-0.4

-0.4

-0.2

0.0

-0.1

0.0

-0.1

0.0

0.5%

-2.1%

-11.6%

-13.8%

-16.5%

-15.6%

-14.3%

-9.1%

-1.6%

-3.1%

-1.3%

-3.9%

0.3%

YoY Grow th, net mb/d YoY Grow th, % Mideast

1.7

1.6

1.4

1.5

1.5

1.5

1.5

1.4

1.4

1.4

1.4

1.4

1.4

0.0

-0.1

-0.4

-0.2

-0.2

0.0

-0.2

0.0

-0.1

-0.1

-0.1

-0.1

0.0

1.2%

-5.6%

-20.8%

-11.1%

-10.9%

1.8%

-10.7%

2.5%

-6.6%

-9.5%

-8.1%

-5.6%

-1.3%

8.5

8.3

8.4

8.3

8.5

8.6

8.4

8.4

8.5

8.5

8.5

8.5

8.5

0.3

-0.2

0.0

0.0

0.2

0.3

0.1

0.0

0.1

0.1

-0.1

0.0

0.0 0.1%

YoY Grow th, net mb/d YoY Grow th, % Asia YoY Grow th, net mb/d

4.3%

-1.8%

-0.3%

-0.2%

2.3%

3.1%

1.2%

0.3%

1.7%

0.6%

-0.6%

0.5%

Processing gain

2.3

2.4

2.4

2.5

2.5

2.5

2.5

2.5

2.5

2.6

2.5

2.5

2.6

OPEC

35.3

36.0

37.1

37.5

37.3

36.7

37.1

36.1

36.7

37.5

37.3

36.9

37.5

YoY Grow th, %

1.1

0.7

1.1

1.8

1.5

0.2

1.1

-0.9

-0.8

0.2

0.6

-0.2

0.6

3.1%

2.0%

3.1%

5.1%

4.1%

0.4%

3.2%

-2.5%

-2.1%

0.6%

1.5%

-0.6%

1.6%

29.8

30.3

31.3

31.8

31.5

31.0

31.4

30.5

31.0

31.6

31.4

31.1

31.6

0.7

0.5

1.2

1.8

1.3

0.1

1.1

-0.8

-0.8

0.0

0.4

-0.3

0.4

2.3%

1.7%

3.9%

6.0%

4.4%

0.4%

3.7%

-2.6%

-2.6%

0.1%

1.3%

-1.0%

1.4%

27.4

27.5

28.6

28.7

28.3

27.9

28.4

27.4

27.8

28.4

28.1

27.9

28.1

0.6

0.2

1.1

1.6

0.9

-0.2

0.8

-1.1

-0.9

0.1

0.3

-0.4

0.2

2.4%

0.6%

4.1%

5.9%

3.2%

-0.8%

3.0%

-3.9%

-3.2%

0.3%

0.9%

-1.5%

0.8%

YoY Grow th, net mb/d YoY Grow th, % Opec Crude Oil YoY Grow th, net mb/d YoY Grow th, % Opec 11 YoY Grow th, net mb/d YoY Grow th, % Opec non-crude

5.5

5.7

5.7

5.7

5.7

5.7

5.7

5.6

5.8

5.9

5.9

5.8

5.9

0.4

0.2

-0.1

0.0

0.1

0.0

0.0

-0.1

0.0

0.2

0.2

0.1

0.1

7.7%

3.9%

-1.0%

0.2%

2.5%

0.4%

0.5%

-1.9%

0.7%

3.3%

3.1%

1.3%

2.6%

YoY Grow th, net mb/d YoY Grow th, %

Source: Credit Suisse Commodities Research

Commodities’ Forecast Update: The Return of “Fundamentals”

38

25 June 2013

Natural Gas: RESEARCH ANALYSTS Commodities Research Jan Stuart [email protected] +1 212 325 1013 Stefan Revielle [email protected] +1 212 538 6802 Supply Model Contributors Equity Research Edward Westlake [email protected] +1 212 325 6751 David Hewitt [email protected] +65 6212 3064 Andrey Ovchinnikov [email protected] +7 495 967 8360 Arun Jayaram [email protected] +1 212 538 8428 Mark Lear [email protected] +1 212 538 0239 Dan Eggers [email protected] +1 212 538 8430 Kim Fustier [email protected] +44 20 7883 0384

Global LNG Global gas markets remain fundamentally disconnected, the more so since ‘spot’ Liquefied Natural Gas tankers are almost all pulled to Asia, which has consistently remained short after the Fukushima tragedy of March 2011. On the other side, the North American market remains over-supplied. But its low-cost molecules remain in splendid isolation until the first LNG export terminal cranks up in 4Q 2015. Somewhere in the middle (see Exhibit 73) floats Europe. Its low import demand is mostly fed by pipelines. Also, its power-markets remain in thrall of renewables and cheap imported coal and thus uncompetitive for LNG. For another quarter, and the near-term future, therefore the global LNG market remains a story of high Asian base-load power demand, supplemented (seasons allowing) by emerging demand from Latin America. On the supply side only very little changes now that nearly all the Mideast’s giant projects, new and old, are up and running. Excitement from the supply side flows really only from the odd unforeseen outage (e.g., the more structural absence of a share of Egypt; and the odd force majeure from Nigeria, Yemen or Algeria). The supply-side wait is now for the next Australian giant (after Pluto came on line) and that first in a string of North American projects. • Spot indices for Asian LNG prices turned lower in February/March as demand weakened, perhaps a month or two earlier than expected. • However, even with the downturn, current spot prices near $14.50/MMBtu are nearly 40% higher than European landed prices and 70% higher than US based natural gas. Most importantly, LNG stays firmly linked to oil (see the line for JCC below).

Exhibit 73: Global gas price benchmarks $/MMBtu $20 $18

Mark Freshney [email protected] +44 20 7888 0887

$16 $14 $12 $10

The commodity price forecasts mentioned in this section have been provided by the Commodities Research analysts above.

$8 $6 $4 $2 Jan-10

Apr-10

Jul-10

Oct-10

JKM (spot LNG)

Jan-11

Apr-11

Jul-11

US Henry Hub

Oct-11

Jan-12

NBP (UK)

Apr-12

Jul-12

JCC formula

Oct-12

Jan-13

Apr-13

Jap LNG

Source: Credit Suisse

An odd dip in trade During Q1 2013 we observed that global LNG trade averaged 32.9 Bcf/d, declining 600 MMcf/d yoy making it the third consecutive quarterly (yoy) decline. Much of the difference, we suspect, involves the combination of late project start-ups (e.g., Angola) and outages. Of the latter there were both planned outages (e.g. Qatari maintenance last summer) and un-planned events (e.g., Egypt, Nigeria and Yemen). In addition, lower utilization rates of liquefaction trains in Indonesia and Malaysia were at least in part due to reserve depletion.

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25 June 2013

From the import side, Europe’s weakness stands out. Europe’s LNG imports fell 2.1 Bcf/d yoy in 1Q 2013. And that outweighed growth in APAC. A weak European power sector, spells of mild winter-weather and the economic malaise, all under-mine Europe’s gas sector. Add in low cost coal as an alternative and it’s clear why LNG imports fell to their lowest levels since earlier this decade.

Asian LNG demand remains stout APAC LNG imports grew 1.3 Bcf/d (5%) yoy last quarter, which is the more impressive as it compares to a strong 1Q 2012. Imports averaged 24.2 Bcf/d in total and accounted for 77% of total LNG trade. Structurally this picture should not change anytime soon – since at the core the biggest question is when Japan’s nuclear reactors come back on line. • 48 out of 50 (96%) Japanese reactors remain shut; • A new regulatory regime may fall into place this summer. But negative news flow from Fukushima and from safety findings at other sites continues to bolster popular opposition to any re-starts; • And new coal-fired generation appears to be putting a dent only in oil demand for powergen, while leaving LNG’s share of the sector at record highs. South Korea’s power-generators should add further support to LNG markets this summer. • 10 of 23 reactors (43%) of South Korea’s nuclear reactors are currently offline. Several were closed by regulators after findings of improper maintenance. Restarts are unlikely until after the peak summer season. South Korea faces power shortages and its incremental demand for alternatives is already felt on fuel oil and coal markets.

Exhibit 74: Japanese LNG imports Bcf/d

14 13 12 11 10 9 8 7 6 Jan

Feb

Mar

Apr

May 5-yr range

Jun

Jul 2013

Aug

Sep

Oct

Nov

Dec

2012

Source: Credit Suisse

Americas South American imports are growing too. According to reports, Commission Federal de Electricida (CFE), the Mexican state-owned electric utility, has been buying up cargoes to supply its Manzanillo terminal (started in May) and to support its growing electric power and industrial demand. Increased imports to Argentina, Chile and Brazil have led aggregate South American 0.37 Bcf/d in March and they are up an average of 0.53 Bcf/d or 78% ytd.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 75: Total LNG imports by region

Exhibit 76: Yoy LNG imports by region

Bcf/d

Bcf/d

35

6

33

5 4

31

3 29

2 27

1

25

0

23

-1 -2

21

-3 19

-4 Jan-11

17 15 Jan-11

May-11 Asia Pacific

Sep-11 Europe

Jan-12 Middle East

May-12 North America

Sep-12

Jan-13

May-11

Sep-11

Jan-12

May-12

Sep-12

Asia Pacific

Europe

Middle East

North America

South America

Total

Jan-13

South America

Source: Credit Suisse, Wood Mackenzie

Source: Credit Suisse, Wood Mackenzie

Supply update: LNG supply capacity grew by unusually little in 2012 and the pace has not picked up materially since. • After an 18 month delay Angola LNG should begin exporting in June. The Credit Suisse global LNG team of equities research still expects startup at an initial rate of 0.5 Bcf/d (3.75 MTA), ramping to 0.7 Bcf/d (5.25 MTA) in 2014. • In the US, regulators approved a second non-FTA LNG export terminal last month (see US LNG export: Take-two). That opens the door for additional approvals. Timing is less certain, however, since regulators have affirmed their intention to monitor the market impact of exports “periodically”. (For more on US exports, see below.)

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25 June 2013

US: Raising our forecast (modestly) to balance storage The big picture of US natural gas markets remains one of abundant supply. Despite market expectations to the contrary, the multi-year uptrend of US dry-gas production has still not turned – and we think It will not in our forecast time-frame. That said, we are raising our near-term price outlook, mostly because an unusually long winter created a deep inventory deficit versus five-year norms. Despite a relatively large storage deficit, US natural gas prices should remain captive to the power-generation stack, when they rise too high, too much demand is lost to coal and gas inventories risk over-filling; when they get too low gas backs out so much coal that not enough is left for pre-winter inventories. In plain numbers, we’ve observed that since winter, natural gas has settled within a 60 cent range from $3.80 to $4.40/MMBtu, ebbing and flowing when power producers make economic decisions to burn gas or coal. • This summer, front-month futures prices at the Henry Hub below $3.80/MMBtu looks attractive according to our models. − And our s/d model now shows that filling storage to between 3.7 and 3.8Tcf by endOctober requires gas prices in the low $4s next quarter, some 5-10% higher than the current futures strip. − The relatively large remaining ‘spec’ length in the market, even with some recent liquidation of length, may provide additional near term prices support.

Key revisions: nudging 2013 prices higher, lowering 2014 on supply In 2014-2015, we do not think that there is much upside to this price range, as too little changes, fundamentally, on the demand side. New exports, initially alongside existing pipeline corridors to Mexico, and eventually LNG (though not materially until 2017/18 – see below) should help. In addition, power-sector and industrial demand, even gas use in transportation also should help, eventually.

Exhibit 77: US natural gas price outlook $/MMBtu

But we remain persuaded that the supply side’s ample and easy to accelerate growth should keep a lid on prices. Currently, markets under-appreciate the new growth in gas flows associated with the ongoing infrastructure build out. Specifically, substantial gas processing additions within the Utica and Eagle Ford shale and the second wave of Marcellus pipeline additions in 4Q2013 will add another dynamic to US supply growth.

Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service

• A late winter price rally. Our last forecast for 2Q2013 of $3.65/MMBtu was 44 cents too low. To blame was a record cold March/April, which sent the yoy inventory deficit to a peak of 807 Bcf by late-April. As the storage balance tightened over that period, US gas prices rallied 36% from January 1 levels. Prompt month prices hit two-year highs of $4.40/MMbtu, early in 2Q. • Summer 2013 has started off sluggish. Normal to below normal temperatures have dominated the first half of the storage injection season. Add relatively high prices ($4.16/MMBtu and $4.19/MMBtu for the calendar May and June bid-weeks pushed utilities toward coal) and the yoy storage deficit was cut by ~25% or 220 Bcf through the week of June 7. And since late May prices have collapsed to sub $3.80/MMBtu levels. Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

• We revise 2H 2013 prices higher by 30 cents to $4.20. The upward revision is driven by a hangover of lower yoy storage levels that will require higher gas prices relative to coal to adequately loosen the summer supply and demand. Our updated supply model points toward annual dry gas growth of +1.1 Bcf/d yoy (up 300 MMcf/d from last quarter). We’ve also factored in losing in ~3 Bcf/d in gas power demand though summer, largely driven by coal to gas switching losses on higher prices yoy. • We now target $4 average prices in 2014, a downward revision of 20 cents. Substantial gas processing additions within the Utica and Eagle Ford shale and the second wave of Marcellus pipeline late in 2013 will add substantial supply to market. • First LNG exports in 4Q 2015 and longer term will likely add to demand for US gas. And attendant (unpredictable) volatility may amplify their impact on prices, and we raised our target for 4Q2015 modestly. But we only added $0.10 to our calendar 2016 target, since a slew of low cost supplies should become available above $4.50/MMBtu.

Supply – Infrastructure bonanza opens still more supply floodgates Upping our supply expectations. With an additional few months of data, our bottoms-up basin-by-basin model forecasts aggregate up to still more growth this year and next. Though growth rates fall short of the 2011-2012 surges (Exhibit 78). In total, production is now expected to grow an average of 1.3 Bcf/d through the summer period (300 MMcf/d higher than last quarter’s update), pushing full year growth to 1.1 Bcf/d.

Exhibit 78: Year-over-year growth should continue...

Exhibit 79: Year-over-year supply growth by basin, summer 2013

Bcf/d

Bcf/d 2.5

7

2.3

2.0

6

1.5

1.2

5 1.0

4

0.1

0.2

Niobrara

Permian

0.0

MS

-0.1

0.0

Granite Wash

-0.1

0.0

Fayetteville

-1.0

1

-0.2

Cana-Woodford

-0.5

-0.4 -0.9

-0.9

Conventional

2

Haynesville

0.0

DJ

0.5

3

2012 yoy

2013 Fcst

2014 2011-2012 Avg

Source: EIA, Credit Suisse

2015

Marcellus

2011

Eagle Ford

2010

GOM

0

Barnett

-1.5

Source: Credit Suisse

Our higher-than-consensus supply expectations are driven by the number processing and pipeline additions currently underway in a number of low cost liquids basins (Exhibit 80). • 2.3 Bcf/d yoy growth in Marcellus is aided by 3+ Bcf/d of pipeline projects becoming available, skewed mostly toward year-end. Also, the addition of 1.4 Bcf/d of processing capacity during 2H 2013 (in both Marcellus and Utica) will add to constrained wet gas takeaway capacity. • The completion of 1.1 Bcf/d of new and expanding processing capacity in the Texas Gulf Coast region during 3Q 2013 should provide support for Eagle Ford our 1.2 Bcf/d of supply growth in 2013. • Associated gas growth within the Permian was revised up to account for 0.5 Bcf/d of added processing capacity.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 80: Processing capacity additions by region

Exhibit 81: Natural gas breakeven prices by basin

MMcf/d by quarter

Breakeven for 15% ATAX return (excludes land cost) – assumes $90 oil and $4 natural gas

Appalachian Q1 2013 Q2 2013 Q3 2013 Q4 2013 2013 Q1 2014 Q2 2014 Q3 2014 2014 Q1 2015 Q2 2015 Q1 2015 2015

320 725 800 600 2445 1165 1000

Anadarko 865 1868 240 2973 400

2165 200 200

Texas GC 200 570 1050 1820 800

Permian

Williston

200 285

100 40 205 485

400 1200

400

345

200 200 100 400

100 100

200 400

200

0

0

100

Source: Bentek Energy, Credit Suisse

Source: Credit Suisse

Rising dry gas production activity is not a foregone conclusion. Following the rise in US natural gas prices to two-year highs in April, discussions surrounding a possible return to a select few dry gas plays began circling. For those with liquids plays in their portfolio, dry gas drilling still makes very little sense. Others, however, may be able to generate real volume growth – the life-blood of the E&P industry – and now that gas prices are nearly 40% up yoy they may finally generate some profits as well. We don’t anticipate any significant increases in activity in the Haynesville just yet. But we understand that several dry gas basins in the Rockies are seeing interest picking up. • We’ll keep a very keen eye out for signs of rising upstream activity this summer.

Demand – thinning gas margins give generation edge back to coal A year ago, natural gas was favored at record levels over nearly all coal prices.

Exhibit 82: Front-month natural gas vs. CAPP coal

Exhibit 83: 2013 power demand components

$/MMBtu

% of generation met by fuel type (all industries)

$7.0

$3.0

$6.0

$2.0

50% Coal

Coal and gas reached parity on April-12, 32%

40.3%

40%

$5.0

$1.0

$4.0

$-

$3.0

$(1.0)

$2.0

NG

30%

26.0%

20%

19.3% Nuke

$(2.0) Natural Gas = NYMEX + ($0.50 Basis) Coal = ((Coal+Rail $/ton)/(12*2)+O&M($3/MWh/10HR))*HR conversion: (10/7.2))

$1.0 Feb-09

10%

Aug-09

Feb-10

Aug-10

Feb-11

Aug-11

Feb-12

Aug-12

Hydro 6.9%

$(3.0)

Other Renew

Feb-13

6.3%

0% Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 CAPP-HH

Nat Gas

CAPP Coal

Source: the BLOOMBERG PROFESSIONAL™ service , Credit Suisse

Source: EIA, Credit Suisse

The wide margin for gas, which at its highs was favored over CAPP coal (adjusted for O&M and deliver) by over ~$2/MMBtu (Exhibit 82), sent year-on-year natural gas consumption 6.6 and 7.9 Bcf/d higher than 2011 levels during April and May. Gas’s competitiveness allowed for gas generation consumption parity with coal for the first time in history at 32% in April 2012 (see Exhibit 83). Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

However, most recent Energy Intelligence Administration (EIA) data point toward a reversal of last year’s anomaly as natural gas prices have risen nearly 40% yoy. Specifically, the EIA Electric Power Monthly report showed that coal consumption rose ~23% yoy and ~5% mom accounting for 40.3% of total power generation during March. Meanwhile, natural gas consumption fell ~4% yoy and 0.4% mom, meeting 26% of total power generation yet remained 5% above similarly priced March 2011 levels. Also noteworthy, coal inventories drew for time in nearly 40 years in March as the improved generation margins vs. gas and lagging coal production led to the historic storage pull. Updating the power demand waterfall – fewer nukes, more reverse switching In our last quarterly, we highlighted a bottoms-up approach to natural gas power demand as introduced by Credit Suisse US Utilities Analyst Dan Eggers (A Deep(er) Dive into Gas Demand from the Power Sector). Exhibit 84 highlights our updated version which accounts for recent data and announcements. Specifically we highlight: • Gas power demand in 2013 is now expected to average 22.9 Bcf/d, 800 MMcf/d less than was expected in our 2Q update and 2.1 Bcf/d less than 2012 levels. • Accounting for the June 7 announced retirement of SONGS Units 2 and 3, gas demand lost to higher yoy nuclear output should be average 466 MMcf/d yoy, an upward revision of 35 MMcf/d (higher net gas demand). • Coal to gas switching, by far the largest moving part to our gas demand equation, is forecasted to fall -2.5 Bcf/d yoy using our regional gas price driven model. Prices near our forecasted $4.20/MMBtu for 2H13 are expected to adequately reduce gas demand so that storage may refill toward 3.7 Tcf levels by the end of October. • New additions for gas generation and wind as well as demand growth and coal retirements are left unchanged and add an 862 MMcf/d net uplift to gas demand in 2013.

Exhibit 84: 2013 power demand components (MMcf/d) 2000

Change in Nat Gas Consumption (mmcf/day)

359 572

1500 1000

700 -769

500

- 466

0 -500 -1000 -1500 -2000

-2,470 -2500 New Gas

Demand Growth

Retired Coal

New Wind

Nuclear Shift

C2G @ $4.20/Mcf

Source: EIA, Credit Suisse

Two pronged expansion of US gas exports Easily overlooked, but more quickly meaningful are rapidly expanding Mexican pipeline exports to Mexico. These can add 2-3 Bcf/d of capacity in the next two years – if promoters are only half right. And while the ultimate ceiling of LNG exports may be much higher, 9-12 Bcf/d is now routinely bandied about, US LNG export capacity of that magnitude will take much longer to reach those heights, and in the shorter term is highly unlikely to add more than 1 Bcf/d by mid-2016. Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

US gas hitches a ride south of the border Year to date, natural gas exports to Mexico are 300 MMcf/d higher than 2012 levels, and are expected to grow another 700 MMcf/d in 2013 and an additional 700 Mmcf/d in 2014 according to our forecasts. Driving this growth has been the duly impressive build out of pipeline capacity and Mexican gas-fired power plants. Export capacity to Mexico is expected to increase nearly 3.0 Bcf/d by 2014 (Exhibit 86). In 2012, the major completed pipeline was the 185 MMcf/d capacity Wilcox Lateral 2013 Expansion Project while two additional projects (the New Samalayuca Lateral and Norte Crossing Project), bringing gas from South Texas to Mexico, are scheduled to be complete in 2013. In 2014, the major announced project is the Eagle Ford Shale Pipeline System Expansion which will deliver 2.1 Bcf/d of gas from Agua Dulce Hub in Nueces County, Texas to the Mexican border, nearly doubling total export capacity to Mexico. Adding total new builds and expansions, Mexican power plant nameplate capacity is scheduled to increase 3.5 GW by 2014. Shown in Exhibit 87, following the completion of the Nuevo Pemex Cogeneration plants in October of 2012, we highlight five new power plants that are estimated to become available during 2013/2014. Additionally, a substantial number of plant expansions in 2014, specifically the 464 MW Agua Prieta II project in Chihuahua, Mexico and 250 MW La Caridad Project in Sonora, should add to aggressive natural gas demand growth in the country. Going forward, we expect increased pipeline exports to more closely follow the expansion of power plants (as pipeline capacity should be ample), indicating higher exports are expected in the months ahead.

Exhibit 85: US gas exports to Mexico

Exhibit 86: Natural gas pipeline project additions

(Bcf/d)

(MMcf/d of export projects sending gas from the US to Mexico) 7,000

2.5

6,000

2 5,000

1.5

4,000 3,000

1

2,000

0.5 1,000

0

0

Jan

Mar

May

Jul

5-year range

Sep 2012

1997

Nov 2013

1998

1999

2000

2001

Added Capacity (MMcf/d)

Source: Credit Suisse, Bentek Energy

2002

2003

2004

2012

2013 Exp

2014 Exp

Total export Capacity

Source: Credit Suisse, EIA

Exhibit 87: Mexican power plant new builds and expansions (2012-14) Plant Name Plant Operator Name Nuevo Pemex Cogeneration* GE Energy Financial Services Inc Nuevo Pemex Cogeneration* GE Energy Financial Services Inc Gral Manuel Alvarez Moreno (Manzanillo I)** Comision Federal de Electricidad Gral Manuel Alvarez Moreno (Manzanillo I)** Comision Federal de Electricidad Gral Manuel Alvarez Moreno (Manzanillo I)** Comision Federal de Electricidad Gral Manuel Alvarez Moreno (Manzanillo I)** Comision Federal de Electricidad Gral Manuel Alvarez Moreno (Manzanillo II)** Comision Federal de Electricidad Gral Manuel Alvarez Moreno (Manzanillo II)** Comision Federal de Electricidad Norte II Korea Electric Power Corp La Caridad Project Siemens Energy Baja California sur VI Comision Federal de Electricidad CFE Salamanca Project Comision Federal de Electricidad San Luis Rio Colorado Project San Luis Rio Colorado Agua Prieta II Maestros Group LLC La Caridad Project Siemens Energy Total New Builds (MW) Total New Builds and Expansions (MW)

Unit*** GT1 GT2 5 6 7 8 3 4 CC CC1 CC ST CC CC CC2

Plant State Tabasco Tabasco Colima Colima Colima Colima Colima Colima Chihuahua Sonora Nayarit Guanajuato Sonora Chihuahua Sonora

Phase Type Phase Online Date (estimated) Net Capacity MW Status New Build 10/25/2012 150 Operating New Build 10/25/2012 150 Operating Expansion 4/26/2013 172 Testing Expansion 4/26/2013 172 Testing Expansion 4/26/2013 172 Testing Expansion 4/26/2013 172 Testing Expansion 5/31/2013 172 Under Const Expansion 5/31/2013 172 Under Const New Build 5/31/2013 433 Under Const New Build 7/31/2013 250 Proposed New Build 9/30/2013 47 Under Const New Build 12/31/2013 430 Under Const New Build 5/31/2014 605 Proposed Expansion 6/30/2014 464 Under Const Expansion 7/31/2014 250 Proposed 2,190 MW 3,935 MW

*The Nuevo Pemex Cogeneration Plant went into service in October of 2012 ** Gral Manual Alvarez Moreno (Manzanillo I & II receive gas from the Manzanillo LNG regas facility) *** GT= Gas Turbine, CC= Combined Cycle, ST= Single Turbine

Source: Credit Suisse, Energy Velocity

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25 June 2013

US LNG exports update On May 17, the US Department of Energy approved the Freeport LNG Terminal, the second LNG project involving exports to customers in countries without a free trade pact (so-called non-Free Trade nations, FTA). As mentioned in US LNG export: Take-two, we think the approval removed doubts that had arisen around possible misgivings in Washington about “exporting away the competitive advantage of low-cost natural gas.” Instead, there is now greater confidence about the export-approval process and criteria. Timing of approvals for individual projects now is the largest uncertainty, as is, of course, ultimately the question of what overall ceiling may be imposed. We’ve developed three scenarios with different approval time-lines and export ceilings to frame the impact that exports would have on ‘demand’ for US gas. The range of outcomes is 6-10 Bcf/d of exports by 2020. All three cases start with the outstanding list of projects to-be examined by DOE (Exhibit 88). We also assume a FID is taken six months after approval, and allow a three year construction time (Exhibit 89):  Base case: The DoE reviews applications every nine months (vs. the two years between Sabine Pass and Freeport LNG). We have excluded the Oregon projects (Jordan Cove and Oregon LNG) due to their environmental opposition. We also excluded Gulf LNG and Corpus Christi as they don’t have off-take agreements. In this scenario, 8.5 Bcf/d of exports could be possible in 2020. The total export ceiling reaches 10.5 Bcf/d.  Fast ‘n high: Assuming an accelerated approval timeline of every three months, and the same underlying and project assumptions as the base case, exports of 10.1 Bcf/d could be reached by 2020. Like the base case, a 10.5 Bcf/d export ceiling is created.  Slow ‘n low: Assuming approvals will occur every 12 months and the only additional approved project is Lake Charles, we see 6 Bcf/d of exports by 2020 with an export ceiling of 6 Bcf/d.

Exhibit 88: A laundry list of non-FTA US LNG export projects remains Project

Exhibit 89: Scenarios for total annual feed gas requirement (i.e. “demand”) of US LNG exports

File / Pre file

Sabine Pass

0

Freeport

1.11

Lake Charles

4.12

Cove Point

6.12

Cameron

5.12

Jordan Cove

3.12

Oregon LNG

6.13

Corpus Christi

12.11

Elba Island

4.13

Gulf LNG

6.12

Golden Pass LNG

5.13

*Projects highlighted in green have fully applied to FERC while others have pre-filed. Source: DOE, FERC, Credit Suisse

Source: Credit Suisse

Seasonal storage projections  Our s/d models point to an end of summer inventory fill of 3.71 Tcf. Our projected changes for each of the key elements of our s/d add up to a bearish residual yoy delta of 2.7 bcf/d (see Exhibit 90).  For next winter our much less bearish residual of 1.1 bcf leaves 1.64 Tcf at end March.

Commodities’ Forecast Update: The Return of “Fundamentals”

47

25 June 2013

Exhibit 90: Summer ’13 base case: 3.7 Tcf

Exhibit 91: Winter ’13-’14 base case: 1.64 Tcf

Bcf

Bcf

4,050 (In Bcf/d) CS Base Case Production 1.4 Imports/(exports) LNG (0.1) Mex Exports (0.4) Canada (0.3) Demand Power Gen (2.8) Industrial 0.6 "Residual" 2.7

3,750 3,450 3,150

3600 3100 2600 2100 1600

2,850

1100

2,550

(In Bcf/d) CS Base Case Production 1.8 Imports/(exports) LNG (0.1) Mex Exports (0.6) Canada (0.2) Demand Power Gen (0.8) Industrial 0.5 "Residual" 1.1

600 Nov-12

2,250 Jun

Jul

Jul

Aug

Summer range

Dec-12

Jan-13

Feb-13

Mar-13

Sep

10-yr range

summer 2013 Fcst

Winter 13-14 base

Source: EIA, NOAA, Credit Suisse

Source: EIA, NOAA, Credit Suisse

Exhibit 92: Henry Hub forecast comparison

Exhibit 93: Henry Hub historical price and forecast

US$/t

US$/t

$4.40

CS Forecast

Forward Curve

Bloomberg Forecast Mean

$18

NYMEX Henry Hub

Quarterly Avg Forecast

$16 $4.20

$14 $4.00

$12

$3.80

$10 $8

$3.60

$6 $3.40

$4 $3.20

$2 $3.00 Q3 13

Q4 13

Q1 14

Q2 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

Q3 14

$0 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

48

25 June 2013

Exhibit 94: Credit Suisse US natural gas supply demand model (Bcf/d) (Bcfd)

Marketed Gas Production Y-o-Y Y-o-Y%

Dry Gas Production Y-o-Y Y-o-Y%

Conventional Y-o-Y Y-o-Y%

Offshore (GOM) Y-o-Y Y-o-Y%

Unconventional Y-o-Y Y-o-Y%

Barnett Y-o-Y Y-o-Y%

Cana-Woodford Y-o-Y Y-o-Y%

Eagle Ford Y-o-Y Y-o-Y%

Fayetteville Y-o-Y Y-o-Y%

Haynesville Y-o-Y Y-o-Y%

Marcellus Y-o-Y Y-o-Y%

Mississippian Y-o-Y Y-o-Y%

Denver-Julesburg Y-o-Y Y-o-Y%

Niobrara Y-o-Y Y-o-Y%

Permian Y-o-Y Y-o-Y%

Granite Wash Y-o-Y Y-o-Y%

Canadian Imports (Net) Y-o-Y Y-o-Y%

Mexican Exports (Net) Y-o-Y Y-o-Y%

LNG Imports (Net)

2010

2011

2012

Q4/2013

2013

2014

2015

61.3

65.8

69.2

69.3

70.3

70.5

70.9

70.3

71.3

71.9

72.4

73.2

72.2

74.6

2.0

4.5

3.4

0.5

1.5

1.4

1.1

1.1

2.0

1.5

1.9

2.2

1.9

2.4

3.4%

7.4%

5.1%

0.7%

2.2%

2.0%

1.5%

1.6%

2.8%

2.2%

2.7%

3.1%

2.7%

3.4%

58.4

62.7

65.7

65.8

67.0

67.2

67.6

66.9

67.9

68.4

69.0

69.7

68.7

71.0

1.9

4.3

3.0

0.4

1.5

1.4

1.2

1.1

2.1

1.5

1.8

2.1

1.9

2.3

3.3%

7.4%

4.8%

0.6%

2.3%

2.1%

1.8%

1.7%

3.1%

2.2%

2.7%

3.1%

2.8%

3.4%

31.2

32.9

31.9

31.6

31.9

Q1/2013 Q2/2013 Q3/2013

31.4

32.1

32.0

31.9

Q1/2014 Q2/2014 Q3/2014 Q4/2014

31.5

31.3

31.3

31.4

31.1

-2.6

-0.8

1.7

-1.8

-0.8

-0.9

-0.7

-1.0

0.2

-0.6

-0.7

-0.6

-0.4

-0.3

-7.4%

-2.4%

5.5%

-5.3%

-2.3%

-2.7%

-2.2%

-3.1%

0.7%

-1.9%

-2.1%

-2.0%

-1.3%

-0.9%

6.3

5.1

4.3

4.2

4.0

3.9

3.8

4.0

3.7

3.7

3.6

3.6

3.6

3.4

-0.6

-1.2

-0.9

-0.5

-0.2

0.0

-0.4

-0.3

-0.4

-0.4

-0.3

-0.2

-0.3

-0.2

-8.0%

-18.7%

-16.6%

-10.2%

-5.2%

-1.1%

-10.2%

-6.8%

-10.5%

-9.1%

-7.7%

-6.3%

-8.5%

-5.8%

21.9

28.5

32.0

33.8

34.2

34.6

35.2

34.4

36.0

36.7

37.5

38.3

37.1

40.0

4.2

6.5

3.6

2.7

2.5

2.3

2.2

2.4

2.2

2.5

2.8

3.1

2.7

2.9

24.0%

29.9%

12.5%

8.8%

7.8%

7.1%

6.7%

7.6%

6.5%

7.4%

8.2%

8.8%

7.7%

7.9%

5.0

5.9

6.0

5.8

5.6

5.6

5.6

5.6

5.6

5.7

5.8

6.0

5.8

6.5

0.2

0.9

0.1

-0.3

-0.4

-0.4

-0.3

-0.4

-0.2

0.0

0.2

0.5

0.1

0.7

3.5%

17.6%

1.4%

-5.0%

-7.2%

-7.3%

-5.2%

-6.2%

-3.3%

0.2%

4.0%

8.1%

2.2%

12.3%

1.3

1.1

1.1

1.1

1.0

1.1

1.1

1.1

1.1

1.1

1.1

1.1

1.1

1.1

0.0

-0.2

0.0

-0.1

-0.1

-0.1

0.0

-0.1

0.0

0.0

0.0

0.0

0.0

0.0

1.3%

-14.2%

2.7%

-5.4%

-6.7%

-5.7%

-2.3%

-5.0%

1.4%

4.3%

4.6%

3.7%

3.5%

2.0%

0.3

1.0

2.1

2.9

3.2

3.4

3.6

3.3

3.8

4.0

4.2

4.3

4.1

4.7

0.2

0.8

1.1

1.3

1.3

1.2

1.1

1.2

0.9

0.8

0.7

0.7

0.8

0.6

486.1%

274.4%

102.6%

80.0%

68.6%

52.5%

41.1%

58.1%

29.5%

23.7%

21.4%

19.4%

23.2%

15.8%

2.1

2.6

2.7

2.9

2.8

2.7

2.7

2.8

2.7

2.7

2.6

2.6

2.6

2.7

0.7

0.5

0.2

0.2

0.1

0.0

-0.1

0.0

-0.1

-0.2

-0.1

-0.1

-0.1

0.0

48.1%

22.7%

6.5%

7.6%

2.5%

-0.9%

-2.2%

1.7%

-5.2%

-5.5%

-4.3%

-3.0%

-4.5%

1.2%

4.1

6.9

6.0

5.2

5.0

4.9

4.9

5.0

5.0

5.1

5.1

5.1

5.1

5.3

2.7

2.8

-0.9

-1.6

-1.2

-0.7

-0.4

-1.0

-0.2

0.1

0.2

0.2

0.1

0.2

184.8%

66.8%

-12.8%

-23.2%

-19.9%

-13.0%

-8.0%

-16.5%

-3.8%

1.1%

3.6%

4.3%

1.2%

4.9%

1.0

2.8

5.7

7.4

7.8

8.2

8.6

8.0

8.9

9.3

9.6

10.0

9.5

10.8

0.7

1.8

2.8

2.8

2.6

2.1

1.8

2.3

1.6

1.5

1.4

1.4

1.5

1.4

259.6%

184.8%

100.4%

62.7%

48.4%

34.7%

26.1%

40.9%

21.4%

18.6%

17.0%

16.0%

18.1%

14.7%

0.2

0.2

0.2

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.0

0.0

0.0

0.1

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

-0.6%

-3.8%

25.1%

35.5%

19.8%

17.6%

-5.3%

14.9%

2.0%

4.9%

6.2%

6.5%

4.9%

5.9%

0.8

0.8

0.8

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.6

0.6

0.6

0.6

0.0

0.1

0.0

-0.1

-0.1

-0.1

-0.1

-0.1

-0.1

-0.1

-0.1

-0.1

-0.1

-0.1

0.6%

10.2%

-2.5%

-14.4%

-13.0%

-11.7%

-10.6%

-12.5%

-9.7%

-9.4%

-9.2%

-8.9%

-9.3%

-8.1%

0.0

0.0

0.1

0.2

0.2

0.3

0.3

0.2

0.3

0.4

0.5

0.5

0.4

0.6

0.0

0.0

0.1

0.1

0.1

0.1

0.2

0.1

0.2

0.2

0.2

0.2

0.2

0.2

#DIV/0!

1733.3%

274.4%

92.3%

101.8%

110.9%

108.3%

104.3%

90.9%

83.0%

76.7%

71.2%

79.1%

52.0%

4.7

4.4

4.6

4.7

4.8

4.8

4.8

4.8

4.9

4.9

5.0

5.0

4.9

4.6

-0.4

-0.3

0.2

0.2

0.2

0.2

0.2

0.2

0.2

0.1

0.1

0.1

0.2

-0.4

-7.9%

-5.8%

3.8%

4.0%

4.1%

3.5%

3.6%

3.8%

4.2%

3.1%

2.8%

2.8%

3.2%

-7.5%

2.4

2.6

2.6

2.7

2.6

2.6

2.7

2.7

2.7

2.7

2.7

2.8

2.7

2.8

0.2

0.2

0.0

0.1

0.1

0.0

0.0

0.0

0.0

0.1

0.1

0.1

0.1

0.1

6.7%

7.7%

-0.5%

3.8%

2.0%

0.8%

-1.0%

1.4%

-0.2%

3.0%

3.7%

3.7%

2.6%

2.8%

7.0

6.0

5.4

5.0

5.2

5.8

4.5

5.1

4.6

4.9

5.6

4.3

4.9

4.6

-0.1

-1.0

-0.5

-0.5

-0.4

-0.2

-0.2

-0.3

-0.3

-0.2

-0.3

-0.2

-0.3

-0.3

-1.2%

-14.2%

-9.0%

-9.0%

-7.6%

-3.1%

-3.3%

-5.8%

-6.7%

-4.6%

-4.8%

-3.4%

-4.9%

-5.6%

-0.8

-1.4

-1.7

-2.1

-2.0

-2.5

-2.3

-2.1

-2.5

-2.7

-3.2

-3.1

-2.9

-3.6

0.0

-0.5

-0.3

-0.7

-0.2

-0.6

-0.6

-0.4

-0.4

-0.7

-0.7

-0.7

-0.7

-0.7

-2.3%

63.6%

24.5%

48.4%

14.2%

30.2%

32.4%

26.1%

20.1%

36.7%

29.5%

31.0%

33.8%

25.5%

-0.1

1.0

0.8

0.4

0.4

0.1

0.3

0.2

0.3

0.3

0.1

0.2

0.2

0.2

-0.1

-0.2

-0.4

-0.1

-0.2

-0.1

-0.1

-0.1

-0.1

0.0

-0.1

-0.1

-0.1

-0.3

-12.3%

-24.4%

-47.3%

-25.0%

-52.3%

-30.5%

-30.5%

-32.8%

-30.5%

-30.5%

-30.5%

-30.5%

-30.5%

-177.6%

68.4

71.2

73.3

72.6

73.7

74.2

73.3

73.5

73.7

74.2

75.0

74.6

74.4

75.5

1.8

2.8

2.1

-0.8

0.7

0.5

0.2

0.2

1.1

0.5

0.8

1.3

0.8

1.1

2.7%

4.0%

3.0%

-1.1%

0.9%

0.6%

0.3%

0.3%

1.5%

0.7%

1.0%

1.7%

1.1%

1.5%

Industrial

18.7

18.9

19.5

21.7

19.4

19.0

20.6

20.2

22.1

19.9

19.9

21.4

20.8

21.5

Y-o-Y

1.8

0.2

0.6

1.0

0.7

0.4

0.5

0.7

0.5

0.5

0.9

0.8

0.6

0.6

10.7%

1.1%

3.1%

5.0%

3.8%

2.2%

2.7%

3.5%

2.1%

2.4%

4.6%

3.8%

3.2%

3.0%

20.2

20.7

24.9

20.0

22.3

29.5

19.8

22.9

18.6

20.8

28.1

18.4

21.5

22.1

1.4

0.5

4.2

-1.7

-4.4

-2.1

-0.2

-2.1

-1.4

-1.4

-1.4

-1.4

-1.4

0.6

Y-o-Y%

7.5%

2.5%

20.4%

-7.9%

-16.4%

-6.5%

-0.8%

-8.3%

-7.1%

-6.4%

-4.8%

-7.2%

-6.2%

2.8%

Res/Comm

21.7

21.7

19.4

40.1

13.1

7.5

27.6

22.1

35.4

12.9

7.5

27.3

20.8

20.7

0.0

-0.1

-2.3

7.4

1.5

-0.5

2.3

2.7

-4.7

-0.2

0.0

-0.3

-1.3

-0.1

-0.1%

-0.2%

-10.4%

22.5%

12.5%

-6.7%

9.3%

13.7%

-11.7%

-1.8%

-0.2%

-1.0%

-5.9%

-0.3%

5.5

5.6

5.9

6.4

5.8

5.9

6.1

6.0

6.6

6.0

6.0

6.3

6.2

6.4

0.0

0.1

0.3

0.2

0.2

0.2

0.2

0.2

0.2

0.2

0.2

0.2

0.2

0.2

0.8%

2.5%

4.7%

3.6%

3.0%

3.0%

3.0%

3.2%

3.0%

3.0%

3.0%

3.0%

3.0%

3.0%

66.1

66.9

69.7

88.2

60.6

61.9

74.1

71.2

82.7

59.6

61.5

73.3

69.3

70.6

3.2

0.8

2.8

6.9

-2.0

-2.0

2.9

1.4

-5.5

-1.0

-0.4

-0.7

-1.9

1.4

5.1%

1.2%

4.2%

8.5%

-3.2%

-3.2%

4.1%

2.1%

-6.2%

-1.7%

-0.6%

-1.0%

-2.7%

2.0%

Y-o-Y Y-o-Y%

Total Supply Y-o-Y Y-o-Y%

Y-o-Y%

Electric Power Y-o-Y

Y-o-Y Y-o-Y%

Other (Lease Fuel, Pipeline Distribution) Y-o-Y Y-o-Y%

Total Demand Y-o-Y Y-o-Y%

Source: EIA, Bentek Energy, Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

49

25 June 2013

UK (NBP) NBP (National Balancing Point) natural gas prices have come off their highs from late March as the bleak late winter storage situation has steadily improved. Indeed, it is somewhat remarkable that just three months ago, the UK balance that looked terribly short supply with inventories nearing total exhaustion, since storage is already almost sufficiently full ahead of next winter. It does validate our slightly more bearish April view. The sometimes inflexible UK gas supply appears to have responded to late winter price signals, leaving the balance well supplied. Specifically, steady Norwegian and UK Interconnector (IUK) flows are, through May, providing more than enough supply to replace lagging continental shelf production and LNG imports. Meanwhile, gas demand returned to reality after weather driven strength in March/April. Power market prices still favor coal generation at wide margins. And as UK gas demand moves seasonally lower through summer, the system looks on track to return to more comfortable levels. • Prompt prices have responded, falling c.8% from mid-April levels while long-dated futures contracts have also lost ground, albeit to a lesser extent. • Against this backdrop that we reiterate our already bearish versus futures view on prices. Holding our forecast unchanged as price premiums should hold When we revised our forecasts higher a quarter ago, we pegged our new targets well below the curve at the time. It seemed obvious that late winter markets had run ahead of themselves, because • Much like the US gas market, the exceptionally cold close to winter pushed storage levels near total exhaustion. Our previous forecast for 2Q13 of 64 p/therm proved to be too low as actual 2Q2013 prices averaged 67.95 p/therm. • 2013 prices have since settled. 2H2013 futures prices have fallen 1.3 p/therm since our last update as recent storage injections have been healthy. Storage levels are on track to end near full ahead of October. • 2014 average prices have fallen 1.6 p/therm or 2% as storage worries have lessened and early summer injections have been healthy, reducing risks for shortages next year.

Demand – A 1Q 2013 pop turns seasonally lower

Exhibit 95: UK NBP natural gas futures P/therm

Period 1Q12 (a) 2Q12 (a) 3Q12 (a) 4Q12 (a) FY12 (a) 1Q13 (a) 2Q13 (a) 3Q13 4Q13 FY13E 1Q14 2Q14 3Q14 4Q14 FY14E 1Q15 2Q15 3Q15 4Q15 FY15E FY16E FY17E Long-Term

Actuals & Forecast 57.97 56.70 55.11 64.18 58.49 66.04 67.95 62.00 68.00 66.00 72.00 65.00 64.00 70.00 67.75 71.00 64.00 63.00 70.00 67.00 65.50 65.00 61.00

Futures

64.00 69.35 66.84 72.13 64.05 63.30 68.79 67.06 71.79 63.03 62.31 67.32 66.11 64.45 64.25

BBG Concensus*

64.00 69.00 66.75 70.00 64.33 63.77 66.15 -

66.00 65.67

*Bloom berg forecasts from previous three m onths only

Source: the BLOOMBERG PROFESSIONAL™ service , Commodities Research

UK Natural gas demand saw a rare increase during 1Q 2013, but looks to have returned to reality. The coldest March since 1962 according to UK Met offices helped boost US natural gas by 24% yoy. In total, the colder than normal winter sent 1Q 2013 average gas demand to ~324 Mcm/d, 9% higher than 2012 levels and the first annual 1Q increase since 2010. Partial data for 2Q2013 shows additional yoy growth, albeit at a much lower rate and still below 5 year average levels (Exhibit 96). Today, gas demand has moved lower, as is commonplace during the UK summer, Commodities’ Forecast Update: The Return of “Fundamentals”

50

25 June 2013

The root of structurally weak UK gas demand remains much the same. Put simply, coal remains the fuel of choice in the UK power-sector as shown by clean dark/clean spark spreads (see Exhibit 97). While clean dark spreads have reduced ~25% from year beginning levels, clean spark spreads recently turned negative thanks to the run up in UK gas prices. A UK carbon floor may help gas demand eventually, but for now, it looks as though gas demand could see another leg down particularly at today’s relatively high NBP gas prices.

Exhibit 96: UK natural gas demand

Exhibit 97: UK spark spreads

Mcm/d

GBp/MWh

400

30 UK Clean Dark

27 350

UK Clean Spark

Coal favored

24 21

300

18 15

250

12 9

200

6 3

150

0 100 Jan

Feb

Mar

Apr

May

Jun

5-yr range

Jul

Aug

2012

Sep

Oct

Nov

Dec

-3 -6 Oct-09

2013

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Gas unfavored Feb-10 Jun-10

Oct-10

Feb-11 Jun-11

Oct-11

Feb-12

Jun-12

Oct-12

Feb-13 Jun-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Supply – responding to price signals, but inflexibility holds North Sea production and LNG imports continue to be weak: • Plagued with outages, ytd Continental Shelf production is down -2.7 Mcm/d yoy; • Spot LNG cargoes remain focused on higher value gas markets in Asia. YTD imports are down -17.2 Mcm/d yoy, importing predominantly contracted gas (Exhibit 98).

Exhibit 98: Year-over-year UK supply change by source Mcm/d

100 80 60 40 20 0 Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Apr-12

Jul-12

Oct-12

Jan-13

Apr-13

Source: the BLOOMBERG PROFESSIONAL™ service , Credit Suisse

Meanwhile import dependence is up so far in 2013. In tandem with the spike in spring gas prices and near-zero storage, previously low imports from Europe have been called upon to meet higher demand (Exhibit 99). YTD total pipeline imports from Europe are ~6% higher yoy: • Averaging just 1.2% of total supply during 2012, imports along IUK from Belgium supplied 6% of supply YTD, averaging ~17 Mcm/d higher yoy.

Commodities’ Forecast Update: The Return of “Fundamentals”

51

25 June 2013

• BBL imports from the Netherlands have averaged 10.2% of total supply or 2.7 Mcm/d higher yoy through May. • Imports from Norway via Langeled are up 3.7 Mcm/d yoy YTD.

Exhibit 99: UK LNG Imports have recently increased, but from a low level (Mcm/d) 80

UKCS

Langeled

BBL

IUK

LNG Send Outs

60 40 20 0 -20 -40 -60 -80 -100 Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Apr-12

Jul-12

Oct-12

Jan-13

Apr-13

Source: the BLOOMBERG PROFESSIONAL™ service , Credit Suisse

Storage on track to re-fill by October • Storage reached lows of 122 Mcm in April which led to a seven-year high price; • Injections in spring have averaged roughly 27 Mcm/d, well above average rates; • At current pace, injections won’t need to continue into October as inventories will be amply full for winter demand.

Exhibit 100: NBP gas storage levels – back from the brink 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 Jan

Mar

May 5-yr Range

Jul

Sep 2013

Nov

2012

Source: the BLOOMBERG PROFESSIONAL™ service ,Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

52

25 June 2013

Steel: RESEARCH ANALYSTS Commodities Research Andrew Shaw [email protected] +65 6212 4244 Marcus Garvey [email protected] +44 20 7883 4787

Supply Model Contributors Equity Research Michael Shillaker [email protected] +44 20 7888 1344

The commodity price forecasts mentioned in this section have been provided by the Commodities Research analysts above.

Struggling for traction In aggregate, global crude steel production has effectively flat-lined in the year to date, with May’s output, after seasonal adjustment (sa), registering 130 Mt, a mere 1.2% higher than December’s figure (Exhibit 101). Behind the headline figure, however, lies a more interesting story. China and the rest of the world ex-China production, having diverged on China’s seeming 1H production overshoot, now look set to start moving back together on account of a China slowdown running counter to the beginnings of recovery in the OECD (Exhibit 102). Such developments fit the steel story we outlined in The Setting of the Sun but with the exChina recovery still fragile, we have trimmed our global production forecast from 1,587 Mt to 1,575 Mt. Further out, we have also cut back our global production growth figures for each year through to 2016 but, in these cases, principally on structurally slower growth for China. Our concern about China’s growth outlook has been well publicised (see for example – Commodities Advantage: Adjusting to slower Chinese growth) and we expect the cyclical slowdown from 2H 2013 to carry over into reduced production growth in 2014 as well. Beyond this, steel output growth should continue its structural moderation as steel intensity per unit of GDP gradually retreats. In consequence, by 2016 we expect global steel output to reach 1,730 Mt, of which China would account for 833 Mt.

Exhibit 101: World crude steel production

Exhibit 102: Crude steel production in major regions

Mt, Monthly, SA

Mt, Monthly, SA

140

21

130 120 110 100 90 80 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

JKT

EU27

USA

China (rhs)

70

19

65

17

60

15

55

13

50

11

45

9

40

7

35

5

30

3 2005 2006 2007 2008 2009 2010 2011 2012 2013

25

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

China already looks “toppy” In terms of China specifically, raw run rates peaked above 800 Mt/y in February and have subsequently maintained production levels above 780 Mt/y (Exhibit 103). This has been a clear overshoot of not just trend growth but also the country’s current economic fundamentals. Increasingly, 2013 looks to be a repeat of 2011, when steel production turned negative in 2H as the broader economy also struggled. Though steel growth has now stagnated in seasonally adjusted terms, raw production runs remain at a high level and steel continues to outperform other components of industrial production, such as electricity generation (Exhibit 104).

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25 June 2013

Exhibit 103: China crude steel production Mt/y, Monthly, DAAR – days adjusted annualised run rate, SAAR – seasonally adjusted annualised run rate

900 800

DAAR

SAAR

700 600 500 400 300 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, China NBS

Moreover, though steel benefitted from gains in construction activity and infrastructure FAI in late 2012, both of these key end-use sectors now appear to be slowing (Exhibits 105 and 106) and are unlikely to turn around without a policy stimulus that we do not believe the government is inclined to provide. Indeed, we caution that the authorities may even step in and implement the beginnings of a more meaningful industry re-organization centered on a selection of state-owned enterprises, combining entities and potentially closing poorly performing plant (on financial and environmental grounds). We would not be surprised if tangible targets emerged from the autumn congress sessions and work councils.

Exhibit 104: China steel production vs. electricity generation

Exhibit 105: Construction activity looks to be rolling over

Trend monthly change

Trend monthly change

3.5% 3.0%

Electricity Generation Crude Steel Production (rhs)

8.0%

15%

6.0%

12%

Sales

Completions

Starts

2.5% 2.0%

4.0%

9% 6%

1.5% 2.0% 1.0% 0.5%

3% 0.0%

0% 0.0% -2.0% -0.5% -1.0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Credit Suisse, China NBS

Commodities’ Forecast Update: The Return of “Fundamentals”

-4.0%

-3% -6% 2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, China NBS

54

25 June 2013

Exhibit 106: …as is infrastructure FAI

Exhibit 107: Traders’ steel product inventories

Trend monthly change

Mt, Weekly

5%

Real China Infrastructure FAI, Monthly SA, Trend Change

16

4%

14

3%

12

2%

10

1%

8

0%

6

-1% 2005

2006

2007

2008

2009

2010

2011

Source: Credit Suisse, China NBS

2012

2013

Long (rebar, wire rod)

Flat (HRC, plate, CRC)

4 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Source: Credit Suisse, MySteel

This excessive steel production can also be seen in the extent of inventory build in the hands of traders (Exhibit 107). Consequently, we expect China’s steel production to, at least, slow along seasonal lines over the course 2H but with the risk, particularly if steel inventory backs up down the production chain, that run-rate cuts will be even harsher when they emerge. Over the medium term, far from believing that China will shortly reach “peak steel”, our base case is still for moderate incremental steel output, moving towards 3.5% p.a. growth by the middle of this decade. This said, we believe that risks to these forecasts lie predominantly on the downside. Specifically, were China’s growth to lie below 7% (1Q 2013 GDP grew 6.6% saar), with construction, infrastructure and manufacturing all playing a reduced role in the aggregate figure, then steel output growth above 3% p.a. would quickly look too optimistic.

Ex-China growth but not yet as we would hope In contrast to the Middle Kingdom, the rest of the world’s anemic performance means its’ continued undershoot of trend growth leaves the door open for a better second half performance. This is though heavily dependent on the macro stabilization story gaining a firmer footing. Within this potential uptick, however, it is far from a case of “one size fits all”. Japan, for instance, has managed relatively to outperform since the inception of “Abenomics” but the country’s net contribution to global steel output is almost negligible, much of it seemingly coming at the expense of other East Asian producers, on account of the Yen’s decline lowering Japanese mills’ relative costs (Exhibit 108). Given the weak state of ferrous export markets, without a more material pick-up in domestic demand, Japan will have limited room to continue this move without purely eating into others’ market share. As such, the country’s run rates look to be supported above 9 Mt/month but should struggle to move materially higher in the short term.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 108: J vs. K+T in East Asia Mt, Monthly, SA

Japan

11.0

South Korea + Taiwan (rhs)

8.0 7.5

10.0

7.0

9.0

6.5 6.0

8.0

5.5

7.0 2005

5.0 2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

Turning to the US, though economic healing is clearly underway, steel production is yet to benefit from a consumer and housing led recovery. The key problem for the ferrous sector is that industrial production is still struggling for traction (Exhibit 109). Eventually, industrial production will gain traction, bringing steel output with it, but the scope for anything more than a minor 2H pick-up still looks limited. In our view, it will not be until 2014 that this effect really starts to take hold.

Exhibit 109: US IP has turned down, again

Exhibit 110: But Europe is staging a tentative recovery

Percentage change, 3MMA (lhs); Index (rhs)

Index (lhs), Percentage change (rhs)

US IP 3MMA 1.5%

Average Markit and ISM new orders (rhs) 65

1.0%

60

0.5%

55

0.0%

50

-0.5%

45

-1.0% 2008

40 2009

2010

2011

2012

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, Markit

2013

70

Eurozone IP mom (rhs) Eurozone Manufacturing PMI NO IP mom 3mma, annualised (rhs)

20%

65

15%

60

10%

55

5%

50

0%

45

-5%

40

-10%

35

-15%

30 2005

-20% 2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, Markit

Finally, with regards to the major steel producing regions, Europe is displaying near opposite tendencies to the US. As highlighted in our macro overview, European domestic demand is continuing to contract but growth is heading back towards positive territory on account of a pick-up in industrial production for export (Exhibit 110). Again, 2013 looks unlikely to offer a significant steel upturn but it should mark the bottom of the cycle, thus paving the way for a mild 2014 upswing if industrial production can establish a greater degree of momentum and demand – or at least, stop heading lower.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 111: World crude steel production in 2004-16 Mt

Mt EU 27 NAFTA China India Japan S Korea Taiwan Russia Ukraine Turkey Brazil RoW Global Total YoY ex-China China YoY ex-China YoY

2006 207 130 424 46 116 49 20 71 41 23 31 90

2007 210 131 493 53 120 51 21 72 43 26 34 92

2008 198 123 499 58 119 54 20 69 37 27 34 93

2009 139 81 574 63 88 49 16 60 30 25 27 61

2010 173 110 624 68 110 58 20 67 33 29 33 66

2011 178 119 683 74 108 69 23 69 35 34 35 66

2012 169 122 717 78 107 69 21 70 33 36 35 64

2013 172 123 755 80 112 69 20 71 34 36 37 66

2014 179 130 779 84 115 71 22 75 36 37 38 68

2015 180 133 806 89 116 73 23 78 37 38 39 71

2016 184 134 833 93 117 75 23 80 38 40 41 72

1248 9.1%

1346 7.9%

1331 -1.1%

1213 -8.9%

1391 14.7%

1493 7.3%

1521 1.9%

1575 3.6%

1634 3.7%

1683 3.0%

1730 2.8%

824

853

832

639

767

810

804

820

855

877

897

19.8% 4.2%

16.3% 3.5%

1.2% -2.5%

15.0% -23.2%

8.7% 20.0%

9.5% 5.6%

5.0% -0.7%

5.3% 2.0%

3.2% 4.3%

3.5% 2.6%

3.4% 2.3%

Source: Credit Suisse, World Steel Association

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Bulk Commodities RESEARCH ANALYSTS Commodities Research Andrew Shaw [email protected] +65 6212 4244 Marcus Garvey [email protected] +44 20 7883 4787 Supply Model Contributors Equity Research Paul McTaggart [email protected] +61 2 8205 4698 Matthew Hope [email protected] +61 2 8205 4669

The commodity price forecasts mentioned in this section have been provided by the Commodities Research analysts above.

Iron Ore – Surplus begins now In 2010 and 2011, prices between $110 and $120 (CFR China) proved to be the bottom of an extreme range for iron ore. Now, however, as the market moves from a period of structural seaborne deficit into the coming years of surplus, we believe such prices will become the top end of iron ore’s trading range. There have been slippages on the supply side and undoubtedly more will emerge over the coming quarters but, in a moderated demand environment, we maintain that key projects remain on-track and will prove more than sufficient to overwhelm the market. In short, we hold fast to our bearish outlook for the steel-making raw material and downgrade our forecasts to $103 for 2H 2013 and $96 for 2014. Our long-run price of $90/t is unchanged. Furthermore, in the wake of rebar’s breakdown and, given our concern that China’s growth may prove softer than the market is currently pricing, we see the risks to these forecasts lying predominantly on the downside (Exhibit 112). Iron ore has a well-established track record of dramatic price swings and 2H 2013 could well prove another case in point. Both FMG and, most importantly, Rio Tinto’s ramp ups should move ahead through the remainder of the year and this incremental supply, in combination with falling Chinese steel production (see previous section), may provide the trigger for another rout. Prices should find some degree of support in early 2014 on account of the market’s pronounced seasonality, but after this we expect prices to decline towards long-run price levels, with the real possibility of a prolonged “undershoot” below this level until surpluses are cleared.

Exhibit 112: Iron ore likely to catch down to rebar RMB/t (lhs), US$/t (rhs)

5250

Spot Rebar

200

Spot Iron Ore (rhs)

5000

180

4750 4500

160

4250

140

4000 3750

120

3500

100

3250 3000 Jan-10

80 Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Recent price declines only the beginning Iron ore prices have already fallen back from their 1Q peak approaching $160/t as Chinese steel mills, facing rising steel product inventories and razor thin margins have drawn down their raw material inventory (Exhibit 113). Unlike in 2012, however, we do not expect an ensuing restock to drive a recovery in prices. Specifically: • In 2012 mills restocked in preparation for an uplift in real production run rates, against a backdrop of rising construction sector activity and infrastructure fixed asset investment. At the same, credit conditions were loosening. Commodities’ Forecast Update: The Return of “Fundamentals”

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• In 2013, however, we believe mills have destocked in advance of cuts to steel production run rates. Moreover, the credit, construction and infrastructure investment cycles all now appear to have turned down (see above steel section and – Commodities Advantage: Adjusting to slower Chinese growth). • When mills do eventually come to restock, we believe the price impact will be more akin to that of 2011, when relative inventories were easily rebuilt against reduced absolute iron ore consumption and in a looser supply environment.

Exhibit 113: Chinese mills have destocked iron ore inventory Surveyed mills’ days inventory cover from imported ore (lsh), US$/t (rhs)

45

Avg Stock Days

190

China CFR 62% Fe (rhs)

40

170

35

150

30

130

25

110

20

90

15 Mar-11 Jun-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13

70

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, MySteel

In consequence, we do not believe China’s call on seaborne tonnage will materially tighten the market over the back half of the year. Moreover, in light of the limited 2H steel growth we expect the world ex-China to generate, neither do we foresee how any other region could provide a sufficient demand-side catalyst to turn the market’s bearish dynamic.

Exhibit 114: China iron ore imports

Exhibit 115: EU27 iron ore imports

Mt, monthly, SA

Mt, monthly, SA

80

16

70

14

60

12

50

10

40 8

30 6

20

4

10 0 2005

2006

2007

2008

2009

2010

2011

2012

Source: Credit Suisse, Customs Data

2013

2 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, Customs Data

It therefore comes down to supply After two and a half years of strong, but choppy, supply growth iron ore is already a far looser market than it was in 2010. Furthermore, over the next two and a half years we estimate that consecutive quarters of above 10% yoy supply growth will push prices back down towards our long-run real price forecast of $90/t and, at times, almost certainly below this level (Exhibit 116). Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 116: Supply growth yoy quarterly YoY growth in seaborne iron ore supply, quarterly 20%

Forecasts

15% 10% 5% 0% -5% 2010

2011

2012

2013

2014

2015

Source: Credit Suisse, Customs Data, Company Data

These forecast increases come despite some cuts having been made to our estimates of supply growth over the past quarter: • In Brazil, operational issues at CSN and Namisa’s Minas Gerais mines, as well as ongoing merger discussions between the two parties, have led us to revise estimates lower. In addition, our forecasts for MMX have been trimmed back, with Serra Azul now only expected to reach 14 Mt/y rather than the earlier full expansion to 22 Mt/y (see our equity research colleagues’ note – Time to Buy or Further Downside?). Finally, with respect to Brazil, we have cut back our forecast Amapa shipments for 2013 and 2014 on account of the mudslide and ensuing damage sustained earlier this year. Until the company has clarified its plans, we assume that operations will not return to normal service until 2015 (Exhibit 117). • In Australia, following Citic’s recent operational difficulties and consequent deferral of first shipments until later this year, we have downgraded our 2013 estimates from 5 Mt to 1 Mt. In addition, based on demonstrated shipments, we have slightly increased our haircut on the country’s export volumes in relation to total reported production. In the period from now until 2016 about 75% of our total forecast market growth comes from Rio Tinto, BHP Billiton, FMG and Vale. Australia’s near metronomic ability to boost iron ore exports has a clear precedent (Exhibit 118) and the market should begin to feel the first of these committed phased expansions during the course of 3Q and 4Q, when Rio begins to ramp up its Pilbara operations towards 290 Mt/y, from existing nameplate capacity of 237 Mt/y. The completion of Rio’s increase in shipments also then underpins the market’s 2014 supply growth, along with the following additions: • BHP Billiton’s Jimblebar will add 35 Mt/y capacity, from which production should begin in March 2014. • FMG should have Chichester operating at full 90 Mt/y capacity through 2014, after hitting run rate targets in 2H of this year. FMG remains on course for Solomon to reach its 60 Mt/y rating in 2H of next year. • Vale’s Serra Norte (+ 40 Mt/y) project, a key test of the Brazilian miners’ planned return to volume growth, should also come on-line in 2H next year, producing 18 Mt as it gradually expands towards full capacity.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 117: Brazil iron ore exports

Exhibit 118: Australia iron ore exports

Mt, Monthly, SA

Mt, Monthly, SA

40

60

35 50 30 40

25 20

30

15 20

10 5 2005

2006

2007

2008

2009

2010

2011

2012

2013

10 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, Customs Data

Source: Credit Suisse, Customs Data

Exhibit 119: World seaborne iron ore supply

Exhibit 120: With Australia continuing to lead the way

Natural Log (Mt), Monthly, SA

Natural Log (Mt), Monthly, SA

18.8

Jan'13-Dec'15 CAGR: 9.3%

World

18.6

18.4 18.0

18.4

17.8 18.2

17.6

18.0

Jan'09-Dec'12 CAGR: 7.4%

17.8 17.6

Jan'02-Jul'08 CAGR: 15%

17.4 17.2 17.0 2002

Australia

Jan'02-Jul'08 CAGR: 15.5%

2006

2008

Jan'09-Dec'12 CAGR: 4%

Jan'13-Dec'15 CAGR: 5.8%

Jan'13-Dec'15 CAGR: 13.6%

17.4 17.2 17.0 16.8

Jan'02-Dec'12 CAGR: 13.2%

16.6 16.4

2004

World ex-Australia

18.2

2010

2012

Source: Credit Suisse, Customs Data, Company Data

2014

16.2 2002

2004

2006

2008

2010

2012

2014

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

The sum of these and other smaller parts, notably African minerals addition of 10 Mt in 2013 and 5 Mt in 2014, should see seaborne supply growth comfortably outstrip increases in global crude steel production over the next three years.

A market adjustment is coming … expect marked price volatility We believe the market will move into growing surplus over the course of 2H this year and begin to post significant surpluses from 2014 onwards. Inevitably, supply and demand must balance, with price the swing factor, and it is the need for the market to make adjustments of this magnitude that underpins our bearish outlook. The transition to a surplus market will, in our view, herald further near-term volatility for iron ore prices. Not least as a result of market participants’ uncertainty about: • The equilibrium range in which iron ore will settle once the market moves back towards a more balanced state. • The process through which sufficient existing production will be curtailed and prospective production will be cancelled or deferred in order for the market to adjust. We doubt that iron ore will follow a similar path to that of its bulk commodities cousin, thermal coal, in slowly grinding lower over time as producers conduct a war of attrition. Instead, the greater concentration of iron ore’s supply and wider disparity in production costs creates the likelihood of a shorter, more aggressive correction. Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 121: World crude steel output

Exhibit 122: Slowing as China loses its lustre

Natural log (Mt), monthly, SA

Natural log (Mt), monthly, SA

World

5.0

F'cast

China

4.5

4.9

F'cast

F'cast

CAGR: 3.4%

CAGR: 2.2%

4.8

4.0

4.7

CAGR: 3.8% CAGR: 8%

4.6

CAGR: 4.3%

3.5

CAGR: 19.8%

4.5 4.4 4.3

World ex-China

3.0

CAGR: 1.5%

4.2

CAGR: 8.7%

2.5

4.1 4.0 1995

1998

2001

2004

2007

2010

2013

2.0 1995

2016

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

1998

2001

2004

2007

2010

2013

2016

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

Indeed, iron ore has already demonstrated its propensity for dramatic price swings and one or more of these plunges is the mechanism by which the market is likely to rebalance – unlike for LME metals, there is no “market of last resort”. Surpluses at the moment are being translated into excessive stocks of steel. Once this stock build comes to an end, mills are likely to reduce purchases of prompt cargoes and spot prices should retreat. It is worth remembering that all mines, even large, low-cost ones, have their marginal tonne. In order to preserve profitability, the major miners are almost certainly focused on reducing operating costs (helped by weakening local currencies); they are contemplating a severe market shake-out and will be determined to re-emerge intact, albeit their capital programs are also expected to be reined back over the longer term. Under conditions of severe oversupply, even lower cost large operators may be forced to withdraw volumes from the market and it is possible that prices bite deep into the (shrinking) supply cost curve to trigger this. Under our price assumptions we anticipate there will be permanent casualties. Despite this fundamental backdrop, prices are likely to edge higher in the very near term, particularly in swaps, because the extent of current short market positioning looks to be excessive (Exhibit 125). Once this short-covering rally has however played out we believe the market will find itself at vulnerable levels from which fundamentals should quickly reexert themselves.

Exhibit 123: A period of low prices needed to rebalance the market Mt

Australia (exports)

Brazil (exports)

China (domestic supply)

Market adjustment required

150 100 50 0 -50 -100 -150

Chinese domestic supply adjustment likely given supply growth in 2014

Additional market adjustments required

-200 2013f

2014f

2015f

2016f

Source: Credit Suisse, Customs Data, Company Data, WSA

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 124: The curve has seen dramatic swings

Exhibit 125: Market positioning creates near-term risk

US$/t

No. of contracts (lhs), US$/t (rhs)

30

SGX Swaps, Options & Futures OI

55000

1Q - 3Q

1Q - 2Q

170

Front Month SGX Swap (rhs)

25

Backwardation

20

50000

160

45000

150

40000

140

35000

130

30000

120

25000

110

15 10 5 0

Contango

-5 -10 Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

20000 Jan-13

Jul-13

100 Feb-13

Mar-13

Apr-13

May-13

Jun-13

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Source: Credit Suisse , the BLOOMBERG PROFESSIONAL™ service, SGX

Exhibit 126: Iron ore forecast comparison

Exhibit 127: Iron ore historical price and forecast

US$/t

US$/t

$125

CS Forecast

Forward Curve

$210

Bloomberg Forecast Mean

Iron Ore (62% Fe CFR Tianjin spot)

Quarterly avg forecasts

$190

$120

$170

$115

$150 $110

$130 $105

$110 $100

$90

$95

$70

$90 Q3 13

Q4 13

Q1 14

Q2 14

$50 2009

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 128: Forecast iron ore prices Units as indicated below, long term prices based on 2012 real prices

2012 Iron ore fines – 62% (China CFR) US$/dmt Iron ore fines - (China CFR) US$/dmtu

128 206

1Q-13 2Q-13f 3Q-13f 4Q-13f 2013f 1Q-43f 2Q-14f 3Q-14f 4Q-14f 2014f 148 239

125 202

105 169

100 1161

120 193

105 169

95 153

95 153

90 145

96 155

2015f

2016f

LT

90 145

90 145

90 145

Source: Credit Suisse Commodities Research

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 129: Global iron ore supply/demand estimates and forecasts In millions of tonnes unless otherwise specified 2012e 717.0 3.2%

1Q 13 190.8 9.5%

2Q 13 197.1 3.3%

3Q 13 186.8 -5.2%

4Q 13 180.4 -3.4%

2013f 755.0 5.3%

1Q 14 194.8 7.9%

2Q 14 203.3 4.4%

3Q 14 194.8 -4.2%

4Q 14 186.2 -4.4%

2014f 779.0 3.2%

2015f 806.0 3.5%

2016f 833.0 3.3%

804.0 1.1%

201.4 3.8%

210.9 4.7%

203.9 -3.3%

203.9 0.0%

820.0 2.0%

212.1 4.1%

219.9 3.7%

210.5 -4.3%

212.5 1.0%

855.0 4.3%

877.0 2.6%

897.0 2.3%

1521.0 2.0%

392.2 6.5%

407.9 4.0%

390.6 -4.2%

384.3 -1.6%

1575.0 3.6%

406.9 5.9%

423.2 4.0%

405.2 -4.2%

398.7 -1.6%

1634.0 3.7%

1683.0 3.0%

1730.0 2.8%

Chinese statistics Total Chinese IO Demand % Change

1,088.4 3.2%

283.3 7.1%

295.9 4.5%

280.4 -5.2%

270.9 -3.4%

1,133.6 4.2%

290.8 7.3%

303.6 4.4%

290.8 -4.2%

278.0 -4.4%

1,163.2 2.6%

1,196.9 2.9%

1,230.1 2.8%

Domestic Production (62%) % Change

353.0 -15.6%

74.5 -19.7%

95.8 28.5%

95.8 0.0%

94.0 -1.9%

360.0 2.0%

66.2 -29.5%

85.1 28.5%

85.1 0.0%

83.5 -1.9%

320.0 -11.1%

300.0 -6.3%

250.0 -16.7%

Iron Ore Inventories at Port % Change

73.1 -25.7%

66.0 -9.8%

73.3 11.0%

84.2 15.0%

83.0 -1.5%

83.0 13.5%

89.6 8.0%

91.4 2.0%

87.3 -4.5%

94.5 8.3%

94.5 13.9%

100.1 5.9%

102.0 2.0%

Seaborne demand (imports) China % change

2012 745.5 8.5%

186.5 -3.5%

199.0 6.7%

195.0 -2.0%

203.0 4.1%

2013 783.5 5.1%

216.3 6.5%

205.1 -5.1%

211.1 2.9%

222.2 5.3%

2014 854.8 9.1%

2015 902.4 5.6%

982.1 8.8%

Japan % change

131.1 2.0%

32.3 -2.1%

34.8 7.7%

35.5 2.0%

34.6 -2.6%

137.1 4.6%

34.2 -1.0%

35.2 2.9%

35.9 2.0%

35.5 -1.2%

140.8 2.7%

142.0 0.9%

143.3 0.9%

South Korea % change

66.0 1.8%

14.8 -12.9%

16.6 12.1%

16.1 -2.7%

17.6 9.1%

65.1 -1.3%

16.5 -6.3%

16.8 1.6%

16.3 -2.8%

17.5 7.4%

67.0 2.9%

68.9 2.8%

70.8 2.7%

Taiwan % change

18.1 -11.7%

4.4 18.8%

4.5 0.8%

4.9 9.7%

4.3 -12.2%

18.1 0.0%

4.9 13.2%

4.9 0.8%

5.4 9.7%

4.7 -12.2%

19.9 10.0%

20.4 2.3%

20.8 2.2%

EU 27 % change

107.8 -7.1%

25.7 1.2%

32.6 26.7%

30.8 -5.4%

27.8 -9.7%

117.0 8.6%

30.0 7.7%

34.1 13.7%

32.2 -5.5%

28.0 -13.1%

124.4 6.3%

125.1 0.6%

127.8 2.2%

World ex-China % change

403.7 -8.7%

96.1 -18.4%

110.3 14.9%

109.6 -0.7%

105.1 -4.1%

421.4 4.4%

107.0 1.8%

113.5 6.0%

112.7 -0.6%

106.9 -5.2%

440.2 4.5%

445.7 1.2%

453.9 1.8%

1,149.3 1.8%

282.6 -9.1%

309.3 9.5%

304.6 -1.5%

308.1 1.1%

323.3 4.9%

318.6 -1.4%

323.9 1.7%

329.1 1.6%

1,436.0 6.5%

2012 493.8 12.5%

128.2 -6.4%

13.8 142.0 10.8%

148.4 4.5%

154.7 4.3%

154.4 -0.2%

169.0 9.4%

174.2 3.1%

176.6 1.3%

1,295.0 7.5% 1294.9 2014 674.2 17.6%

1,348.2 4.1%

Seaborne supply (exports) Australia % change

1,204.9 4.8% 1204.6 2013 573.2 16.1%

2015 723.5 7.3%

791.3 9.4%

Brazil % change

326.6 -1.3%

67.9 -30.4%

77.5 14.1%

86.0 11.0%

89.4 4.0%

320.8 -1.8%

80.7 -9.8%

85.0 5.4%

96.9 14.0%

98.2 1.3%

360.7 12.4%

414.7 15.0%

438.2 5.7%

India % change

35.2 -56.8%

2.2 198.6%

1.5 -31.8%

0.3 -80.0%

1.0 233.3%

5.0 -85.8%

3.5 250.0%

5.0 42.9%

2.5 -50.0%

6.0 140.0%

17.0 240.0%

25.0 47.1%

25.0 0.0%

China Crude Steel Production % Change World ex-China Steel Productio % Change World Steel Production % Change

World % change

Other LatAm % change

27.6 5.3%

7.1 3.3%

7.1 0.0%

7.1 0.0%

7.1 0.0%

28.5 3.3%

8.0 12.3%

8.0 0.0%

8.0 0.0%

8.0 0.0%

32.0 12.3%

32.0 0.0%

32.0 0.0%

South Africa % change

54.0 1.3%

15.4 14.1%

13.9 -9.9%

14.6 5.2%

14.6 0.0%

58.5 8.2%

14.3 -1.8%

14.3 0.0%

15.2 6.0%

15.2 0.0%

59.1 1.0%

59.1 0.0%

59.1 0.0%

Other Africa % change

19.9 65.8%

7.4 13.8%

7.4 0.0%

9.5 27.7%

9.5 0.0%

33.7 69.3%

10.3 9.3%

10.4 0.7%

10.5 1.0%

10.5 0.0%

41.7 23.8%

53.3 27.7%

63.3 18.8%

North America % change

35.6 4.9%

7.8 -10.0%

10.6 35.9%

10.6 0.0%

10.6 0.0%

39.6 11.2%

11.0 3.6%

11.0 0.0%

11.0 0.0%

11.0 0.0%

43.9 11.0%

39.3 -10.5%

39.8 1.2%

EU27 % change

9.0 2.9%

2.0 -29.8%

2.5 27.2%

2.5 0.0%

2.5 0.0%

9.5 5.1%

2.6 4.8%

2.6 0.0%

2.6 0.0%

2.6 0.0%

10.5 10.4%

10.5 0.0%

10.8 3.0%

RUK % change

73.2 0.3%

17.8 -2.4%

18.5 3.9%

18.6 0.5%

18.6 0.0%

73.5 0.4%

18.6 0.0%

18.6 0.0%

18.6 0.0%

18.6 0.0%

74.4 1.1%

73.9 -0.7%

74.4 0.7%

Other % change

74.3 5.1%

17.3 0.0%

17.3 0.0%

17.3 0.0%

17.3 0.0%

69.0 -7.1%

16.9 0.0%

16.9 0.0%

16.9 0.0%

16.9 0.0%

67.6 -2.1%

68.9 1.9%

69.6 0.9%

World % change

1,149.3 1.8%

273.0 -12.2%

298.2 9.2%

314.8 5.6%

325.2 3.3%

1,211.4 5.4%

320.4 -1.5%

340.8 6.4%

356.4 4.6%

363.6 2.0%

1,381.1 14.0%

1,500.2 8.6%

1,603.3 6.9%

---

(9.5)

(11.1)

10.2

17.1

22.2

32.5

34.4

152.0

167.3

Required Market Adjustment

6.6

(2.9)

86.1

Source: Credit Suisse, Customs Data, Company Reports, WSA

Commodities’ Forecast Update: The Return of “Fundamentals”

64

25 June 2013

Metallurgical Coal – From hero to zero RESEARCH ANALYSTS Commodities Research Andrew Shaw [email protected] +65 6212 4244 Marcus Garvey [email protected] +44 20 7883 4787 Supply Model Contributors Equity Research Paul McTaggart [email protected] +61 2 8205 4698 James Redfern [email protected] +61 2 8205 4779

The commodity price forecasts mentioned in this section have been provided by the Commodities Research analysts above.

Tough times continue for the steel-making raw material As recently as 2011, when prices rose above $300/t in the wake of Queensland’s dramatic floods, met coal could claim to be the tightest major commodity market. Those days now look like a lifetime ago. That outage of supply has now fully reversed, with increased availability of material and stagnant end-use markets coming together to force prices sharply lower. At present spot levels around $135/t for hard coking coal, almost no miners are able to turn a profit from met coal and, eventually, production curtailments should allow the market to recover slowly. This recovery is, however, likely to be limited in scope, as the steelmaking raw material now faces considerable structural challenges. In consequence, we have cut our quarterly contract price forecasts for FOB Australia premium hard coking coal to $150/t for 2H 2013 and $163 for 2014. We also downgrade our real long-run price forecast to $165/t, reflecting a reduced call on future supply expansions.

Exhibit 130: Seaborne prices have collapsed over the past two years US$/t

450

Australia HCC, FOB QLD

China HCC, FOB Rizhao, less VAT

400 350 300 250 200 150 100 50 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, McCloskey

Demand growth offers producers little solace Within our moderated outlook for global steel production (Exhibits 131 and Exhibit 132), structural shifts in the nature of production growth are also proving detrimental to met coal. East Asian and European steelmakers, operating integrated mills, are the traditional consumers of premium hard coking coal. Moreover, they have demonstrated a willingness to pay premium prices in order to secure high quality volumes, prioritizing furnace stability, rather than simply minimizing costs. The anticipated cyclical recovery in OECD steel production could therefore provide met coal with some support. However, the slow pace of this recovery means Europe should only import an additional 1 Mt of seaborne material this year, before a further 3 Mt in 2014. Such growth would take European imports to 41 Mt in 2014, still 9 Mt below 2007’s total. In a similar vein, we estimate that Japan’s improving steel production will only result in import growth of 4 Mt for 2013 and 2 Mt for 2014. In short, there is insufficient OECD demand growth to spur more than a tepid market recovery.

Commodities’ Forecast Update: The Return of “Fundamentals”

65

25 June 2013

Exhibit 131: World crude steel output

Exhibit 132: China and ex-China crude steel output

Natural log (Mt), monthly, SA

Natural log (Mt), monthly, SA

World

5.0

F'cast

China

4.5

4.9

World ex-China

F'cast

CAGR: 3.4%

CAGR: 2.2%

4.8

4.0

4.7

CAGR: 3.8% CAGR: 8%

4.6

CAGR: 4.3%

3.5

CAGR: 19.8%

4.5 4.4 4.3

F'cast

3.0

CAGR: 1.5%

4.2

2.5

CAGR: 8.7%

4.1 4.0 1995

1998

2001

2004

2007

2010

2013

2016

2.0 1995

1998

2001

2004

2007

2010

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

Exhibit 133: Japan imports of met coal

Exhibit 134: EU27 imports of met coal

Mt, monthly, SA

Mt, monthly, SA

7

6

6

5

5

2016

4

4 3 3 2

2

1

1 0 2005

2006

2007

2008

2009

2010

2011

Source: Credit Suisse, Customs Data

2012

2013

0 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, Customs Data

Though we believe steel production is set to slow in China, it remains the only country capable of singularly adding meaningfully to seaborne demand. Unlike in iron ore, however, where c.70% of the country’s supply comes from overseas, China only imports c.15% of its coking coal requirements. As a result of this alternative domestic resource, China’s imports are really a function of the price arbitrage between domestic and seaborne coal. Moreover, under a slower pace of growth a number of other factors have dampened demand for premium coking coal in China: • Mills and coke manufacturers have introduced better coke-making facilities and practices; this means they have recovered higher-quality coke from domestic coal. • Deteriorating quality of domestic met coals (mainly sulphur levels) have been pushed further out and with fading steel production rates, the quality issues envisaged a few years ago at a higher pace of steel output may not emerge at all. • The shift towards ever larger blast furnaces has not materialized as widely as expected; China seems to have opted for mid-sized furnaces at 2,000 cubic metres rather than build more mega-furnaces requiring better quality coke. Steelmakers have clearly been able to get by with a greater proportion of lower ranked, or softer, coals in the coke blend Commodities’ Forecast Update: The Return of “Fundamentals”

66

25 June 2013

– this is generally easier to manage in more moderately sized furnaces where high hot metal productivity is not required (in short raw materials purchasing costs have become paramount in a softer market). • Mongolia has emerged as a growing source of landed coking coal, taking market share from seaborne suppliers. A 1H continuation of China’s strong 4Q 2012 imports is the primary cause of our reduced 2013 market surplus but this pick-up in consumption of seaborne tonnage has come as much on the back of met coal’s price collapse as it has any improvement in underlying demand. Were prices to stage a more marked recovery, we doubt that China’s steel mills would be placing any real weight on the bid side of the market. The market’s other emerging giant, India, has also continued to underperform the high hopes placed upon it by exporters, on account of the country’s heavy use of direct reduced iron (DRI) technology (see The Setting of the Sun). Rather than met coal, this utilizes thermal and, often, a degree of petcoke as an alternative energy source. Consequently, we only forecast an additional 3 Mt of Indian demand this year.

Exhibit 135: China imports of met coal

Exhibit 136: India imports of met coal

Mt, monthly, SA

Mt, monthly, SA

7

5

6

4

5 4

3

3

2

2 1

1 0 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, Customs Data

0 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, Customs Data

Australia leads the way Against this backdrop of limited demand growth, Australia has completed its recovery from the damage caused by the 2010-11 floods and should account for 62% and 54% of our respective 2013 and 2014 forecast supply growth. Though some high-cost mines have been closed in the country (e.g., Norwich Park), The BHP Billiton/Mitsubishi Alliance (BMA) is still leading the way on growth, expected to add 8.3 Mt in 2013 and a further 9.9 Mt in 2014 across its key Blackwater, Goonyella, Saraji and Peak Downs mine sites. Against this backdrop, especially if the Australian miners enjoy some cost relief from a falling Australian dollar (our FX strategists forecast a price of US$0.85 in six months’ time – FX Compass), US suppliers stand to be amongst the relative losers. Having enjoyed the opportunity gain market share following Australia’s flood outages in 2011 (Exhibit 138), US exports should now retreat in a surplus market, with risks to the downside until Europe – their primary export market – manages to turn the corner.

Commodities’ Forecast Update: The Return of “Fundamentals”

67

25 June 2013

Exhibit 137: Australia met coal exports

Exhibit 138: US met coal exports

Mt, monthly, SA

Mt, monthly, SA

7

16 15

6

14 13

5

12

4

11 10

3

9

2

8

1

7 6 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Credit Suisse, Customs Data

0 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Credit Suisse, Customs Data

Structurally lower prices In sum, a mild OECD recovery should provide some cyclical support for met coal from later this year and into 2014 but the magnitude of potential developed world demand growth appears too small to fully right the market’s balance. The consequence of this and the structural differences of Chinese and Indian demand, when compared to traditional importers such as Japan and South Korea, means any such recovery should be muted at best. Unless producers therefore act to instigate an unexpected degree of supply discipline, met coal looks set to be stuck in surplus for some time.

Exhibit 139: Metallurgical coal forecast comparison

Exhibit 140: Met coal historical price and forecast

US$/t

US$/t

$170

Hard coking coal

Semi soft coal

PCI coal

Hard coking coal spot

$450

Quarterly avg forecasts

$400

$160

$350

$150

$300

$140 $250

$130 $200

$120

$150

$110

$100

$100 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Commodities’ Forecast Update: The Return of “Fundamentals”

$50 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

68

25 June 2013

Exhibit 141: Forecast metallurgical coal contract prices, FOB Australia Units as indicated below, long term prices based on 2011 real prices

2012 Hard coking coal Semi soft coal PCI coal

US$/t US$/t US$/t

210 139 154

1Q-13f 2Q-13f 3Q-13f 4Q-13f 2013f 1Q-14f 2Q-14f 3Q-14f 4Q-14f 2014f 165 116 124

172 120 141

147 103 110

150 105 113

159 111 122

160 112 120

2015f

2016f

LT

160 112 120

165 116 124

165 116 124

163 114 122

173 121 129

180 126 135

165 125 130

Source: Credit Suisse Commodities Research

Exhibit 142: Global metallurgical coal supply and demand estimates Mt, Surpluses or deficits show market capacity but actual imports/exports should balance at the time Importing Country

2012e

1Q 13

2Q 13

3Q 13

4Q 13

2013f

1Q 14

2Q 14

3Q 14

4Q 14

2014f

1Q 15

2Q 15

3Q 15

4Q 15

2015f

2016f

China % change

53.6 20.0%

17.2 1.1%

14.0 -18.5%

13.0 -7.1%

16.6 27.7%

60.8 13.4%

12.7 -23.3%

16.1 26.3%

16.6 3.2%

18.9 14.0%

64.3 5.8%

14.0 -26.2%

17.6 26.3%

18.2 3.2%

20.7 14.0%

70.5 9.5%

78.3 461.3%

India % change

35.8 8.3%

7.5 -12.6%

10.8 43.0%

9.6 -10.8%

9.7 1.2%

37.6 5.0%

7.9 -18.6%

11.3 43.0%

10.1 -10.8%

10.2 1.2%

39.5 5.0%

8.4 -17.9%

12.0 43.0%

10.7 -10.8%

10.8 1.2%

41.8 6.0%

43.7 422.5%

JKT % change

77.5 -3.9%

18.0 1.0%

20.5 13.6%

21.7 5.9%

21.0 -3.0%

81.1 4.7%

20.8 -1.1%

20.9 0.3%

22.4 7.4%

21.6 -3.8%

85.7 5.7%

21.2 -1.8%

21.2 0.2%

22.8 7.5%

21.9 -3.8%

87.2 1.8%

88.4 317.1%

EU 27 % change

36.9 -5.7%

9.3 -1.1%

8.7 -6.3%

9.9 14.0%

10.2 3.1%

38.1 3.2%

9.8 -4.1%

9.3 -5.0%

10.6 14.0%

11.0 3.1%

40.7 7.0%

9.9 -9.9%

9.4 -5.0%

10.7 14.0%

11.0 3.1%

41.0 0.6%

41.9 324.2%

Turkey % change

6.5 60.2%

1.5 -26.0%

1.5 0.2%

1.7 14.3%

2.0 18.7%

6.6 1.2%

1.5 -24.5%

1.5 0.2%

1.7 14.3%

2.0 18.7%

6.7 2.6%

1.5 -24.6%

1.5 0.2%

1.8 14.3%

2.1 18.7%

6.9 2.5%

7.3 372.7%

North America % change

6.9 6.1%

1.5 -17.3%

1.5 -2.3%

1.5 1.6%

1.6 6.6%

6.0 -12.9%

1.5 -4.2%

1.5 -2.4%

1.5 1.7%

1.6 6.8%

6.1 1.4%

1.5 -5.2%

1.5 -2.4%

1.5 1.7%

1.6 7.0%

6.1 0.6%

6.1 303.9%

Brazil % change

10.8 -10.3%

3.0 24.3%

3.2 6.8%

4.2 29.2%

3.2 -23.4%

13.8 27.1%

3.1 -2.8%

3.3 6.8%

4.3 29.2%

3.3 -23.4%

14.1 2.7%

3.2 -2.9%

3.4 6.8%

4.4 29.2%

3.4 -23.4%

14.5 2.6%

15.2 376.9%

Chile % change

1.3 17.7%

0.3 -7.8%

0.4 18.7%

0.4 5.4%

0.4 1.8%

1.5 15.4%

0.4 -10.9%

0.4 18.7%

0.5 5.4%

0.5 1.8%

1.7 13.3%

0.4 -12.2%

0.5 18.7%

0.5 5.4%

0.5 1.8%

1.9 11.8%

1.9 370.9%

RoW % Change

48.1 -3.9%

12.9 7.3%

12.9 0.0%

12.9 0.0%

12.9 0.0%

51.6 7.3%

13.7 6.1%

13.7 0.0%

13.7 0.0%

13.7 0.0%

54.7 6.1%

14.5 5.8%

14.5 0.0%

14.5 0.0%

14.5 0.0%

57.9 5.8%

60.6 319.0%

World % change

277.3 2.3%

71.2 -0.3%

73.4 3.0%

74.8 2.0%

77.6 3.8%

297.0 7.1%

71.4 -8.0%

78.0 9.2%

81.3 4.3%

82.7 1.6%

313.6 5.6%

74.5 -9.9%

81.6 9.5%

85.0 4.2%

86.5 1.8%

327.8 4.5%

343.4 361.0%

Exporting Country

2012e

1Q 13

2Q 13

3Q 13

4Q 13

2013f

1Q 14

2Q 14

3Q 14

4Q 14

2014f

1Q 15

2Q 15

3Q 15

4Q 15

2015f

2016f

Indonesia % change

6.3 39.2%

1.5 -7.7%

1.6 7.4%

1.7 7.8%

1.9 12.6%

6.7 6.3%

1.6 -17.1%

1.7 7.4%

1.8 7.8%

2.1 12.6%

7.2 8.0%

1.7 -17.1%

1.8 7.4%

2.0 7.8%

2.2 12.6%

7.8 8.0%

7.8 353.5%

Australia % change

144.5 8.6%

37.0 -6.6%

38.5 4.1%

39.0 1.3%

40.0 2.6%

154.5 6.9%

38.5 -3.8%

41.8 8.7%

43.5 4.0%

43.5 0.0%

167.4 8.4%

40.0 -8.1%

43.5 8.7%

45.2 4.0%

45.2 0.0%

173.9 3.9%

177.2 343.2%

Russia % change

16.5 16.4%

4.7 -7.8%

4.1 -12.8%

4.7 13.7%

4.7 0.8%

18.0 9.1%

3.6 -24.5%

5.1 44.3%

5.0 -3.0%

5.5 11.6%

19.2 6.6%

3.8 -31.7%

5.5 44.3%

5.3 -3.0%

5.9 11.6%

20.5 6.6%

21.8 476.3%

South Africa % change

2.5 0.0%

0.6 -15.8%

0.6 -3.8%

0.7 15.5%

0.7 6.9%

2.5 0.0%

0.6 -15.8%

0.6 -3.8%

0.7 15.5%

0.7 6.9%

2.5 0.0%

0.6 -15.8%

0.6 -3.8%

0.7 15.5%

0.7 6.9%

2.5 0.0%

2.5 325.5%

Mozambique % change

3.2 99.4%

1.2 15.0%

1.2 4.3%

1.7 37.5%

1.7 0.0%

5.7 75.3%

2.1 29.1%

2.1 0.0%

2.1 0.0%

2.1 0.0%

8.5 50.0%

2.8 30.4%

2.8 0.0%

2.8 0.0%

2.8 0.0%

11.1 30.4%

16.6 499.4%

Colombia % change

0.9 -9.7%

0.4 24.5%

0.4 3.2%

0.4 0.4%

0.4 -8.5%

1.5 66.0%

0.5 40.7%

0.5 3.2%

0.5 0.4%

0.5 -8.5%

2.0 33.3%

0.5 16.1%

0.6 3.2%

0.6 0.4%

0.5 -8.5%

2.2 10.0%

2.5 356.4%

North America % change

94.2 3.8%

24.2 10.5%

22.4 -7.4%

22.0 -1.8%

23.2 5.5%

91.7 -2.6%

22.4 -3.4%

24.1 7.5%

24.1 0.0%

24.9 3.4%

95.6 4.3%

22.7 -9.1%

24.4 7.6%

24.4 0.0%

25.2 3.4%

96.8 1.2%

96.8 326.9%

China % change

1.3 -63.6%

0.3 -32.7%

0.3 0.0%

0.3 0.0%

0.3 0.0%

1.0 -23.6%

0.3 0.0%

0.3 0.0%

0.3 0.0%

0.3 0.0%

1.0 0.0%

0.3 0.0%

0.3 0.0%

0.3 0.0%

0.3 0.0%

1.0 0.0%

1.0 300.0%

Mongolia % change

19.1 -4.8%

2.6 -58.7%

6.1 133.5%

6.6 9.5%

7.2 8.3%

23.0 20.5%

3.4 -53.5%

6.6 97.0%

7.2 9.5%

7.8 8.3%

25.0 8.7%

3.6 -53.8%

7.1 97.0%

7.8 9.5%

8.5 8.3%

27.0 8.0%

30.0 729.2%

World % change

288.5 6.4%

72.3 -5.9%

75.1 3.8%

77.0 2.5%

80.0 3.9%

304.5 5.6%

72.9 -8.9%

82.8 13.7%

85.2 2.9%

87.5 2.6%

328.5 7.9%

75.9 -13.2%

86.5 13.9%

89.0 2.9%

91.3 2.6%

342.7 4.3%

356.3 369.2%

Surplus / Deficit As a % of exports

11.1 3.9%

1.1 1.6%

1.7 2.3%

2.1 2.8%

2.3 2.9%

7.6 2.5%

1.5 2.0%

4.9 5.9%

3.9 4.5%

4.8 5.5%

14.9 4.5%

1.5 1.9%

4.9 5.7%

3.9 4.4%

4.8 5.2%

14.9 4.4%

12.9 3.6%

Source: Credit Suisse, World Steel, Customs Data, Company Reports

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Thermal Coal – Stagnation RESEARCH ANALYSTS Commodities Research Andrew Shaw [email protected] +65 6212 4244 Marcus Garvey [email protected] +44 20 7883 4787 Supply Model Contributors Equity Research Paul McTaggart [email protected] +61 2 8205 4698 James Redfern [email protected] +61 2 8205 4779

The commodity price forecasts mentioned in this section have been provided by the Commodities Research analysts above.

Prices continue to take the low road Underperforming even the low expectations outlined in our previous forecast update (The Setting of the Sun), thermal coal has put in another poor quarterly performance. The post2010 bear market remains intact and we have again downgraded our price forecasts, now expecting an average FOB Newcastle price of $86/t for 2013 and $91/t for 2014. Our longer-dated prices, however, are unchanged and we estimate the market will be stuck in surplus through to 2016. Over time, prices below marginal costs should take their toll but producers have already demonstrated their unwillingness to cut output. With reduced surpluses, prices should eventually have the opportunity to grind out of their current torpor but there looks to be little chance of this happening until, at least, 2014. Moreover, the risk remains that reduced surpluses merely result in prices moving lower more slowly rather than actually turning around. Evidently, they should make the market more sensitive to fluctuations in demand but consumers continue to act in a price-sensitive manner and, absent a dramatic supply shock, we therefore see little that could generate any substantial short-term upside room.

Exhibit 143: Seaborne thermal coal – this trend is not your friend US$/t

220

DES ARA

FOB RB

FOB Newc

200 180 160 140 120 100 80 60 40 2005

2007

2009

2011

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, McCloskey

A tale of one half – supply has been the dominant factor As with all commodity markets, in the end, high prices kill high prices and low prices kill low prices, triggering as they do a natural, but far from immediate, supply-side response. The dramatic increase in supply over 2011-12 and, on our forecasts, 2013 has been the key driver of thermal’s current bear market. A slowdown in the addition of new tonnage to the market from 2014 onwards should likewise give it the beginnings of an opportunity to recover (Exhibit 144).

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25 June 2013

Exhibit 144: Rapid supply growth over the past two years has sunk the market YoY growth in seaborne supply, quarterly

20%

Forecast

15% 10% 5% 0% -5% 2010

2011

2012

2013

2014

2015

Source: Credit Suisse, Customs Data, Company Data

In terms of this supply growth, Australian and, particularly, Indonesian miners have been the makers of their own downfall (Exhibits 145 and 146). Exports from these two countries have grown at a 9.1% CAGR since 2010 and, when combined with the displacement of coal by shale gas in the domestic US energy market, contrived to put more coal on offer than the market has been able to digest.

Exhibit 145: Indonesia thermal coal exports

Exhibit 146: Australia thermal coal exports

Mt, monthly, SA

Mt, monthly, SA

35

16

30

14

25

12

20

10

15

8

10

6

5 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Credit Suisse, Customs Data

4 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: : Credit Suisse, Customs Data

Though some miners are operating below their cash costs of production, for the reasons detailed in Unabated Abundance, we still do not expect significant closures of existing mine operations to right the market balance. Indeed, we continue to forecast gradual overall supply growth, with notable contributions from: • ADRO, PTBA, Bumi and Harum in Indonesia should add a cumulative 58 Mt of production between 2012 and 2016. This growth should be offset to an extent by a pull-back in output from junior miners which have struggled with higher average strip ratios and lower quality coal grades to keep heads above water but the majors’ growth still means Indonesia’s overall exports look set to expand. Furthermore, the government’s intention to raise IUP royalties in 2014 should add pressure to juniors’ margins but majors, who largely hold CCOW permits, should feel little impact from any change on this front (see our APAC equity research colleagues’ note – Indonesia Coal Mining Sector).

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• Slower Australian expansions are a key factor in our forecast for reduced supply growth, as both general cost inflation and the high Australian dollar have taken their toll on miners’ margins. As such, growth is more about the sum of small parts than any dramatic individual projects – Whitehaven’s intention to, this year, add 1.5 Mt/y at Narrabri being case in point. Furthermore, the potential for some growth projects to instead provide replacement tonnage for higher cost existing operations has been flagged by some miners and developments on this front are certainly worth watching. • Though labor disputes have stymied any significant growth from Colombia in 2013, capacity expansions at the country’s big three coal miners remain in progress and they should add a cumulative 24 Mt by 2016 over 2012 levels. The potential for shipments to under-perform capacity remains a consistent threat for the South American country but with cash costs in the US$50s we see few other reasons for these growth projects to be singled out for deferral. In sum, the impact of project deferrals, certain additional tonnage instead becoming replacement for existing capacity, the shift in fortunes for junior Indonesian miners and, at the margin, small closures, should mean slightly less weight is felt from supply-side growth in the coming years. The sort of supply-side response that would enable a full-blown recovery for thermal coal looks extremely unlikely.

Exhibit 147: Major contributors to supply

Exhibit 148: Major contributors to demand

Mt

Mt

Australia

40

RoW

Indonesia

India

50

35

RoW

China

40

30 30

25 20

20

15

10

10 0

5 0

-10 2011

2012

2013

2014

Source: Credit Suisse, Customs Data, Company Data

2015

2011

2012

2013

2014

2015

Source: Credit Suisse, Customs Data, Company Data

Demand unable to close the gap As Exhibit 148 shows, for much of the world, thermal coal imports look set to decline over the course of 2013. As we have previously detailed (see, for example - Unabated Abundance), the key driver of this dynamic is the expected reduction in European coal burn. European coal imports have outstripped all expectations since recovering from the financial crisis (Exhibit 149), primarily on account of coal’s cheapness over gas in the continent’s merit order. Now, however, coal is beginning to feel the impact of environmental legislation from above and, given the structural oversupply of carbon permits, the competition of lignite from below. Ironically enough, as the large combustion plant directive starts to force the closure of installed coal capacity and renewables take greater market share, the greater relative decline in European power than coal prices means that thermal is also being pushed out by its even less environmentally friendly low-ranked sibling. As CS’ European Utilities team has recently highlighted (Central European power prices getting weaker: 5th cut in forecast in 2 years), with clean spark spreads (the margin when generating power from gas, clean denotes including the cost of a carbon emissions permit) already negative and clean dark spreads heading to zero (the margin when using coal), the clean brown spread (from burning lignite) is the only attractive option left open to power producers. Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 149: EU27 thermal coal imports Mt, Monthly, SA

18 16 14 12 10 8 6 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, Customs Data

Therefore, only Indian and Chinese growth remains producers’ real hope for any demand-led recovery. With regards to the former’s imports, since stepping up in December (Exhibit 150), recent trade data could be taken as a positive indicator of that story. We add several notes of caution: • The fact that India can import such volumes without tightening the market underlines the extent of the current supply glut. • Indian imports are not just a function of the country’s domestic thermal coal deficit but the degree to which this deficit is also closed by demand rationing on account of negative margins for producing power from coal. • As such the country’s consumers are extremely price-sensitive importers and have naturally taken advantage of recently low seaborne prices. Were the market to tighten up, causing prices to rise, we anticipate Indian buyers would significantly reduce the weight of their bid on the market. In many ways this recent strength is of a similar nature to China’s marked import growth (Exhibit 151), although China’s reasons for being a price-sensitive importer are clearly different – the alternative of domestically-sourced material means it does not have a structural deficit of coal to fill – the market impact of both countries in late 2012 and early 2013 has been to tighten the headline supply/demand balance without putting any real pressure on prices. The key point is that recently high imports are merely mirroring export strength and the wide availability of cheap tonnage – the supply/demand has to balance in the end. Indeed, this is really a case of “supply push” rather than “demand pull”. The latest PMI reading for China underlines this metric, with economic activity potentially poised to soften far more than many expect over H2. Our 2013 supply/demand balance has narrowed over the last quarter but it does not represent a truly tighter market. Were supply to leave the market and prices to move higher, we believe much of this near-term demand “strength” would rapidly fade away. Over the long-run China and India should both continue to grow their imports of thermal coal but the degree to which they do so will be heavily price dependent. In the case of China there needs to be an open arbitrage between seaborne and domestic prices, and in the case of India much will depend on domestic mine supply growth and the pace of industrial activity (both in need of significant reforms).

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Exhibit 150: India thermal coal imports

Exhibit 151: China thermal coal imports

Mt, monthly, SA

Mt, monthly, SA

18

21

16

18

14 15

12 10

12

8

9

6

6

4 3

2 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Credit Suisse, Customs Data

0 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Credit Suisse, Customs Data

China and “the ban” Finally, with regards to demand, it should be noted that our base case assumptions do not include China imposing restrictions on the import of coal with any particular specifications. As we have previously stated (Thermal Coal – Will they or won’t they?), the imposition of any restrictions would almost certainly be bearish for thermal coal across the board but, without knowing the details of these potential restrictions, it is impossible to estimate the impact. The potential extent of this action, largely aimed at reducing particulate emissions, and presumably waste, would be highly variable, depending on where the exact cut-off were to be drawn and the scope this left for market participants to blend coal around it. Thus, we merely highlight that China has been importing sub-bituminous coal at annualized rates of 40-50 Mt/y (Exhibit 152), the lion’s share of which comes from Indonesia (Exhibit 153). Not accounting for the fact that Indonesia may restrict its own export of sub-bituminous coal from 2014 (as we discussed in – The Setting of the Sun), the addition of any of this material to the market’s surplus would clearly present a bearish turn. Though higher specification seaborne coal might see some improvement in relative demand from China this would likely then be off-set by reduced demand elsewhere as other consumers turned to now cheaper lower specification coal. Moreover, the real beneficiary of any restrictions would be domestic Chinese miners, although eventual caps on domestic production continue to be discussed.

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25 June 2013

Exhibit 152: China sub-bituminous coal imports …

Exhibit 153: … by source of origin

Mt/y, monthly, SA

Percentage share of total imports

Indonesia

60

Russia

Australia

Other

100% 50

90% 80%

40

70% 60%

30

50% 40%

20

30% 20%

10

10% 0 2009

2010

2011

2012

2013

Source: Credit Suisse, Customs Data

0% 2009

2010

2011

2012

2013

Source: Credit Suisse, Customs Data

Prices under pressure Given our base case supply/demand outlook and the downside risks, it is hard to see how thermal coal will manage to put in a much stronger performance over the second half of the year, hence our respective Newcastle forecasts of $80 and $85 for 3Q and 4Q. From 2014 onwards the potential for some form of recovery does still appear to be in place but we expect little more than a slow grind. Supply should continue in its role as the dominant market factor and, unless producers display the kind of discipline they have hitherto shown little appetite for, it is hard to see demand do more than chip away at the market surplus for some time to come. The latest breakdown in seaborne thermal prices, below $80/t for both API 2 and API 4, could finally take both spot and the curve – through which miners can sell coal swaps forward to hedge production – low enough to trigger a more meaningful supply-side response. This is not our base case scenario, especially as demand clearly remains steady but, if prices were to collapse in dramatic fashion, the speed with which tonnage is withdrawn from the market should naturally increase. As we have long highlighted, a shorter, sharper, price collapse would have resolved the thermal coal market’s balance far more cleanly than the current war of attrition being waged by producers. That scenario does not though appear to be likely quite yet.

Exhibit 154: Thermal coal price forecast comparison

Exhibit 155: Thermal coal price history and forecasts

US$/t

US$/t

$100

CS Forecast

Forward Curve

Bloomberg Forecast Mean

$210

Newcastle coal front month

Quarterly avg forecasts

$190 $95

$170 $150

$90

$130 $85

$110 $90

$80

$70 $75

$50 $70 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service,

Commodities’ Forecast Update: The Return of “Fundamentals”

$30 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service

75

25 June 2013

Exhibit 156: Forecast thermal coal prices US$/t, long-term prices based on 2013 real prices

Newcastle FOB ARA CIF RBCT FOB

New New New

US$/t US$/t US$/t

2012

1Q-13

95 92 93

91 86 85

2Q-13f 3Q-13f 4Q-13f 87 80 80

80 77 78

85 82 82

2013f

1Q-14f 2Q-14f 3Q-14f

86 81 81

90 89 88

90 89 88

90 89 88

4Q-4f

2014f

2015f

2016f

LT

95 94 93

91 90 89

100 99 98

102 101 100

100 100 100

Source: Credit Suisse Commodities Research

Exhibit 157: Global thermal coal supply and demand estimates Mt, Surpluses or deficits show expected market balance but actual imports/exports should net out at the time Importing Country

2012e

1Q 13

2Q 13

3Q 13

4Q 13

2013f

1Q 14

2Q 14

3Q 14

4Q 14

2014f

1Q 15

2Q 15

3Q 15

4Q 15

2015f

2016f

China % change

181.5 31.0%

46.6 -11.1%

48.2 3.4%

44.5 -7.7%

53.2 19.6%

192.5 6.0%

37.3 -29.9%

47.1 26.3%

52.6 11.7%

59.2 12.7%

196.2 1.9%

39.0 -34.1%

49.3 26.3%

55.1 11.7%

62.0 12.7%

205.4 4.7%

213.6 4.0%

India % change

121.8 31.8%

35.1 -9.0%

39.1 11.4%

38.2 -2.5%

25.4 -33.6%

137.8 13.2%

39.0 53.7%

43.4 11.4%

42.4 -2.5%

28.1 -33.6%

152.9 10.9%

42.5 51.1%

47.3 11.4%

46.2 -2.5%

30.7 -33.6%

166.7 9.0%

184.4 10.6%

JKT % Chagne

294.0 0.7%

73.5 -3.8%

69.5 -5.5%

79.3 14.1%

76.5 -3.6%

298.8 1.6%

75.6 -1.1%

70.8 -6.4%

81.2 14.7%

78.3 -3.5%

305.9 2.4%

76.4 -2.3%

71.6 -6.4%

82.1 14.7%

79.2 -3.5%

309.4 1.1%

314.7 311.7%

EU 27 % change

157.5 11.5%

37.0 -14.5%

34.8 -6.0%

35.2 1.1%

39.3 11.6%

146.3 -7.1%

36.3 -7.8%

32.3 -10.8%

32.6 0.9%

38.2 17.1%

139.4 -4.7%

34.8 -8.9%

31.1 -10.8%

31.3 0.9%

36.7 17.1%

133.9 -4.0%

125.3 -6.4%

Turkey % change

22.3 13.5%

5.3 -26.0%

5.3 0.2%

6.1 14.3%

7.2 18.7%

24.0 7.5%

5.7 -20.9%

5.7 0.2%

6.5 14.3%

7.8 18.7%

25.8 7.5%

6.1 -20.9%

6.2 0.2%

7.0 14.3%

8.4 18.7%

27.7 7.5%

29.8 7.5%

North America % change

19.2 -13.8%

3.3 -38.8%

3.4 1.2%

3.7 9.1%

4.1 9.6%

14.5 -24.3%

3.5 -14.4%

3.5 0.8%

3.8 9.1%

4.2 10.2%

15.0 3.4%

3.6 -14.6%

3.6 0.5%

3.9 9.0%

4.4 10.7%

15.5 3.3%

16.0 3.2%

Brazil % change

6.5 -18.2%

1.9 24.3%

2.0 6.8%

2.6 29.2%

2.0 -23.4%

8.5 30.8%

2.3 14.1%

2.4 6.8%

3.1 29.2%

2.4 -23.4%

10.3 20.6%

2.3 -5.4%

2.4 6.8%

3.1 29.2%

2.4 -23.4%

10.3 0.0%

10.3 0.0%

Chile % change

8.9 11.8%

2.2 -7.8%

2.6 18.7%

2.7 5.4%

2.8 1.8%

10.2 15.3%

2.4 -11.4%

2.9 18.7%

3.1 5.4%

3.1 1.8%

11.5 12.7%

2.8 -11.2%

3.3 18.7%

3.5 5.4%

3.5 1.8%

13.0 13.0%

13.0 0.0%

RoW % change

74.1 1.2%

19.0 2.7%

19.0 0.0%

19.0 0.0%

19.0 0.0%

76.1 2.7%

19.6 2.9%

19.6 0.0%

19.6 0.0%

19.6 0.0%

78.3 2.9%

20.1 2.9%

20.1 0.0%

20.1 0.0%

20.1 0.0%

80.6 2.9%

82.9 2.9%

World % change

885.7 11.4%

224.0 -8.6%

223.9 0.0%

231.3 3.3%

229.4 -0.8%

908.6 2.6%

221.6 -3.4%

227.7 2.8%

244.8 7.5%

240.9 -1.6%

935.2 2.9%

227.7 -5.5%

234.9 3.2%

252.3 7.4%

247.3 -2.0%

962.4 2.9%

990.0 2.87%

Exporting Country

2012e

1Q 13

2Q 13

3Q 13

4Q 13

2013f

1Q 14

2Q 14

3Q 14

4Q 14

2014f

1Q 15

2Q 15

3Q 15

4Q 15

2015f

2016f

Indonesia % change

341.2 6.9%

80.0 -20.5%

83.6 4.6%

85.1 1.7%

100.3 17.9%

349.0 2.3%

79.3 -21.0%

85.1 7.4%

91.8 7.8%

103.3 12.6%

359.5 3.0%

81.9 -20.7%

88.0 7.4%

94.8 7.8%

106.7 12.6%

371.4 3.3%

383.7 0.0%

Australia % change

170.7 15.2%

41.6 -13.9%

44.4 6.6%

48.2 8.6%

49.5 2.7%

183.6 7.0%

41.0 -17.1%

45.1 10.0%

49.0 8.6%

50.3 2.7%

185.6 1.7%

42.1 -16.3%

46.3 10.0%

50.3 8.6%

51.6 2.7%

190.4 2.6%

193.6 0.0%

Russia % change

111.5 16.9%

28.2 -8.7%

29.0 2.8%

28.1 -3.1%

29.2 3.9%

114.5 2.7%

25.9 -11.3%

30.4 17.6%

28.8 -5.4%

31.4 8.9%

116.6 1.9%

26.4 -15.9%

31.0 17.6%

29.3 -5.4%

32.0 8.9%

118.8 1.9%

121.0 0.0%

South Africa % change

74.1 8.1%

17.0 -17.1%

17.4 2.4%

20.0 14.9%

21.1 5.3%

75.5 1.9%

18.4 -12.4%

17.7 -3.8%

20.5 15.5%

21.9 6.9%

78.5 4.0%

19.2 -12.6%

18.4 -3.8%

21.3 15.5%

22.7 6.9%

81.5 3.8%

83.5 0.0%

Mozambique % change

2.4 46.4%

0.9 20.8%

0.9 0.0%

1.3 38.6%

1.3 0.0%

4.3 83.8%

1.5 17.4%

1.5 0.0%

1.5 0.0%

1.5 0.0%

5.9 36.4%

1.8 22.6%

1.8 0.0%

1.8 0.0%

1.8 0.0%

7.2 22.6%

10.1 0.0%

Colombia % change

75.6 -1.4%

17.8 -10.4%

20.8 16.8%

22.1 6.0%

22.1 0.0%

82.9 9.6%

24.1 9.0%

24.8 3.2%

24.9 0.4%

22.8 -8.5%

96.7 16.7%

25.2 10.4%

26.0 3.2%

26.1 0.4%

23.9 -8.5%

101.2 4.7%

104.3 0.0%

North America % change

54.6 36.4%

13.1 4.8%

16.3 24.4%

15.1 -7.4%

14.6 -3.3%

59.0 8.1%

12.6 -13.4%

16.8 33.2%

15.9 -5.7%

16.1 1.4%

61.5 4.2%

13.2 -17.8%

17.7 33.3%

16.7 -5.7%

16.9 1.5%

64.5 4.9%

66.5 0.0%

Other % change

40.9 -10.3%

10.0 -1.1%

10.5 5.4%

10.6 0.7%

10.7 0.7%

44.9 9.8%

9.5 -11.4%

9.9 4.8%

10.0 0.9%

10.1 0.8%

42.3 -6.0%

8.3 -17.9%

8.8 6.3%

8.9 1.1%

9.0 1.1%

37.5 -11.4%

36.4 339.1%

World % change

875.9 10.2%

209.3 -14.5%

223.7 6.9%

231.2 3.3%

249.4 7.9%

913.6 4.3%

212.9 -14.6%

232.2 9.0%

243.1 4.7%

258.1 6.2%

946.5 3.6%

218.6 -15.3%

238.5 9.1%

249.8 4.7%

265.2 6.2%

972.4 2.7%

998.9 0.00%

-

-14.7 -7.0%

-0.2 -0.1%

-0.1 0.0%

20.0 8.0%

4.9 0.5%

-8.6 -4.1%

4.4 1.9%

-1.8 -0.7%

17.2 6.7%

11.2 1.2%

-9.1 -4.2%

3.6 1.5%

-2.6 -1.0%

17.9 6.8%

9.9 1.0%

8.9 0.9%

Surplus / Deficit As a % of exports

Source: Credit Suisse, Customs Data, Company Data

Commodities’ Forecast Update: The Return of “Fundamentals”

76

25 June 2013

Base Metals: Life in the slow lane RESEARCH ANALYSTS Commodities Research Andrew Shaw [email protected] +65 6212 4244 Marcus Garvey [email protected] +44 20 7883 4787 Supply Model Contributors Equity Research Paul McTaggart [email protected] +61 2 8205 4698 Matthew Hope [email protected] +61 2 8205 4669 Neelkanth Mishra [email protected] +91 22 6777 3716

The commodity price forecasts mentioned in this section have been provided by the Commodities Research analysts above.

Downside price risks come to the fore LME commodity prices find themselves under renewed downward pressure again in June. As the bellwether, and “last man standing”, copper has shed almost 20% of its value since February’s peak (as we go to publication we are in the midst of what appears another downdraft). The red metal is 34% cheaper than it was at the dizzy heights of early 2011 when it touched US$10,000/t on the LME. Even those commodities which appear to have slipped below marginal cost of production have suffered deeper price erosion. Aluminium, zinc, lead and tin are down 17%-22% from early-year highs and nickel is off by more than 26%; so much for fundamental cost support. The shift in sentiment hinges on two main aspects which markets have taken time to absorb: • That aggregate global demand is soft and unsupportive of intensive industrial commodity use. China’s momentum especially is indisputably on a more muted trajectory than in the run up to the collapse of Lehman. We would argue there is very little chance of a meaningful reversal to this “structural” pattern and orders across key segments are likely to fall in 3Q. • Across the board, supply has caught up and overtaken demand; in virtually all markets “scarcity” is a feature of the past. This has become widely accepted in those markets awash with supply but many still cling to the belief that copper supply will continue to underperform on a persistent and large scale. Here, we feel there are material risks of greater surpluses than we are forecasting if disruption is less intensive. Cost support was never going to provide a solid defensive wall against this combination. That prices have not tumbled even further reflects artificial physical “tightness” in several LME markets, exemplified by aluminum and zinc with weak fundamentals and a substantial overhang of stocks resulting from years of oversupply. Acres of metal are tied up in warehousing, frustrating consumers unable to access tonnage quickly. Copper too has succumbed to this bottleneck as Chinese producers and traders constrict availability. While conceptually the cost of supply should provide a longer-term floor to prices, history demonstrates that in the shorter term prices can invade the cost curve deeply for periods of time. Supply, it seems, is often more “sticky” than the cost curve would suggest. Consequently, cost support is really more about longer-term price influences than it is about pricing in the near term. • Cost factors have also been highly dynamic, with the marginal cost of production (and consensus long-term forecasts) tending to move up with spot prices and then falling as the cycle turns down. • Costs are endogenous to the broader economic environment. Now we are seeing the impact of weakening commodity prices on the exchange rates of those countries responsible for supplying large portions of the world’s natural resources (e.g., Australia). These dynamics are well reflected in previous cycles. For example, the cost of extracting copper more than halved as prices (in real terms) plunged to their troughs in the late 1990s/early 2000s. Costs more than doubled again by 2011-12. In conclusion, while costs remain a critical variable in forecasting commodity prices, in the shorter term, there is much less rigid support in bear markets than many expect. This opinion features in our revised forecasts for LME commodity supply, demand and prices. Risks, we believe, remain skewed to the downside, across the complex, but with copper perhaps the most vulnerable given that more of its “scarcity premium” looks set to be dislodged in 2013-14.

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Copper – At home on the (lower) range Copper prices expected to dip below US$6,000 in 2014 Copper’s world has changed. Rising mine-through-refined supply has met waning demand and market surpluses are likely to build through 2013-14. Indeed, our refreshed forecast now includes a surplus of around 380 kt in 2012. A similar excess of supply over demand we expect will herald in 2013 and once again in 2014 before price-induced cuts eat into planned mine supply. Even in the face of more modest retreats in prices than we anticipate, severe capital prudence will be the mantra for the next few years to come. Inevitably, we think prices must come under further downward pressure soon. Although we question strict faith in short-term cost support – prices almost always under- or over-shoot when supply and demand swing – the price today sits more than US$1,500/t above the short-run marginal cash cost of supply. • Within the next 6-12 months we expect LME prices to be tracking at the bottom of the US$6,000-9,000/t range in which the metal has traded since 2006. • Our forecast pitches us fairly and squarely at the bottom of consensus but we would remind readers that this price path still allows profitability for virtually all mines, even if the pickings will start to become much leaner.

Physical tightness is an artificial construct The only reason we can see for prices holding at current levels a shade above US$7,000 is because of investor positioning (helped by a residual belief in copper’s price immortality) and physical tightness in accessing cathode. This tightness is not a function of buoyant demand and fundamentally constrained supplies – it appears to be an orchestrated move aimed at controlling metal flows, boosting regional premiums and, for now, keeping a floor under prices. Physical tightness now extends to China where the major copper producers seem intent on countering speculative short positions in an effort to lift meager profits from smelting and refining as primary- and byproduct prices slip away. However, with the investor profile having shifted already to a more neutral stance, it may become increasingly difficult for producers to defy the laws of gravity. As with their mining counterparts, we contemplate that Chinese smelters/refiners will also cut back (on previously planned output), though we believe a wall of plant expansions will keep the system in growth mode. • The move above the $9,000 mark in 2011 was fuelled by a ‘perfect storm’ of a large demand stimulus (mainly in China) and weak copper supply growth; this is a combination unlikely to be repeated soon. • In contrast, in 2013 copper faces weak global economic growth, with a structural downshift in China, conspiring with much-improved delivery of copper mine supply growth. • While prices are likely to fall towards $6,000, we highlight that this remains consistent with a relatively tight market – essentially, we are keeping the “super cycle” (2002 to 2006) price gains in place. For the market to remain in supply shortfall this year, optimists need to believe in much stronger world demand and/or wholesale disruptions to supply well in excess of 1 Mt/y in 2013-15. These allowances do not include those disruptions which are now more visible in 2013 where we have trimmed forecast mine-through-refined supply. • A more modest level of disruptions could lead to much greater surpluses than most forecasters predict. Such an outcome does not appear to be encapsulated in current spot and futures prices.

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Exhibit 158: Copper prices are expected to fall to the lower part of the US$6,000-9,000/t range in which they have traded for much of 2006-13 US$/t, LME 3-month copper price

12000 10000 8000 6000 4000 2000 0 2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Supply: on a higher track We have made a range of important changes to our supply/demand outlook since April. However, we continue to expect improved performances in delivering new mine supply. • That said, we have modified our mine-by-mine forecasts to show likely investment deferrals, with lower growth rates postulated in all major regions – our forecast is for an expansion rate of just below 4% p.a. in 2013-15, with the momentum easing from 2014 as prices decline. − We are much more skeptical that ambitions to return African production back to historical peaks will take place as smoothly as intended, with 2 Mt/y still an ambitious undertaking by 2015. − We have trimmed our expected production levels for both Peru and China, where we think growth will be maintained but lower prices will mean slower progress. − Our view of Chile’s production profile is generally unchanged; here we balance improved performance at key mines against the challenges associated with deteriorating ore grades (Chile is no longer the sole catalyst for copper mine expansions). • We have retained our 6% allowance for unexpected disruption and “market adjustments” in response to prices. Over and above the losses experienced at Freeport’s Indonesian mine (probably more than 100 kt) and at Kennecott’s Bingham Canyon in the USA (125 kt), we have factored in additional unforeseen losses of almost 450 kt in the final six months of this year, losses which mount to almost 1.5 Mt/y by 2015. − There is a crucial caveat in our S&D outlook in this regard – if disruption does not take place at this scale, market surpluses could be substantial; under this scenario prices would likely plunge, probably into a range below US$5,000 for a period of time. High prices have essentially included a “scarcity premium” over and above the marginal cost of producing copper, a level currently of around US$5,000-5,500/t in our estimates. Copper miners have struggled to lift production and the universe of highly-enriched deposits amenable to low-cost exploitation has shrunk.

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Exhibit 159: If surpluses build significantly, the case for rigid short-term cost support is hard to argue

Exhibit 160: Copper prices are far higher than underlying costs of production … both will likely fall

Direct cash costs of copper mine supply, US$/t

Direct cash operating costs of copper mine supply. Real (2012) USc/lb 440

10000

400

9000

Annual range of LME prices - monthly averages Tick denotes annual

75th

360

8000

Current price = US$7,370/t

320

7000

90th 280

6000

90th

percentile = US$5,335/t

5000

240 200

4000

160

3000

120

2000

80

1000

40

0

0

50th

Source: Credit Suisse, Wood Mackenzie

2012

2010

2008

2006

2004

2002

2000

1998

1996

1994

1990

1992

1988

1986

15,000

1984

10,000

1982

5,000

1980

0

25th

Source: Credit Suisse, Wood Mackenzie

Costs have risen but concerns over operational challenges and investment risks mask likely advances in adding supply already financed and committed as a consequence of the high price years. This supply has been delayed, not lost forever. The track record on mine delivery in the year to date is much better than in recent times, even taking into account present labor tensions in Chile and a variety of incidents elsewhere.

Better progress for (most) brownfield and greenfield projects Progress at existing mines and new projects is mixed, but is generally taking better shape than in recent years: • The accident at Freeport’s Grasberg mine in Indonesia has undermined progress made since a strike-disrupted 2011-12. Q1 copper production returned to the 100 kt mark, compared to 324 kt in 2012. We have prudently forecast that the current halt, even if concluded within 2-3 months, will have some impact on progress in opening up new block caving sections. Our forecasts for broader Indonesian production have been cut to 435 kt in 2013 and a more modest increase to 600 kt in 2014. Freeport also expects increases from its US and Chilean operations, including Candelaria, where improving head grades will lift output. • Anglo American’s latest interim quarterly statement indicates a mixed performance early in the year, with Los Bronces’ output running at higher levels. Production at Collahuasi remains impacted by the planned 45-day shutdown of its SAG Mill 3 responsible for 70% of the mine’s throughput. Lower grades also led to a 17% year-on-year drop in output. However, completion of maintenance work at the mill and a focus on addressing 2012’s problems is likely to lift production in the balance of 2013.

• Copper production at BHP Billiton’s Escondida in Chile increased by 61% during the ninemonth financial period to end-March while output remains on track to rise by 20% in the company’s financial year to end-June 2013. In the March 2013 quarter output was running at an annualized 1.2 Mt of payable contained copper, 250 kt/y higher than a year ago. Antamina in Peru also achieved record production for the nine-month period ended March 2013. Olympic Dam’s production in Australia increased as well by 42% in the March 2013 quarter following the completion of major planned maintenance. • Codelco continues to suffer industrial relations tensions, but this has resulted in delivery delays rather than meaningful production losses at this stage. The Chilean state producer saw copper output slip 5% to 1.65 Mt in 2012 due to dwindling performance at its large, Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

ageing mines, its lowest level since 2008. The company has embarked on an ambitious long-term investment plan with the aim of producing more than 2 Mt/y by the 2021. Despite a fractious industrial relations landscape, Chile posted a 4% yoy increase in mine supply to 422 kt in February, following greater increases in January. Largest gains were made at previously troubled Chuquicamata, Radomiro Tomic and at El Teniente. • Antofagasta’s Esperanza mine has shaken off the teething troubles that held back ramp-ups at the Chilean operation last year (90% towards capacity targets). Despite these challenges, Esperanza’s introduction contributed to a 10% increase in the company’s copper production last year to 710 kt, a level it expects to match in 2013. • More broadly, a list of mines entering production in 2012 and 2013 will make a mark. These include: − Commissioning of Xstrata Copper’s Antapaccay project in southern Peru in August 2012 and with initial copper production in October (the mine could add more than 100 kt to 2013 totals). − Vedanta’s Konkola Deep in Zambia, on stream in Q4 2012. − Vale’s Salobo mine in Brazil commissioned in H2 2012. Our projections are as follows: Salobo I; 100 kt/y nominal capacity of copper concentrate after capex of US$2.5 billion. Salobo II: 2014 start-up with a nominal capacity of 200 kt of copper concentrate, at a cost of US$1.7 billion, with Vale stating its target is 200 kt of copper production in 2016. However, Salobo II is subject to delays as operational licenses have yet to be obtained (H1 2014) and the project is only 68% completed. − First commercial production from Rio Tinto’s Oyu Tolgoi mine in Mongolia. Despite tensions over the JV structure with the Mongolian government, we expect the operation to move to 250 kt/y by 2015.

Exhibit 161: World copper mine production has grown very slowly since the 1990s, but this looks about to change in 2013-15

Exhibit 162: Copper mine production costs have risen steeply, but many of these costs are endogenous and are expected to fall in line with prices

kt Cu (lhs), % annual change (rhs)

Estimated costs of mine supply, US$/t

22000 20000

Mine Supply (without disruption), kt Mine Supply, kt Increase, % (rhs)

10 8

4000 3500 3000

6

16000

4

14000

2

1500

Electricity

12000

0

1000

Labour

10000

-2

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

18000

Source: Credit Suisse forecasts, Wood Mackenzie

Services & Other

2500

Stores

2000

Fuel

500 0 1990

1995

2000

2005

2010

2012

Source: Wood Mackenzie, Credit Suisse

Meanwhile, we highlight that our seemingly pessimistic price forecasts retain profitability for most copper miners, especially allowing for additional savings as factor costs start to come down alongside product prices. Historically, copper prices have invaded the supply curve less deeply than is the case for some major commodities, suggesting a more immediate responsiveness on the part of suppliers in rebalancing over-fed markets. • On this basis, a projection that prices could dip below US$6,000/t for a quarter in H2 2014 does not seem such a bold prognosis. Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

China’s smelter output is on the rise but scrap is scarce Falling prices have, of course, put smelters/refiners under profit pressure, exacerbated by weaker acid prices and lower credits from precious and other byproduct metals. The shortage of scrap has also impacted processors and fabricators alike, especially in China. However, scrap supply tightness is nothing new, even if the H1 retreat in prices has stimulated hoarding of stocks by scrap merchants, as usually happens in a deteriorating price environment. • Availability of scrap has been poor throughout 2012, largely as a result of weaknesses in manufacturing activity and reductions in scrapping rates of obsolete goods in the main sources of scrap, the US, Europe and Japan. • Scrap supplies domestically in China are growing rapidly, but from a very low base; the country still has a shallow reservoir of goods in use that will eventually be scrapped. While we have tempered our forecasts for refined supply in China, we do not feel these shortages will mean that output completely stands still as is suggested by some major refiners. Cuts announced are mainly from earlier targeted levels of 2013 production. Copper smelters are aggressively installing new primary smelting capacity and, with it, increasing their importance at the hub of the world’s refined copper production chain. • Jinchuan states it has suspended a 200 kt/y facility in Gansu due to shortages of scrap feed for the plant, reducing planned output by 100 kt/y from the 600 kt targeted earlier in the year. Last year, Jinchuan produced 386 kt of copper from the facility, with just over 230 kt derived from primary feed. Jinchuan has been unable to secure sufficient scrap fully to utilize its new tilting furnaces installed in 2011 and in theory capable of treating around 200 kt/y of copper in scrap. We believe these units achieved output of around 155 kt of copper in 2012. Given that the plant is land-locked and far from sources of imported feed (Guangdong’s ports are almost 2,000 km from the plant), and that domestic supply of copper in scrap rose by just 73 kt nationwide last year, these plans were always going to be ambitious, at least in the shorter term. • The company also had plans to start up a secondary smelter using the Ausmelt process in southern China’s Guangxi province. Again, the lack of imported scrap would seem likely to hamper plans to yield 200 kt/y from this plant in the immediate future. • Jinchuan’s news follows Yunnan Copper’s decision to suspend a 100 kt/y unit and Jiangxi Copper, China’s largest producer, indicating a flat production profile in 2013 may result due to constraints in secondary production. • Elsewhere, a number of smelter/refineries are undertaking maintenance programs in H1 to take advantage of weak economics of treating scrap, encouraging copper semi-fabricators to shift to refined copper from primary sources as the main feed for their furnaces.

Secondary smelter expansions likely to be held back Perhaps most surprising against this background are ambitions to install considerable additional secondary smelting capacity in China. Our sources list no fewer than seven facilities intended to come on stream in 2013-14 with aggregate copper production capacity of more than 1.4 Mt/y, although just three plants (with a rating of 500 kt/y) look likely to achieve a 2013 start-up. • In 2012, scrap imports totaled 4.9 Mt, a rise of just 174 kt, or 3.7%, on 2011 volumes (by gross weight). Assuming an average copper content of close to 40% (always a tricky assumption), this equates to around 1.9 Mt of copper units. • Domestic scrap supplies, while rising more strongly by 7% to 1.17 Mt (copper content), are doing so off a much lower base. Old scrap generation rose by 11%, but this represents a gross tonnage of just 625 kt. Growth in new scrap supply arising from the manufacturing process was much weaker, in line with a slower pace of industrial activity in China. Commodities’ Forecast Update: The Return of “Fundamentals”

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• Direct use of scrap by semi-fabricators (i.e., scrap use directly in their melt-shops, and not through the smelting/refining industry) fell by more than 100 kt in 2012 and is expected to grow by barely 2% in 2013. All in all, this places a greater emphasis on growth in primary refined supply; with imports of cathode down on 2012 levels, this means assessing the pace of copper in concentrate supplies to determine if smelters/refiners will struggle to lift production. • Scrap shortages have prompted us to halve our forecast growth in Chinese refined supply in 2013 to 733 kt. • As we have outlined before, a 5%-6% increase in Chinese copper consumption equates to little more than 500 kt of copper; we do not envisage constraints on primary supplies will fall short of this mark.

Exhibit 163: China mine-through-refined copper balances in 2010-13 kt 2010 kt Cu Concentrate Production Net Imports Other Raw Materials Conc. (gross) Conc. (Cu) Blister Other Sources, Stocks & Losses Secondary Refined Production Primary Refined Production Of Which SXEW Total Refined Production

2011

1,120 1,267 6,468 1,649 399 61 1,337 3,197 110 4,534

Q1 320

Q2 360

2012 Q3 380

Q4 Year 360 1,420

6,386 1,760 1,670 1,840 2,558 1,628 444 421 464 645 416 123 128 133 139 242 -30 79 43 -5 1,680 430 480 490 460 3,517 848 978 1,010 1,128 115 25 33 33 34 5,197 1,278 1,458 1,500 1,588

Q1 350

Q2 375

2013 Q3 380

Q4 Year 395 1,500

7,828 2,219 2,150 2,150 2,181 1,974 559 542 542 550 523 134 140 140 136 87 129 100 90 103 1,860 440 480 510 510 3,964 1,160 1,145 1,140 1,172 125 25 32 33 48 5,824 1,600 1,625 1,650 1,682

8,700 2,193 550 422 1,940 4,617 138 6,557

Source: BGRIMM, Credit Suisse estimates and forecasts

Substantial primary smelter capacity additions under way While China’s copper producers may be protesting shortages of scrap, they clearly do not anticipate similar constraints on securing feed for their ambitious primary smelting expansion programs. Although utilization rates have eased back a shade in April, these still stand at close to 90%. Rising spot treatment terms have also helped smelters partially offset the sapping effects of weaker sulphuric acid and precious metals prices. We have counted 15 plants that have recently commissioned or plan to do so soon at brownfield or greenfield facilities in 2013. Allowing for some deferments into 2014, these plants account for more than 2.5 Mt/y of incremental smelting capacity. All these plants have received government permits. A further nine or ten projects totaling 1.5 Mt/y of primary smelting capacity are also on the drawing board. While not all these smelters will expand according to ambitions, continued constraints on secondary production, including new rulings on capacity limits, environmental standards and energy consumption aimed at this subsector, mean that forecasting China’s copper supply is increasingly about forecasting mine supply, or rather, concentrate flows. The bottom line is that concentrate shipments to China have doubled since 2009 and further rises are in store, swinging the balance of copper units consumed in China away from imported primary cathode and scrap. Whether consumers can access this material without paying hefty premiums remains to be seen.

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25 June 2013

Exhibit 164: Imports of copper concentrates on the rise

Exhibit 165: Refined copper production in China has grown, despite scrap shortages

Monthly, kt (gross), SA

Monthly refined copper output, kt, SA

1,000

600

900 550

800 500

700 600

450

500 400

400 300

350

200 300

100 0 2006

2007

2008

2009

2010

2011

2012

Source: Credit Suisse, Customs Data

2013

250 2008

2009

2010

2011

2012

2013

Source: Credit Suisse, China NBS

Demand: not bad, but not too great … worries for 2H 2013 Global demand is undoubtedly soft and we are now picking up reports from manufacturers of very weak orders looming in 3Q in both the tube and cable areas. Most significantly for commodity markets, after “outperforming” substantially in 2010 and 2011 as the largest stimulus in history worked its way through the system, it is now evident that growth in China has moved to a new structurally weaker pace and we would not be surprised to see economic expansion drift below the 7% mark for CY2013. It is also notable that consumption growth for copper was not as rapid as seen in many other commodities over the past decade, mainly because supply growth continued to struggle. • In a world of greater demand growth (as evidenced by the increase in global GDP growth and in particular Chinese growth of all persuasions) and continued weak supply, higher prices were needed to ration demand. • In the case of copper, given the fact that it is relatively demand inelastic, at least in the shorter to medium term, the surge in demand, coupled with still weak supply, required a dramatic increase in price. − India is a good case in point where the loss of production from the 300 kt/y Tuticorin smelter (India suspended pending an environmental probe) and maintenance work at Hindalco’s 400 kt/y Dahej facility have effectively resulted in virtually no growth in demand for copper this year. This regional lack of supply has killed demand and is far more neutral to price than many think. This period of high prices has had its toll and the pressures of substitution and weight saving are common talking points on our regular visits to Chinese manufacturers. Discussions with experts put these losses somewhere in the 400-500 kt/y range. Examples include: • Downsizing of copper tube in aircon units (typical room aircon units now use thinner-walled 5 mm tube as opposed to 7 mm diameter tube a few years ago). The average copper content of a typical aircon unit in China today has fallen by more than 50% since 2005. • Loss of markets to aluminium in the high-voltage and medium-voltage power grid. Aluminium has also made strong inroads in the rural grid on which a significant part of current investment activity is centered. • Loss of copper tubing in plumbing applications worldwide. The uptick in US housing activity is positive for copper but loss of markets for tubing mean this growth is likely to no higher than 100 kt/y in 2013-15. Commodities’ Forecast Update: The Return of “Fundamentals”

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Exhibit 166: World refined copper demand – all about China at the “first use” level

Exhibit 167: Copper use did not grow prolifically in the “super cycle” – scarce supply held demand back

Refined copper use, kt

Annual increase in copper demand and 3Y moving average, kt

2500 2000 1500 1000 Australasia

500

China Asia (ex China)

0

Africa S America N America

-500

USSR/CIS Europe

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

-1000

Source: Credit Suisse forecasts (assuming 6% disruption factor), Wood Mackenzie

Source: Credit Suisse forecasts, Wood Mackenzie

Nevertheless, we are forecasting annual increases in global copper demand of 700800 kt/y in 2013-15, a major improvement on 2011-12, but less than half the pace of 2009 when major stimulus had its impact. China dominates this usage pattern, with annual increases of 5%-6% projected. Use of copper in power applications continues to dominate, currently accounting for 35% of overall world refined copper demand of 20 Mt/y, while use in buildings follows close behind at 28% market share. This leads us to contemplate annual surpluses of supply over demand of about 350400 kt in 2013-14, with obvious ramifications for prices. • This price weakness will likely slow the pace of supply growth and shrink this surplus by 2015-16, potentially sowing the seeds for tighter markets and a subsequent price recovery.

Exhibit 168: Copper forecast comparison

Exhibit 169: Copper historical price and forecast

US$ per metric tonne

US$ per metric tonne

$8,000

CS Forecast

Forward Curve

$11,000

Bloomberg Forecast Mean

$7,800

$10,000

$7,600

$9,000

$7,400

$8,000

$7,200

Copper 3M

Quarterly Avg Forecast

$7,000

$7,000

$6,000

$6,800 $5,000

$6,600 $4,000

$6,400 $3,000

$6,200 $2,000 2005

$6,000 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 170: Forecast copper prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

LME copper 3M

New New Old

US$/t US¢/lb US$/t

1Q-13 7,958 3.60 7,934

2Q-13f 7,200 3.25 7,700

3Q-13f 7,000 3.20 7,300

4Q-13f 6,800 3.10 7,000

2013f 7,240 3.30

1Q-14f 6,600 3.00

2Q-14f 6,300 2.85

3Q-14f 6,100 2.75

4Q-14f 5,900 2.70

2014f 6,225 2.80 6,675

2015f 6,750 3.05 6,200

2016f 7,250 3.30 6,300

LT 6,600 3.00 5,500

Source: Credit Suisse Commodities Research

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Commodities’ Forecast Update: The Return of “Fundamentals”

Exhibit 171: Global copper supply and demand estimates Thousands of metric tonnes (kt)

World Copper Supply & Demand Balance 2008 2009 MINE PRODUCTION (kt) North America 1,952 1,682 Western Europe 198 205 CIS & other E Europe 1,788 1,798 China 1,157 1,113 Chile 5,402 5,457 Peru 1,229 1,225 Australia 875 845 Indonesia 650 995 Africa 1,039 1,185 ROW 1,426 1,495 World Mine Production 15,717 16,001 Highly Probable Grow th Probable & Possible Grow th Disruption & Market Adjustment SX/EW 3,071 3,274 Concentrate 12,646 12,727 World Mined Copper 15,717 16,001 % Change 3.6% 1.8% Conc. avail after direct use 12,630 12,706 Smelter Capacity 16,597 17,078 Smelter Production 14,292 14,178 Required Adjustment Scrap/Remelted Blister (2,067) (1,937) Smelter loss 482 440 Primary Feed Required 12,707 12,681 SURPLUS/(DEFICIT) CONC (77) 25

2010

2011

2012

2013f

2014f

2015f

1,628 253 1,758 1,230 5,481 1,204 860 871 1,344 1,523 16,153 3,335 12,818 16,153 1.0% 12,796 17,554 14,786 (2,618) 471 12,639 157

1,697 285 1,775 1,382 5,307 1,183 937 543 1,407 1,694 16,209 3,444 12,765 16,209 0.3% 12,743 18,007 15,447 (2,867) 456 13,037 (294)

1,754 326 1,762 1,545 5,520 1,280 921 398 1,531 1,744 16,781 3,640 13,141 16,781 3.5% 13,119 18,889 15,718 (2,986) 440 13,171 (53)

1,758 346 1,783 1,638 5,869 1,380 1,000 435 1,790 1,881 17,881 (447) 3,705 13,729 17,434 3.9% 13,707 19,761 17,350 (1,050) (3,097) 440 13,643 64

1,933 367 1,791 1,825 6,132 1,355 999 600 1,991 2,168 19,161 64 45 (1,156) 3,935 14,178 18,113 3.9% 14,156 20,788 19,083 (2,250) (3,124) 456 14,221 (64)

2,088 385 1,778 1,900 6,215 1,500 983 650 2,023 2,248 19,769 249 193 (1,415) 4,098 14,699 18,797 3.8% 14,677 21,295 19,819 (2,670) (3,122) 451 14,672 5

REFINED COPPER PRODUCTION (kt) North America 1,710 Western Europe 1,932 Eastern Europe 1,558 China 3,795 Other Asia & Oceania 4,593 Africa 608 Latin America (inc Mex ico) 4,064 Probable Grow th Adjustments to refined prod Scrap/Blister 897 Electro Refined 15,189 Net SX/EW 3,071 World Production 18,260 % Change 5.6%

1,406 1,903 1,692 4,534 4,424 883 4,136 857 15,643 3,335 18,978 3.7%

1,282 2,043 1,736 5,197 4,370 970 4,164 871 16,318 3,444 19,762 4.1%

1,262 2,089 1,720 5,824 4,443 1,097 3,776 (82) 770 16,488 3,640 20,128 1.9%

1,319 2,138 1,744 6,557 5,235 1,441 3,878 (1,507) 799 17,099 3,705 20,804 3.4%

1,374 2,241 1,824 7,936 5,396 1,694 4,319 56 (3,205) 811 17,700 3,935 21,634 4.0%

1,420 2,256 1,835 8,747 5,456 1,774 4,292 194 (3,701) 832 18,175 4,098 22,273 3.0%

1,497 1,811 1,567 4,109 4,383 727 4,200 843 15,020 3,274 18,294 0.2%

STOCKS (kt) LME + COMEX Stocks SHFE Stocks Total Ex change Stocks Weeks Cons (Exch. Stocks) Commercial Stocks Total Reported Stocks Price (US$/t) Price (US$/lb) TC (US$/t) RC (¢/lb)

2008

2009

2010

2011

2012

371 18 389 1.1 417 806

592 96 688 2.1 388 1,076

437 132 569 1.5 407 976

459 93 552 1.5 417 969

6,932 3.14 45 4.5

5,149 2.34 75 7.5

7,547 3.42 47 4.7

COPPER CONSUMPTION BY COUNTRY (kt) North America 2,188 1,780 Western Europe 3,422 2,807 Eastern Europe 1,086 729 Latin America 889 761 Japan 1,184 875 China 5,230 6,500 South Korea 812 871 Other Asia 2,032 1,839 Middle East 740 760 Oceania 151 130 Africa 306 304 World Consumption 18,039 17,357 % Change 0.8% -3.8% China 13.2% 24.3% World ex China -3.5% -15.2% COPPER CONSUMPTION BY SECTOR (kt) Building & Construction 6,070 5,408 % Change 0.6% -10.9% Transport 2,024 2,335 % Change 0.3% 15.4% Electrical 5,878 5,847 % Change 0.5% -0.5% Consumer Goods 1,808 1,686 % Change 1.6% -6.7% Machinery & Equipment 2,260 2,081 % Change 1.7% -7.9% Total 18,039 17,357 Annual Substitution (468) (394) SURPLUS/(DEFICIT) 221 937

2014f

2015f

384 205 589 1.6 471 1,060

2013f May 684 177 861 2.2 418 1,279

8,813 4.00 56 5.6

7,956 3.61 64 6.4

7,240 3.28 70 7.0

6,225 2.82 75 7.5

6,750 3.06 85 8.5

1,902 3,098 820 921 1,060 7,204 901 2,060 916 131 292 19,306 11.2% 10.8% 11.5%

1,902 2,928 1,082 875 1,007 7,815 788 2,000 942 120 290 19,748 2.3% 8.5% -1.4%

1,926 2,678 1,054 906 1,006 8,204 665 1,972 1,000 101 231 19,744 0.0% 5.0% -3.3%

1,977 2,679 1,074 933 1,028 8,700 663 2,030 1,031 103 238 20,457 3.6% 6.0% 1.9%

2,040 2,689 1,095 962 1,042 9,237 674 2,102 1,063 106 245 21,254 3.9% 6.2% 2.2%

2,081 2,700 1,128 996 1,065 9,726 685 2,197 1,112 109 257 22,057 3.8% 5.3% 2.6%

5,463 1.0% 1,921 -17.7% 6,795 16.2% 2,452 45.5% 2,675 28.6% 19,306 (450) (328)

5,523 1.1% 1,887 -1.8% 6,974 2.6% 2,547 3.9% 2,816 5.3% 19,748 (550) 14

5,517 -0.1% 1,929 2.2% 6,984 0.1% 2,523 -1.0% 2,791 -0.9% 19,744 (450) 384

5,685 3.1% 2,020 4.7% 7,225 3.4% 2,656 5.3% 2,872 2.9% 20,457 (450) 347

5,881 3.4% 2,145 6.2% 7,516 4.0% 2,757 3.8% 2,955 2.9% 21,254 (400) 380

6,064 3.1% 2,284 6.5% 7,797 3.7% 2,867 4.0% 3,045 3.1% 22,057 (400) 217

Source: Brook Hunt, Credit Suisse 25 June 2013

86

25 June 2013

Aluminum – All pain and no gain Aluminum prices have traded benignly in a range of US$1,850-1,950/t for much of Q2. Despite a short-lived rally in early June, the light metal appears at risk of slipping into a new, lower trading range in the weeks ahead. There are two main reasons we feel support may yet evaporate at the US$1,850 mark: • As with other major commodities, we are concerned that H2 2013 will see an ebbing of the largely seasonal growth momentum in China, while other regions are providing only tepid support. • On the supply side of the equation, despite announced plans for smelter cuts, we estimate the pace of greenfield and brownfield expansions will keep supply well in excess of underlying needs. Aluminium surpluses have led to an accumulation of more than 100 days’ demand cover. For consumers, stocks are hard to access and support from robust regional premiums has also propped up supply; despite tight margins, too many smelters are immune at current aggregate price levels to embracing much deeper cuts to stem surpluses. We now believe that underlying prices will need to fall further to trigger meaningful smelter responses. We would not be surprised to see the US$1,800 level tested in coming weeks.

Exhibit 172: Aluminum prices are expected to slip into a lower trading band in 2013-14 LME aluminum 3M, US$/t

3500 3000 2500 2000 1500 1000 500 0 2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Demand: losing pace in H2 2013 While global demand growth is brighter than for most metals (brought about not least by the metal’s relative “affordability”), we worry that China’s demand boost in Q2 is overwhelmingly seasonal. China is responsible for about 46% of global primary aluminium use, hence more muted growth there will weigh heavily on the overall balance. • Improving orders in Q2 mask overcapacity and utilization rates at large extruders (principally supplying the construction industry), for example, are less than 70% and no higher than 2011-12 rates. While this might largely reflect overcapacity, we also feel that it is a signal of steady, rather than exuberant, demand activity.

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• The picture is no better in consumer-oriented fabrication, with flat-product operating rates at 62% on average in March. • The wire and cable sector has been relatively slow to gear up after the Chinese New Year, with March operating rates just 56% at larger manufacturers exposed more heavily to power grid investment. • The power sector accounts for more than 20% of aluminium demand in China and is expected to be its strongest performing use in terms of growth this year. However, activity here is almost certain to be patchy, with periods of accelerated demand growth, followed by flatter off-take. • Core manufacturing sectors in the US may prove broadly supportive, but we have a lower regard for prospects in Europe. Nevertheless, at 5%-6% p.a., world primary aluminium demand is a notch ahead of most of its LME peers, driven by an annual rate of 6%-8% p.a. in 2012-15. However, this pace is not enough to counter similar rates of smelter production increases, leaving the market with annual surpluses well above 1 Mt in 2013-14.

Supply: new smelter capacity is overwhelming demand All eyes are therefore on smelters and whether they will cut back on a sufficient scale to avoid greater price weakness ahead. Previously, we have highlighted the growing pace of cutbacks as prices have eased, but high regional premiums have acted as a buffer against these underlying price falls. Smelter profit margins are lean (as evidenced by recent producer results), but higher premiums and the effects of vertical integration mean that deeper curtailments in supply are likely only to come with further falls in raw prices, or a fiercer retreat in premiums than we envisage. • As we have pointed out before, piles of aluminium are tied up in financing deals or are stuck in long load-out queues, frustrating consumers attempting to access metal from LME warehouses. These features have led to a rise in regional premiums – in other words, while the price slipped to its lowest levels since 2009 earlier this month, smelters have benefitted from premiums as high as US$300/t in Europe and more than US$250/t in the USA in recent weeks.

Exhibit 173: The downward drift in aluminum prices since 2011 has resumed

Exhibit 174: High regional premiums have helped prop up supply

Three-month LME prices, US$/t

US$/t

350

2900

US

Europe

Singapore

300

2700

250

2500 200

2300 150

2100 100

1900

1700 Jan-11

50

Jul-11

Jan-12

Jul-12

Jan-13

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Commodities’ Forecast Update: The Return of “Fundamentals”

0 2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

88

25 June 2013

Cuts to date are not enough to put a dent in surpluses Of course, the scale of vertical integration means that smelter costs alone are not the only part of the equation, but the largest producers have collectively been highlighting the need for greater supply-side discipline if aluminium prices are to hold up. In a market likely to top 50 Mt of primary metal in 2013, measures to rein back production have so far been modest. These include the following: • The possibility of deeper reductions by Alcoa at its higher-cost plants. The company currently has 568 kt/y offline, about 13% of its global capacity, and has stated it will review the potential for an additional 460 kt/y of cuts over the next 15 months. Options will include permanent closures at higher-cost plants. • Suspension of some operations by Rusal, which aims to reduce output by 300 kt in 2013, equivalent to about 10% of its exports. The cuts will take place at the Nadvoitsky, Bogoslovsky, Volkhovsky and Novokuznetsky plants, although the suspensions are likely to prove a delicate socio-political affair. Rusal’s halts include continued suspension at the 96 kt/y Alscon plant in Nigeria, in which Rusal is embroiled in ownership wrangles over its 85% holding and access to low-cost gas. • India’s National Aluminium Company (Nalco) may reduce daily output at its 400 kt/y smelter at Angul in Odisha due to shortages of domestic coal. The company normally operates seven power units, producing about 800 MW of power to feed the smelter that is rated at about 1,050 t/d of aluminium. However, these losses may amount to little more than 20 kt per quarter. • Cuts in Brazil due to high power prices and a continued decline at Venalum’s smelters in Venezuela. These are best seen as continued constraints on growth rather than deepseated losses. The International Aluminium Institute (IAI) estimates members’ voluntary curtailments in 2012 amounted to about 1.1 Mt/y of smelting capacity. On top of this about 800 kt/y of production was lost due to involuntary stoppages, but this idled capacity has largely been restored.

Smelter expansions continue… Worse still for those expecting a meatier supply response to stem price erosion, expansions contributing more than 1.2 Mt of additional aluminium in 2013 outside China will come on top of a seemingly inexorable rise in smelter capacity within the Middle Kingdom. Moreover, these new plants are replacing higher-cost units elsewhere, with the net effect of pushing down overall costs of production. In short, the global supply curve is becoming flatter. Prominent announced capacity additions this year and planned for 2014 include the following: • The ramp-up at Ma’aden’s 740 kt/y smelter in Saudi Arabia (Alcoa has a 25% interest in this JV). • An additional contribution totaling around 750 kt/y from India, with smelter and refinery expansions led by Hindalco and Vedanta. Growth from Indian smelters will probably gather pace in 2014. • Emirates Aluminium’s plant in the UAE is earmarked to add an extra 500 kt of metal, with plans to take the world’s largest smelter from 800 kt/y to 1.3 Mt/y by 2015. • Russian plants are expected to commission new capacity amounting to 375 kt/y from 2013. • Improved technical performances at Rio Tinto’s Alma plant in Canada and BHP Billiton’s Hillside plant in South Africa amounting to more than 350 kt of extra aluminium in 2013.

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25 June 2013

• Further, we expect new power deals will spare a number of other plants more grief. For example, Century Aluminium we assume will strike a satisfactory deal to keep its 244 kt/y Hawesville plant in Kentucky going well beyond termination of the power contract in August, as will, we expect, negotiations for power contract terms at the Sebree smelter, also in Kentucky (Century recently agreed to purchase this 205 kt/y plant from Rio Tinto).

China’s capacity surges ahead … Meanwhile, in China, capacity cuts of around 1.5 Mt/y since the beginning of 2012 (at 17 plants we have identified), including 800 kt/y in 2013 to date, mainly in Henan province, are little cause for bullish celebration. Some two-thirds of these reductions are seen as temporary. A sober perspective on this is provided by a total headline capacity figure for China that is poised to surpass 30 Mt/y by the end of this year, an increase of more than 7 Mt/y since the start of 2012. • New smelters are under construction largely in China’s northern and western provinces, where unfettered industrial development is a prerogative for now. This is to be led by a contribution of more than 2 Mt/y in 2013 alone from plants drawing on low-cost coal-based power in Xinjiang. • Nationwide, the sum comes to more than 3.9 Mt/y of new capacity in 2013, following last year’s increase of 3.3 Mt/y. Despite possible moves by the government to consolidate the industry – probably centered on key state-owned enterprises that account for about 40% of supply – new, lower-cost capacity seems likely to come on stream in an inexorable tide, at least in the medium term. Strong vertical integration upstream into captive power and coal mining, combined with deep connections to downstream fabrication industries, is not a recipe for cutting back sharply. Depletion of domestic bauxite resources does not seem to pose a barrier either, at least for the next few years, with a new large discovery being reported in Henan which accounts for almost one quarter of China’s alumina supply. SMM’s surveys list 10 Mt/y of new alumina refining capacity under construction in 2012-14 in China.

But action will have to come … when prices retreat far enough Inevitably prices will succumb to further weakness and in time this will rein back supply. Indeed, we have incorporated required cuts of 1.5 Mt in 2014 and 2.25 Mt simply to keep projected market surpluses within “reasonable” limits. Cuts would have to lie in the 34 Mt/y range to bring about a balanced market – this may happen, but we doubt this will take place in the next 1-2 years In many ways, it is perhaps surprising that prices of aluminium have held up as well as they have, even allowing for bloated premiums. This is where we think over-reliance on fundamental cost support to provide a firm a floor under prices runs risks of disappointment. We believe aluminium prices are exposed to a potential fresh down-draft, even if it proves to be a relatively mild one. Without premiums, more than 20% of RoW smelters in theory would be cash negative. Adding in a US$260 premium reduces this proportion to less than 10%. In part, this also reflects that, at least for a portion of non-Chinese smelters, costs fall with prices. • In the case of alumina, where roughly 70% of trade takes place on an arms-length basis, rather than at cost, medium-term and short-term contracts with direct metal price clauses probably account for about 25-30% of all “market-based” transactions. In other words, about 20% of aluminium production is associated with alumina costs that rise or fall with the metal price, worldwide. This lies in the hands of non-Chinese plants (i.e., not far off 40% of these smelters).

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Exhibit 175: Although profits are lean, premiums are sparing most smelters from major losses

Exhibit 176: Chinese smelters have the added benefit of higher domestic aluminium prices

Cash costs of smelter production, excluding China, US$/t

Cash costs of smelter production in China, US$/t

3,000

3,000

2,500

2,500

$260/t Premium Added 2,000

Current LME 3M: $1,785

Current China Spot: $2346 (incl. VAT)

89%

89% 2,000 57%

1,500

1,500

1,000

1,000

Source: Credit Suisse, Wood Mackenzie

Source: Credit Suisse, Wood Mackenzie

Exhibit 177: Differences in energy prices are the main smelter cost variable World direct cash costs of aluminium production, US$/t

Source: Wood Mackenzie

• The other main variable, power costs, is a much more important determinant of differences in aluminium smelter costs. Although year-on-year changes in power costs tend to be small, changes to realized tariffs are influenced by a range of factors, including: currency effects, fuel costs, national or regional power market dynamics and regulatory imposts. • In China, tariffs are set by the NDRC and there is no material linkage to the metal price. However, after implementing increases to the fixed tariff for smelters, Beijing relieved pressure on producers at a time of sensitive political transition, effectively heavily subsidizing the industry. This relief is unlikely to persist and further gradual tariff rises are to be expected as China’s quest for energy efficient industrial growth eventually gets pressed home. Currently, we estimate that more than 90% of China’s smelters are profitable on a cash basis, based on current spot prices (40% of production is in the hands of state-owned enterprises, while extensive vertical integration also protects smelters from immediate responses to price weakness).

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• For plants outside China, many have tariffs that either partly or adjust fully with movements in metal prices. Wood Mackenzie estimates that just over 20% of nonChinese smelters benefit from price-linked power costs. In summary, we believe that aluminium prices raw prices must fall further to trigger meaningful cuts in supply. Our revised forecast anticipates LME 3M quarterly prices will dip below US$1,800/t in H2 2013, before a slow and painful mild recovery from 2015 when surpluses should have reduced. The unraveling of financing yields would assist in the process of trimming supply, but this is unlikely to emerge from the point of view of both interest rate movements and regulatory intervention in 2013.

Exhibit 178: Aluminium forecast comparison

Exhibit 179: Aluminium historical price and forecast

US$ per metric tonne

US$ per metric tonne

$2,200

CS Forecast

Forward Curve

$3,700

Bloomberg Forecast Mean

$2,100

Aluminium 3M

Quarterly Avg Forecast

$3,200

$2,000

$2,700 $1,900

$2,200 $1,800

$1,700

$1,700

$1,600 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

$1,200 2005

2006

2008

2007

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 180: Forecast aluminium prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

LME aluminium 3M

New New Old

US$/t US¢/lb US$/t

1Q-13

2Q-13f

3Q-12f

4Q-13f

2013f

1Q-14f

2Q-13f

3Q-13f

4Q-14f

2014f

2015f

2016f

LT

2,040 95

1,875 85

1,800 80

1,750 80

1866 85

1,800 80

1,850 85

1,900 85

1,900 85

1863 85

2,000 90

2,100 95

2,250 1.00 2,250

Source: Credit Suisse Commodities Research

Commodities’ Forecast Update: The Return of “Fundamentals”

92

25 June 2013

Alumina – Looking gloomy Our new pessimism about the alumina price expressed in our April Commodities review turned out to be well founded, with fundamentals turning sour over the past months. Bauxite supply to China rose significantly, China’s domestic alumina output picked up moving into domestic surplus, and Australian alumina imports fell. Meanwhile downstream, the aluminium price was diabolical all quarter and Western producers are cautiously and reluctantly concluding that they will need more cuts and closures, not helpful for alumina producers.

Near-term alumina dampening on aluminium price capitulation The 1Q 2013 alumina price spike on Australian supply issues is long past and the spot price sank on another bout of aluminium price capitulation. Given that a significant portion of the alumina supply remains priced by linkage, the aluminium price continues to influence the spot alumina price. The only positive we can see is that the spot price is not hitting the lows that a 15.5% linkage to the aluminium price would suggest. Spot alumina is registering stronger prices and seems to be on a slow upward trend. However, given the dampening influence of aluminium price, we reduce our price forecast for the next two quarters.

Exhibit 181: Spot prices for Australian Chinese and Chalco alumina US$/t

FOB Australia spot price Chalco spot SGA less VAT

Other China spot SGA less VAT 15.5% of spot aluminium

420 400

US$/t

380 360 340 320 300

Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13

280

Source: Metal Bulletin, Chalco, Credit Suisse estimates

Exhibit 182: Alumina spot price forecast 1Q-13 2Q-13f 3Q-13f 4Q-13f Alumina (spot)

New Old Chg

US$/t US$/t %

340 341 0%

330 340 -3%

340 350 -3%

340 350 -3%

2013f 1Q-14f 2Q-14f 3Q-14f 4Q-14f 338 345 -2%

350 350 0%

350 350 0%

350 350 0%

350 350 0%

2014f

2015f

2016f

2017f

350 350 0%

360 415 -13%

400 415 -4%

400 415 -4%

Source: Company data, Credit Suisse Commodities Research

Negative read on alumina prices from Indonesia comments about restrictions In March, the commentary from Indonesia suggested that exports to China would continue, even after the January 2014 raw material export ban is instituted. This was a negative development and we downgraded our prices across the medium term. The lack of restrictions on Indonesian exports seems to have been borne out in the latest statistics that show Chinese imports from Indonesia back at their highs. Commodities’ Forecast Update: The Return of “Fundamentals”

93

25 June 2013

Import rates sufficient to meet Shandong refinery needs In January and February, exports from Indonesia returned to the levels of mid-2011, around 3Mt per month. Combined with supply from Australia, India, Fiji and other localities, the monthly supply is reaching an annualized rate of 50-60 Mt/y, sufficient for over 20 Mt/y of alumina production. The refineries in Shandong have total capacity of 14.4 Mt/y, according to Wood Mackenzie, suggesting they will be adequately supplied by these imports. Worse, as we feared in the last commodity report, it appears that there really is no restriction in place right now. Indonesian imports were the third highest on record at 4.6 Mt/y, and combined with other imports, set a new record for Chinese bauxite imports.

Exhibit 183: China’s monthly imports of bauxite

Exhibit 184: China smelter grade alumina output and domestic surplus/(deficit)

Mt/month

Daily production, kt/d Indonesian bauxite

Alumina surplus/(shortfall) (kt)

other

7.0 6.0 5.0 4.0 3.0 2.0 1.0 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13

0.0

Source: China customs, Credit Suisse

China alumina output

130 120 110 100 90 80 70 60 50 40 30 20 10 0

35 30 25 20 15 10 5 -5 -10 -15 -20 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13

Daily Prod Rate (kt)

China bauxite imports (Mtpm)

8.0

China domestic SGA surplus/(shortfall) (kt)

Australian bauxite

Source: IAI, Credit Suisse

Will China actually build Indonesian refineries if it doesn’t need to? With China again having sufficient bauxite feed, the imperative to develop refineries in Indonesia will diminish. We question whether any activity will actually occur on the two Indonesian alumina refineries previously announced by Chinese consortiums after the bauxite restrictions last year and if the Indonesian government’s plan to value-add is not met, will we see real restrictions implemented? There may be further changes to Indonesia’s exports in the years ahead.

China’s alumina output climbing After falling steadily since the middle of 2012, daily alumina production in China is now lifting again. Aluminium production has steadied since mid-2012, so according to our calculations, China is now self-sufficient in alumina, and produced a surplus in March and April. We suspect Shandong refineries picked up output given abundant imported bauxite feed.

Alumina imports falling – a negative read for pricing Not surprisingly, with surplus alumina production, China’s appetite for alumina imports fell. The Pacific market, which has been tight, with all Australian refineries working at stretch capacity, may soon slacken. We have lowered our spot alumina price forecasts for 2H from US$350/t to $340/t.

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25 June 2013

Exhibit 185: China’s monthly alumina imports Alumina imports from Australia

Other net imports

800

China alumina imports (kt)

700 600 500 400 300 200 100

Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

Jul-10

Jan-10

Jul-09

Jan-09

Jul-08

Jan-08

Jul-07

Jan-07

Jan-06

Jul-06

0

Source: China customs, Credit Suisse estimates

Exhibit 186: Landed price of bauxite in China Australian bauxite

Indonesian bauxite

Apr-13

Jan-13

Oct-12

Jul-12

Apr-12

Jan-12

Oct-11

Jul-11

Apr-11

Jan-11

Oct-10

Jul-10

Apr-10

Jan-10

Oct-09

Jul-09

Apr-09

Jan-09

Oct-08

Jul-08

Apr-08

Jan-08

US$/t

100 90 80 70 60 50 40 30 20 10 0

Source: China customs, Credit Suisse estimates

Alumina price recovery? We may now have to wait for global demand for alumina to outpace supply and a deficit in refining capacity to develop before alumina is priced at a more commercial rate. Using Wood Mackenzie estimates, the first domestic deficit would occur in 2018. We are less pessimistic, as the pace of new-starts slackens after 2013. Nevertheless, at this point, without an obvious bauxite constraint, we see higher alumina prices receding into the distance – 2016 on our current price forecasts. The landed Indonesian price jumped after the imposition of Indonesia’s 20% export tax, but fell sharply in February. We suspect that may have reflected a supply of poor quality material, given the price has subsequently recovered.

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25 June 2013

Indonesian ban…not really a ban According to Metal Bulletin (18 March), Indonesia’s Director of Exports of Industrial and Mining Products said in an interview that exports of raw materials will be restricted from 2014, but not banned: “The export law will be fully enforced on January 12 2014; this will be the final decision of the government. To export, a company must be certified as a registered exporter for mining products. It will need to possess an export license from the Ministry of Trade; raw materials must be certified by a legitimate certifier appointed by the Minister of Trade prior to export, and there will be a 20% export duty”. The Director said companies had misinterpreted the restriction which came into place in May 2012 as a ban when it was in fact the start of the system he described, and bauxite exports increased through the latter half of 2012 as miners became registered and certified. The January 2014 date is the deadline by which companies must register and become certified. The Director said the new system is not a quota and there is no limitation to exports in volume terms, but the export law will allow Indonesia to track where its exports are going. At face value, these statements suggest that Indonesia’s exports of bauxite will continue at the levels seen in January or February 2013 or higher after the 2014 ban comes into place as the current exports are by companies that are already registered to export. There is no reference in the Director’s statements about companies needing to have an approved refining project underway, which was the emphasis ahead of the restrictions last year. Perhaps it was implicit in the conversation the Director had with Metal Bulletin, and the only companies that have refinery projects are certified to export, but we cannot say. As things stand, without any further clarification of Indonesia’s position, we have to suppose that bauxite exports will continue into 2014 and beyond at sufficient rates to feed Shandong’s current refining capacity and expansions.

Longer term view: +$400/t needed for commercial return to refineries Our estimates suggest that new start global refineries need an alumina price of +$400/t to gain a commercial IRR. At the current spot price of $335/t, the IRR of all refinery builds – irrespective of their position on the cost curve – is skinny. Around the world, including in China, when integrated bauxite mines are included in the development, the capital intensity is greater than $1000/t. At this investment level, the alumina price needs to be higher than $400/t to gain an IRR of 15%, even with the newest cheapest refineries such as Hindalco’s Utkal. This view is supported by recent commentary from Rio Tinto: According to Metal Bulletin (18 March 2013), at a bauxite and alumina conference, Rio Tinto’s General Manager of Commercial Bauxite and Alumina said that there is almost no reason for Western companies to invest in new alumina capacity due to low prices and high costs: “Prices have been lackluster for 12 months and are stuck in the uncomfortable zone where they are neither low enough to see capacity fall, nor high enough to invest in new greenfields. Considering the cost-curve, most producers are around break-even. It’s not enough to incentivize Western producers to expands or invest in new projects”.

Only Shandong refineries using imported bauxite have a stronger IRR Our view on the necessary alumina price differs only for non-integrated refineries, without accompanying bauxite mines. We estimate that the Nanshan refinery, operating in China’s Shandong Province using imported Indonesian and Australian bauxite, can gain a commercial IRR at $350/t and above. The key control on the IRR is not the operating cost but the capital intensity of the refinery. The cost of expanding Shandong refineries is low because only the refinery infrastructure is needed, and the refineries can be built to use low-temperature Bayer process unlike other Chinese refineries that use China’s domestic low quality bauxite. Building cheaply is China’s strength. Commodities’ Forecast Update: The Return of “Fundamentals”

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Exhibit 187: Estimated IRRs for alumina refineries at various alumina prices Capex intensity (US$/t cap) Operating cost (US$/t)

Alumina price (US$/t)

Wagerup (expansion) 1,000

Yarwun 900

Boffa 1,500

Utkal 1,034

230

209

218

159

179

-2% 1% 3% 5% 6% 8% 9% 11% 12% 13%

2% 4% 6% 8% 10% 11% 13% 14% 16% 17%

-2% 1% 3% 6% 7% 9% 11% 12% 14% 15%

6% 7% 9% 10% 11% 13% 14% 15% 16% 17%

2% 4% 6% 8% 9% 11% 12% 13% 15% 16%

270 290 310 330 350 370 390 410 430 450

Lam Dong Chalco Xing 1,007 1,000

Nanchuan 1,034

Nanshan 370

Weigiao 500

241

202

297

306

-4% -1% 2% 4% 5% 7% 8% 10% 11% 12%

2% 4% 5% 7% 8% 10% 11% 12% 14% 15%

-2% 6% 12% 17% 21% 26% 30% 34%

-14% -3% 2% 6% 9% 12% 14% 17%

Source: Wood Mackenzie, Credit Suisse

Key control on Pacific alumina price is supply of bauxite to Shandong With this backdrop, expansion of coastal refineries using imported bauxite would seem to be the most commercially sensible strategy for China, and indeed in recent years, the capacity of Shandong refineries did increase more rapidly than China overall. We consider these cheap expansions capped the global alumina price. Chinese refineries outside Shandong Province, with integrated bauxite mines and roasters to allow use of poor quality Chinese bauxite, need a strong alumina price, as evident in the Chalco alumina price. Ex 17% VAT, Chalco’s ex-works price is nudging $400/t, whereas the Shandong price is sub-$360/t. Given the coastal location, Shandong refineries are direct competitors to Australian alumina imports. If Shandong refineries have sufficient bauxite to readily expand, then tightness in the Pacific price cannot be maintained. Therefore, the key issue in predicting the spot alumina price in our view, is whether China’s Shandong refineries have sufficient bauxite imports to operate at full capacity.

Indonesian bauxite remains the key source for China Despite commentary about China developing alternative bauxite sources, Indonesia remains the mainstay. Australian supply has barely increased and other overseas feed sources remain piece-meal – a few hundred thousand tonnes from India, a small mine in Fiji, and wherever else a shipload of bauxite can be sourced. The dominant and critical bauxite source remains Indonesia, so we maintain our focus on its supply.

Exhibit 188: Position of tested alumina refineries on global cost curve (Wood Mackenzie)

Source: Wood Mackenzie, Credit Suisse estimates

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Exhibit 189: Global aluminium and alumina supply and demand estimates Millions of metric tonnes (Mt)

World Alumina and Aluminium Supply & Demand Balance ALUMINA PRODUCTION North America Western Europe Eastern Europe China Kazakhstan & Azerbaijan India Other Asia Australia Africa Jamaica Brazil Other Latin America Highly Probable Grow th Disruption Allowance Required Cuts World Alumina Production % Change Capacity Utilisation (%) NMA Consumption % Change SGA Av ailable SGA Requirement SURPLUS/(DEFICIT) SGA

2008

2009

2010

2011

2012

2013f

2014f

2015f

6.16 6.95 5.63 25.37 2.05 3.62 1.00 19.73 0.59 4.16 7.86 3.75 86.9 7.6% 89.5% 5.62 1.4% 81.26 77.45 3.80

4.28 4.66 4.75 23.85 1.74 3.69 1.00 20.26 0.53 1.77 8.65 2.85 78.0 -10.2% 77.3% 4.74 -15.6% 73.30 73.88 (0.59)

5.34 5.64 5.39 31.00 1.64 3.62 1.21 20.12 0.60 1.78 9.52 2.51 88.4 13.2% 82.5% 5.98 26.0% 82.39 83.31 (0.92)

5.71 5.85 5.56 38.00 1.67 3.83 1.22 19.64 0.56 1.96 10.55 2.59 97.1 9.9% 83.0% 6.48 8.4% 90.66 89.64 1.01

6.00 5.71 5.12 42.30 1.88 3.86 1.24 21.56 0.16 1.72 10.41 2.01 102.0 5.0% 83.2% 6.67 3.0% 95.30 93.67 1.63

6.35 5.62 5.57 45.25 2.10 5.06 1.62 23.61 1.70 10.58 2.10 (2.6) (0.3) 106.7 4.6% 81.8% 7.07 6.0% 99.63 98.35 1.27

6.51 5.68 5.70 48.29 2.13 7.09 2.29 23.83 1.91 10.76 2.38 1.09 (2.7) (3.7) 111.2 4.2% 82.0% 7.50 6.0% 103.72 103.13 0.59

6.53 6.00 5.89 50.25 2.13 7.69 3.50 24.00 2.57 10.81 2.40 1.79 (2.8) (5.0) 115.8 4.1% 84.1% 7.95 6.0% 107.88 108.07 (0.19)

ALUMINIUM PRODUCTION North America Western Europe Eastern Europe China Other Asia & Oceania Africa Latin America (inc Mex ico) Highly Probable Grow th Disruption Allowance Required Cuts World Production % Change Capacity Utilisation (%) World Consumption SURPLUS/(DEFICIT) ALUMINIUM

5.79 4.63 5.12 13.60 6.53 1.71 2.66 40.0 5.0% 87.1% 37.5 2.50

4.759 3.722 4.422 13.500 6.91 1.682 2.507 37.5 -6.3% 75.7% 35.0 2.49

4.69 3.80 4.58 17.30 7.87 1.75 2.31 42.3 12.8% 84.3% 40.5 1.84

4.98 4.03 4.65 19.10 8.77 1.80 2.18 45.5 7.6% 86.7% 44.2 1.29

4.85 3.59 4.65 21.68 8.91 1.82 2.06 47.5 4.5% 86.3% 45.8 1.75

5.08 3.59 4.68 24.10 9.59 1.91 2.16 (1.19) 49.9 5.0% 86.1% 48.4 1.55

5.25 3.73 4.88 26.10 10.90 1.99 2.29 0.01 (1.27) (1.50) 52.4 4.9% 86.6% 51.2 1.17

5.17 3.87 5.23 27.90 11.72 2.06 2.44 0.08 (1.36) (2.25) 54.9 4.8% 86.1% 53.9 0.94

STOCKS LME + COMEX Stocks SHFE Stocks IAI Stocks Japanese Port Stocks Estimated Unreported Stocks Total stocks Weeks Consumption Al Price (US$/t) Alumina Linkage Alumina Price (US$/t) ALUMINIUM CONSUMPTION North America Western Europe Eastern Europe China India Japan Other Asia Oceania Africa Latin America (inc Mex ico) World Consumption % Change (World) % Change (China) ALUMINIUM CONSUMPTION Building & Construction % Change Transport % Change Electrical % Change Packaging % Change Consumer Goods % Change Machinery & Equipment % Change Other % Change Total

2008

2009

2010

2011

2012

2013f

2014f

2015f

2.37 4.63 0.20 0.30 2.96 2.23 0.32 0.18 1.75 2.75 7.60 10.09 10.5 15.0 2,567 1,665 13.5% 14.5% 341 230 BY COUNTRY 6.09 4.71 6.59 5.24 2.13 1.55 12.56 13.88 1.28 1.48 2.25 1.71 3.99 3.97 0.46 0.44 0.47 0.42 1.69 1.59 37.5 35.0 -1.6% -6.7% 1.7% 10.5% BY SECTOR 9.84 9.82 -0.2% -0.3% 9.59 8.33 -6.9% -13.2% 4.81 5.13 19.3% 6.6% 5.77 5.11 1.6% -11.5% 2.68 2.49 -0.2% -6.9% 3.03 2.61 -19.0% -13.9% 1.81 1.53 -2.3% -15.6% 37.5 35.0

4.28 0.44 2.52 0.22 4.47 11.93 15.3 2,173 15.3% 332

4.97 0.21 2.39 0.25 5.40 13.22 15.5 2,398 15.8% 378

5.21 0.44 2.28 0.28 6.76 14.97 17.0 2,027 15.7% 319

16.52 17.8 1,866 18.6% 348

17.70 18.0 1,863 18.8% 350

18.64 18.0 2,000 18.0% 360

5.23 5.88 1.77 16.47 1.71 1.79 4.74 0.47 0.53 1.83 40.5 15.5% 18.7%

5.53 5.97 2.00 19.17 1.84 1.70 4.97 0.46 0.54 2.00 44.2 9.3% 16.4%

5.71 5.79 2.02 20.33 1.93 1.79 5.11 0.48 0.56 2.06 45.8 3.6% 6.0%

5.97 5.79 2.10 21.93 2.06 1.86 5.40 0.49 0.59 2.17 48.4 5.6% 7.9%

6.21 5.83 2.18 23.57 2.21 1.94 5.79 0.50 0.62 2.29 51.2 5.8% 7.5%

6.48 5.89 2.28 25.10 2.38 1.97 6.20 0.52 0.66 2.42 53.9 5.3% 6.5%

11.55 17.7% 10.62 27.5% 5.49 7.1% 5.31 4.0% 3.02 21.3% 2.83 8.4% 1.63 6.3% 40.5

13.23 14.5% 11.09 4.5% 6.01 9.4% 5.51 3.7% 3.41 13.0% 3.22 13.6% 1.75 7.3% 44.2

13.85 4.7% 11.49 3.6% 6.23 3.7% 5.64 2.4% 3.51 2.8% 3.28 1.9% 1.81 3.5% 45.8

14.65 5.8% 12.23 6.5% 6.56 5.3% 5.84 3.6% 3.78 7.8% 3.43 4.7% 1.88 4.1% 48.4

15.47 5.6% 13.17 7.7% 6.93 5.6% 6.07 4.0% 3.99 5.5% 3.58 4.2% 1.97 4.4% 51.2

16.17 4.5% 14.17 7.6% 7.30 5.3% 6.31 3.8% 4.22 5.6% 3.72 4.0% 2.04 4.0% 53.9

Source: Credit Suisse 25 June 2013

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25 June 2013

Nickel – Testing lower price bounds With demand for nickel in its main use, stainless steel production, cyclically soft, a strong advance in supply from newly-commissioned nickel projects and generally successful plant ramp-ups are leading to growing market surpluses. Similarly, while the highest-cost nickel pig iron production has fallen away in China, new rotary kiln-electric furnace (RKEF) configurations at lower operating costs are replacing idled operations. A further variation on this theme could result in even greater cost savings. • Although we anticipate prices will eat into profits and force curtailments, we continue to expect refined nickel supply to grow by 3% p.a. in 2013-15. • This falls behind the pace of global demand growth, at a relatively encouraging 4% p.a., but the effects of the surge in supply from nickel pig iron since 2008-09 will continue to hold prices back. • In the absence of wholesale setbacks to projects, which now seem unlikely, prospects for price rises look bleak in 2H 2013; surpluses are expected to exceed 50 kt this year and there are risks of further falls, perhaps into the US$13,000-14,000 range for spells ahead. • The need for production cuts will likely intensify, eventually stimulating a rebound and we consider price movements could be far more volatile than we postulated at the time of our April forecast. In other words, nickel prices look like they are undershooting a level where they will resettle later next year.

Exhibit 190: Nickel prices have gradually receded to fresh four-year lows LME 3-month nickel prices, US$/t

60000 50000 40000 30000 20000 10000 0 2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Supply: growing but under pressure Current price levels have wiped out profits for a range of producers. Indonesian ore suppliers, for example, are under cost pressure; the price of nickel ore grading 1.8% Ni has fallen to RMB280/wmt, or US$26/wmt, around US$3- US$4 below the average costs of production, delivered to port in China. Several mines are reported to have cut production. Further, the approach of Ramadan and monsoonal weather in the Philippines will reduce production and shipments seasonally in July-August. Nickel ore imports from Indonesia fell 10.2% in May to 2.7 Mt; while imports from the Philippines climbed 5.9% to 2 Mt, this left net imports down 4.7% on the month at 4.7 Mt. Although nickel laterite inventories at Chinese ports are persistently high, traders are reluctant to sell these as they were purchased at higher prices (these stocks total 17 Mt). Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

NPI production in China is estimated by SMM to have declined 13.6% in May to 32.5 kt (Ni content). Output of high-grade NPI slipped 14.4% to 27.9 kt, with the high-grade contribution from rotary kiln-electric furnaces (RKEFs) easing 14.3% to 12 kt (37% of total NPI on a nickel content basis). Medium-grade production slipped 5.4% to 1.1 kt and lowgrade NPI was down 5.4% to 3.5 kt. Essentially, all NPI producers, with the exception of RKEFs, are running at a loss, with cash margins negative by 5%-11%. RKEFs on average have costs of RMB840/mtu, affording margins of around 7% at current price levels.

Looking for positive influences … There are other factors that superficially seem bullish, or at least less bearish: • There are reports China’s State Reserve Bureau (SRB) plans to purchase a further 30 kt of refined nickel, bringing totals to a potential 60 kt in 2013, with speculation that even higher levels could emerge, largely from Russian and domestic sources. • However, we are also not convinced the SRB will step in as heavily as some expect. Beyond purchases from Jinchuan (in a move no doubt supportive of a domestic producer struggling with profitability), the economics of buying refined nickel from overseas do not stack up, in our opinion, and we so little reason for the SRB to sponsor offshore suppliers in the absence of much brighter demand prospects ahead. • Bonded warehouse stocks of nickel in China are estimated to have fallen from 100 kt in early 2013 to around 70 kt while imports of nickel in refined form and ferronickel rose 13% to 18 kt in April.

…But dampeners on price abound • SMM’s surveys of NPI producers suggest that one half of recent production has merely accumulated in inventory rather than being consumed in stainless steel production, illustrating the dire straits in which China’s stainless steel sector finds itself. • Consequently, prices for high-grade NPI (10-15% Ni) plunged 12.6% to RMB900/mtu by the end of May from a month earlier. Low- and medium-grade NPI prices eased by 5%11% over the month. • Despite pain being felt by higher-cost NPI producers, RKEFs have managed to achieve cost reductions, primarily as power requirements and costs have fallen and ore purchasing costs have scaled back. This has boosted NPI’s advantage over refined nickel, a trend that is likely to persist. • Even though plants reduced production in May, much of these cuts have already taken place – we do not believe the scale of further reductions will intensify as costs are declining in line with prices.

Major new nickel plants more than cater for needs Although many of newly-commissioned plants have struggled to achieve targets – and certainly capital and operating costs have been a burden to many developers – it looks like supply growth in aggregate is poised to outpace underlying demand by far in the next year or two. • Even taking into account some setbacks, we project that finished nickel production will rise by 4%-5% p.a., leading to supply surpluses in the order of 20-30 kt/y. • In the absence of widespread setbacks to programs, prospects for price rises look bleak in this timeframe; instead, we highlight that, with global demand currently soft, there are risks of further falls, perhaps below US$14,000 for spells in H2 2013. The need for production cuts will intensify, eventually stimulating a modest recalibration.

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25 June 2013

Exhibit 191: At less than US$7/lb, prices have invaded deep into the cash cost supply curve – cuts are likely to escalate US$/lb

Source: Credit Suisse, Wood Mackenzie

The major increases in supply stem from two to three operations commissioned in early 2013 and where progress to date is reported to be going well. These are as follows: • SMSP’s and Xstrata’s Koniambo ferronickel project in New Caledonia, which has gone into production in the past month, six years after construction first began. The US$5 billion project is reported to be on track to reach its rated capacity of 60 kt/y of nickel by the end of 2014. • The 60 kt/y nickel operation of Sherritt, Sumitomo and Korea Resources at Ambatovy in Madagascar has commissioned all five pressure acid leach autoclaves in Q1 and is expected to reach commercial operating rates (defined as 70% of designed ore throughput for at least 30 days) later this year. Total capital costs are projected at US$6.9 billion. • Q1 also saw the initial production of ferronickel pellets from the Tagaung mine and rotary kiln/electric furnace (RKEF) in Myanmar. Operated by China’s CNMC and ENFI, the operation is designed to achieve 25 kt/y of contained nickel.

Some solid progress … • Solid progress has been made by First Quantum at its Ravensthorpe pressure acid leach operation in Western Australia. The plant recovered a record 11 kt of nickel in Q1, with a target of 31-35 kt now expected for 2013 as a whole. Cash costs of production were trimmed to US$5.36/lb (US$11,800/t). First Quantum is also on target to produce 9-10 kt of nickel at its Kevitsa mine in Finland after recovering 2 kt of nickel in concentrate in Q1 following commissioning in 2012. The company is seeking environmental approval for a doubling of mill throughput to 10 Mt/y of ore. • The Ramu nickel-cobalt project in Papua, New Guinea is expected to reach full production of 31 kt/y by the end of 2013. The operation, owned by a Chinese consortium that includes Jinchuan, as well as minority equity partner, Highlands Pacific, commenced output in November 2012 after delays due to environmental permitting and labor disputes.

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• After years of cost overruns and technical problems, Vale’s VNC (Goro) high pressure acid leach plant in New Caledonia produced 5.1 kt of nickel in oxide products in Q1 and was stated to be on schedule to recover 26 kt of nickel this year and 45 kt in 2014. Reaching full capacity of 57 kt/y requires further plant improvements and debottlenecking. However, recently there are reports of the plant being taken offline again, although the reason for this alleged halt is not clear. • Vale is also planning to commence production at its 50 kt/y Long Harbour hydrometallurgical plant in Newfoundland, Canada in 2H 2013. The facility will treat nickel sulphide concentrates from the company’s Voisey’s Bay mine in Labrador.

… and some inevitable setbacks … Other projects have continued to suffer extended teething troubles and the sapping effects of weakening nickel prices. • These include Anglo American’s Barro Alto ferronickel operation in Brazil where a furnace sidewall rebuild interrupted production in Q1. 4.1 kt of nickel was produced at the plant, which is targeting eventual production of 40 kt/y nickel in ferronickel. • Vale’s Onca Puma ferronickel operation in Brazil has faced even tougher problems, with one furnace out of action for relining. Vale plans to resume the ramp-up of operations in the second half of 2013. Nominal capacity with only one furnace operating is 25 kt/y nickel. Vale has taken an impairment of US$2.8 billion on the project.

• Progress is also uncertain at the Taganito nickel project in the Philippines. The high pressure acid leach plant came under attack from rebels in October 2011, during construction, but damage is believed to have been repaired. First production from the 50 kt/y project, in which Sumitomo Metal Mining and Mitsui have interests, is touted for the final quarter of this year.

… no big cuts in supply yet Elsewhere, the effects of depletion, especially of sulphide-based operations, and deteriorating market conditions, have led to some permanent and temporary closures (for example, Vale has put its Frood mine in Sudbury on care and maintenance). However, a number of small mines are also entering production this year, including Asian Mineral Resources’ 6.4 kt/y Ban Phuc sulphide-based mine in Vietnam and the refurbishment of Mwana Africa’s Trojan mine (Bindura Nickel) in Botswana, which hauled its first concentrate last month (7 kt/y).

China’s NPI industry evolves China’s nickel pig iron producers have represented a significant portion of swing supply, with highest cost operators switching off supply when prices weaken. The highest cost NPI producers are represented by those that import low-grade nickel ore (limonite) and process this via sinter plants and (small) blast furnaces, a crude but easy to manage means of yielding nickel-bearing pig iron as a feedstock to stainless steel furnaces. According to Wood Mackenzie, average costs for BF-based NPI operations are close to US$18,000/t of nickel. However, low and medium-grade NPI – mainly used to make lower nickel bearing 200-series stainless steels – are diminishing in importance. Apart from higher costs of production in BFs, the main reason for this is the rising popularity of higher nickel containing stainless and alloy steels, such as 300-series specifications. These require a higher nickel charge, with stainless operators increasingly integrating NPI units into their stainless mills to capture synergies and lower-cost raw materials.

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25 June 2013

RKEF configurations on the rise A growing proportion of China’s NPI is now produced in so-called rotary kiln-electric furnace configurations (RKEFs), currently accounting for almost 40% of total NPI supply. Plans are under way for the construction of a number of these plants, at larger scale. RKEFs afford lower energy costs than the alternative of using a sinter plant and electric arc furnace. In these plants, ore – typically higher-grade saprolite at 1.8-2.0% Ni – is charged to the rotary kiln, along with fluxes and high-ranking coal or coke. The RK effectively produces “green pellets” of calcined Ni-Fe oxide, with temperatures of around 800°C required to fuse the constituent particles. This feed is then charged to an electric furnace, sometimes along with stainless steel scrap, as part of the stainless steel-making process. Further nickel and other alloying elements, such as chrome, are usually added at the refining stage to complete the stainless steel chemistry. Integration with NPI and stainless steel production is therefore highly beneficial. Output in Jan-May from RKEFs came to 36 kt of nickel contained in higher grade NPI, representing 36% of China’s totals. Overall NPI production in China fell by almost 14% in May month-on-month to 32.5 kt, for a year-to-date total of 180 kt (433 kt/y). Of this, highgrade NPI (10-15% Ni) represented 85% of total NPI output. Low-grade production accounted for 10% and medium-grade NPI just 5%.

Exhibit 192: High-grade NPI (10-15% Ni) accounts for 85% of China’s NPI production Tonnes of contained nickel in NPI

Jan

Feb

Mar

Apr

May

YTD

% of total

By Region: Shandong Inner Mongolia Jiangsu Fujian Other

5,800 8,100 6,900 4,600 11,200

5,000 7,600 6,300 4,400 11,000

6,200 8,500 8,200 5,100 11,500

5,200 8,300 7,900 5,000 11,200

4,400 6,500 7,300 5,000 9,300

26,600 39,000 36,600 24,100 54,200

14.7 21.6 20.3 13.4 30.0

By Grade: High Grade NPI - of which: RKEF Medium Grade NPI Low Grade NPI

30,400 13,100 2,400 3,800

28,400 12,100 2,200 3,700

33,600 14,000 2,200 3,700

32,600 14,000 1,300 3,700

27,900 12,000 1,100 3,500

152,900 65,200 9,200 18,400

84.7 36.1 5.1 10.2

36,600

34,300 -6.3%

39,500 15.2%

37,600 -4.8%

32,500 -13.6%

180,500

100.0

TOTAL % Change mom Source: Credit Suisse, SMM

However, prices have now fallen to a level resulting in a pinching of margins for even the lower-cost RKEF NPI producers. This price fade explains additional attempts of RKEFs to rein back costs even more, with four operators (Qichang Stainless, Henan Yusheng, Pansen and Liaoning Kaisheng) trialing an extra step in the kiln to produce a full-blown direct reduced Ni-Fe pellet. The technology promises to reduce energy consumption to as little as 950 kWh, from the 3,500-4,000 kWh level typical of RKEFs, with significant savings in electricity costs. Moreover, China’s Tsingshan Group is believed to be interested in testing this pilot process in Indonesia this year, potentially overcoming the effects of the intended ban on nickel laterite exports from next year. The group is involved in a JV to construct an NPI plant with PT Sulawesi Mining Investment, aimed to commence operation by the end of 2014. Indonesia’s only other plant, started last year by Indoferro in Java, is based on blast furnace technology to produce 250 kt/y of NPI at 2%-5% Ni. Commodities’ Forecast Update: The Return of “Fundamentals”

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We are also aware that Chinese NPI producers are assessing ways of utilizing nickel sulphide concentrates in a roasting step, presumably in an attempt to increase nickel yields in NPI from RKEF units. However, with concentrates in generally scarce supply, we doubt this will become an endemic feature of NPI plants, but it is an illustration of the flexibility that operators demonstrate to achieve improved feedstock at competitive cost.

Exhibit 193: RKEFs produce higher grade NPI at far lower cost than BF or EAFbased plants, largely through unit energy savings C1 cash operating cost, US$/t Ni

20000 18000 16000 14000

Coke/Coal

12000

Power

10000

Ore Freight

8000

Ore Purchase

6000

Other

4000 2000 0 BFs

EAFs

RKEFs

Source: Credit Suisse, Wood Mackenzie

Chinese NPI is moving mainstream and is less a source of swing supply In conclusion, higher-cost NPI operations are already effectively off line, some perhaps permanently, especially if environmental scrutiny intensifies. This places the onus on RKEFs and more costly EAFs to trim production costs. New variations on the RKEF theme are likely to emerge, commonly integrated with stainless steel mills. Moreover, while Indonesia’s intended ban on laterite ore exports may impact prices for feed from next year, a number of Chinese players are exploring constructing processing steps in Indonesia, in an attempt to secure NPI feed, and possibly also to free up highgrade ore under quota. With supply growth now almost certain to advance strongly elsewhere, we hold the view that nickel prices will remain under downward pressure in the shorter term, prompting cuts in production outside China to restore market balances. All in all, we expect much more price volatility ahead, firstly in the form of an undershoot, followed by a return to more sustainable levels, closer to long-run prices of US$20,000/t (US$9/lb).

Commodities’ Forecast Update: The Return of “Fundamentals”

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Exhibit 194: Prices of higher-grade ore have fallen in line with weaker LME nickel prices

Exhibit 195: Nickel ore shipments to China have eased back in 2013

Index: Jan 2009=1.00

Monthly, kt, gross tonnage Indonesia

8,000

Philippines

Other

7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2008 Source: Wood Mackenzie

2009

2010

2011

2012

2013

Source: Credit Suisse, Customs data

The Indonesia factor – looking less positive for prices Although reports have yet to be confirmed officially, it appears Indonesia’s Minister of Energy & Mineral Resources is signaling that the country is unlikely to implement the proposed ban on nickel ore exports from 2014. According to a report by Shanghai Metals Market, the government is believed to be reviewing legislation and assessing further tax and quota policies while encouraging investment in downstream processing. To us, this looks like a softening of the stance on a firm insistence of installing processing capacity as a strict edict on accessing Indonesia’s ore resources. In nickel especially, the economic attractiveness of installing often-complex and expensive processing facilities was always going to be in doubt. It could be that the Indonesian authorities have now realized this, a mere six months before the January 2014 ban was targeted to begin. The most likely outcome, in our view, is the granting of export quotas to operators constructing processing facilities in Indonesia. However, it remains to be seen how this quota system would work in practice and whether there would be restriction on volumes. In markets that are under pressure and investment money flows tightening, we would not be surprised to see a major last minute rethink or at least delays to any outright ban while alternatives are contemplated.

Demand: structurally sound but stainless producers struggling Although “structural” demand for nickel in stainless steel is likely to chart an attractive course, the market responsible for the LME metal’s primary use is currently languishing. In China, the most important market in terms of growth, stainless steel production fell 2% month-on-month in April, with the nickel-bearing 300-series products recording the sharpest drop off at 6% mom. It will be interesting to see if this is a precursor to broader corrections in industrial activity as we move into 3Q. Even so, with the total number of mills in China now totaling 33, we continue to expect aggressive underlying expansion. Indeed, the demand profile for nickel, while periodically patchy, is quite encouraging with off-take at the world level likely to maintain an average of about 4% p.a.

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25 June 2013

Exhibit 196: Nickel forecast comparison

Exhibit 197: Nickel historical price and forecast

US$ per metric tonne

US$ per metric tonne

$18,000

CS Forecast

Forward Curve

Bloomberg Forecast Mean

$55,000

Nickel 3M

Quarterly Avg Forecast

$50,000 $17,000

$45,000 $40,000

$16,000

$35,000 $30,000

$15,000

$25,000 $14,000

$20,000 $15,000

$13,000

$10,000 $12,000 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

$5,000 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 198: Forecast nickel prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

LME nickel 3M

New New

US$/t US$/lb

1Q-13

2Q-13f

3Q-13f

4Q-13f

2013f

1Q-14f

2Q-13f

3Q-13f

4Q-14f

2014f

2015f

2016f

17,376 7.90

15,250 6.90

14,500 6.60

14,000 6.35

15,282 6.95

14,500 6.60

15,000 6.80

15,500 7.05

16,000 7.25

15,250 6.90

17,000 7.70

18,000 20,000 9.05 9.00

LT

Source: Credit Suisse Commodities Research

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Commodities’ Forecast Update: The Return of “Fundamentals”

Exhibit 199: Global nickel supply and demand estimates Millions of metric tonnes (Mt)

World Nickel Supply and Demand Balance

107

Source: Credit Suisse

kt

2008

2009

2010

Europe 8,079 6,113 % change -4% -24% China 7,200 9,158 % change -8% 27% Japan 3,566 2,607 % change -8% -27% South Korea 1,743 1,644 % change -21% -6% Taiw an 1,313 1,357 % change -12% 3% India 1,550 1,690 % change -13% 9% USA 1,925 1,618 % change -11% -16% Brazil 450 339 % change -8% -25% Other 809 625 Total World 26,635 25,151 % change -8% -6% Austenitic ratio 70.7% 73.7% Scrap ratio 46.1% 40.3%

7,756 27% 12,415 36% 3,427 31% 2,022 23% 1,526 12% 2,170 28% 2,201 36% 464 37% 467 32,448 29% 72.0% 40.9%

Stainless production by Country

2011

2012

2013F

2014F

2015F

7,870 7,820 7,742 7,777 7,848 1% -1% -1% 0% 1% 14,000 14,490 15,359 16,435 17,585 13% 4% 6% 7% 7% 3,256 3,158 3,158 3,190 3,190 -5% -3% 0% 1% 0% 2,116 2,095 2,116 2,179 2,223 5% -1% 1% 3% 2% 1,191 1,108 1,108 1,141 1,164 -22% -7% 0% 3% 2% 2,365 2,507 2,632 2,790 2,985 9% 6% 5% 6% 7% 2,074 2,033 2,093 2,177 2,238 -6% -2% 3% 4% 3% 499 519 535 556 578 8% 4% 3% 4% 4% 410 460 474 492 507 33,781 34,190 35,217 36,738 38,319 4% 1% 3% 4% 4% 71.5% 72.7% 73.0% 73.2% 73.3% 37.6% 38.6% 39.6% 39.7% 39.8%

Nickel Production (bars) versus Consumption (kt Ni) 2,000

1,500

1,000

500

0

2008 Nth America Can ada

2009 Europe We stern Europe

2010 Chin a CIS

2011 Japan

Japan

In dia Chi na

2012 Other Asi a Austra lia

2013F Othe r World Other

25 June 2013

2008 2009 2010 2011 2012 2013F 2014F 2015F Mine Production 1,594 1,451 1,655 1,963 2,110 2,255 2,286 2,371 Disruption allow ance (68) (69) (71) Mine Output 1,594 1,451 1,655 1,963 2,110 2,187 2,217 2,300 REFINED Ni AND FeNi PRODUCTION Canada 164 117 107 148 153 143 137 122 Western Europe 234 187 222 245 237 241 250 249 CIS 279 269 281 280 276 262 262 264 Japan 157 144 166 157 168 183 196 206 China 205 250 335 454 457 511 511 522 Australia 109 131 101 110 125 122 120 120 Other 232 235 240 258 284 341 391 452 Highly Probable Grow th 1 5 8 Disruption Allowance (54) (56) (58) Required Adjustment (20) (30) Total Production 1,380 1,333 1,452 1,652 1,699 1,749 1,796 1,854 % change -2.4% -3.4% 8.9% 13.7% 2.9% 2.9% 2.7% 3.2% Capacity Utilisation % 73% 66% 67% 65% 64% 64% 64% 66% NPI 77 96 168 267 250 285 270 260 CONSUMPTION Nth America 132 109 132 135 142 149 154 158 Europe 422 361 408 414 415 418 423 429 China 298 443 541 666 668 676 722 770 Japan 176 154 170 167 168 173 175 176 India 34 42 50 56 59 62 67 72 Other Asia 142 142 155 137 137 138 141 144 Other World 86 77 75 67 78 81 84 87 Total consumption 1,289 1,325 1,529 1,642 1,666 1,697 1,765 1,836 % change -6.1% 2.8% 15.4% 7.4% 1.5% 1.8% 4.0% 4.0% For Stainless 779 834 1,010 1,103 1,104 1,108 1,153 1,201 % change -10.6% 7.2% 21.0% 9.2% 0.1% 0.3% 4.1% 4.1% For Non-Stainless 511 491 519 541 562 589 611 634 % change 1.7% -4.0% 5.8% 4.3% 3.8% 4.8% 3.8% 3.7% Restocking SURPLUS/(DEFICIT) 90 8 (77) 9 33 52 31 18 LME stocks 79 158 136 90 140 183 Producer Stocks 103 89 91 98 128 158 Estimated Total Stocks 389 402 331 329 362 414 445 463 Weeks Consumption 15.7 15.8 11.3 10.4 11.3 12.7 13.1 13.1 Price (US$/t) 21,204 14,651 21,806 22,843 17,536 15,282 15,250 17,000 Price (US$/lb) 9.62 6.65 9.89 10.36 7.95 6.93 6.92 7.71

25 June 2013

Zinc – Lock, stock and barrel Zinc prices on the LME have plodded along in a dull and narrow trading range between US$1,750 and US$2,200/t since the autumn of 2011. With surpluses expected to be maintained, albeit much lighter ones than the 1 Mt/y excesses of 2009-10, we see little hope that zinc prices will break out into a higher band in 2013-14. In fact, we now consider the opposite a realistic prospect – further price weakness is indeed required to instill supply-side discipline, especially among Chinese smelters, but also to choke off growing concentrate supplies to under-utilized plants. With estimated supply outpacing demand by more than 300 kt this year, cuts must take place if any semblance of price stability is to kick in. Stocks may be tightly locked up at present but the market is staring down the barrel of another price slide if producers do not hold back refined supplies. Although we acknowledge that mine supply growth has started to slow – this will lie in a range either side of 2% p.a. in 2013-15, we believe – we are now of the view that a bolder stepping up in price is a few years down the road. Symptomatic of this vague prospect is MMG’s Century mine in Queensland. As one of the few large-scale zinc mines the operation is currently producing 480-490 kt/y zinc in concentrates; deemed to close in about 2016, MMG continues to look for options to extend mine life – zinc’s “day in the sun” it seems may have to wait a while longer. However, a fall in prices below US$1,800/t could be the trigger to a gradual turnaround in zinc’s fortunes by 2015-16. Under current market conditions we doubt many projects will be pushed ahead with vigor. We have therefore expanded our so-called allowance for unexpected disruption in 2014-15, mainly to reflect mine curtailments or, at the very least, pulling back on project schedules.

Exhibit 200: Zinc prices have been trapped in a narrow band since 2011 LME three-month zinc prices, US$/t

5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0 2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Chinese refined supply the key variable The single-most important caveat in our forecast is Chinese refined supply, the weakness of which had been a major fundamental positive for zinc in 2012. Output has climbed again in 1H 2013, fed by both concentrate imports and domestic mine supply, although we are skeptical that smelter production will turn out as high as in some forecasters’ tallies. Here data are a problem, with statistics for domestic mine supply missing. Commodities’ Forecast Update: The Return of “Fundamentals”

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We believe mines closed earlier in the year may have resumed more recently and smelter operating rates have moved up above 70% once more. Even so, we have scaled back our forecast growth in Chinese supply but this still equates to an increment of almost 900 kt for the full year. The recovery has been driven primarily by the improvement in metal premiums, prompting small price-sensitive smelters to government has also sought to bail out struggling operators, with and Yunnan provincial government each purchasing 50 kt of stockpiles. The SRB has also been active.

treatment charges and increase output. The the central government metal for government

A further note of caution on our China forecasts is the observation that all 10 smelter expansion projects that we identified for 2013 commissioning (for an aggregate total of 800 kt/y of capacity) have been postponed. Clearly, lower Chinese refined output than we have projected has the greatest impact on 2013-15 market balances.

Exhibit 201: Chinese refined zinc production has rebounded in recent months

Exhibit 202: SHFE inventories are off their peaks

Kt, monthly, SA

Kt, SHFE deliverable Zinc stocks

Thousands

500

450

450 400 350 300

400

250

350 200 150

300

100

250 50

200 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

0 2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse. China NBS

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Exhibit 203: Chinese refined zinc imports have fallen back from elevated levels

Exhibit 204: Shifts in the import arbitrage are highly volatile

Kt, monthly, SA

US$/t 300

160

LME Cheap

250

120

200 150

80

100 50

40

0 -50

0 2008

LME Expensive 2009

2010

2011

2012

Source: Credit Suisse, Customs Data

Commodities’ Forecast Update: The Return of “Fundamentals”

2013

-100 Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

109

25 June 2013

Imports have been volatile in recent months as the Chinese import arb has seen very large swings (imports generally respond at a two-month lag). With stronger domestic production, the conditions that led to 2012’s elevated imports are no longer present, and 2H 2013 imports are likely to be structurally lower.

Mixed signals on demand The signals for demand are a mixture of positive and negative influences. After a bubbly 2012, auto production across the board is generally softer in the first half of 2013, with China being the main positive factor. US auto and light truck manufacturing has grown 3%-4% in Jan-May, following an impressive advance of 20% last year. More broadly, growth in demand for zinc is being modestly maintained in all major markets with the exception of Europe where we expect continued stagnation through 2013. However, we have edged down our aggregate forecasts to reflect two main features – a slower structural pace of growth in China as we enter H2 (see Macro section) and concerns that core consumption sectors will show less signs of life than we had previously expected, especially in emerging markets still dependent on acceleration of activity in North Atlantic economies. In China, for example, a strong element of Q2’s buoyancy reflects seasonal advances in manufacturing which may have translated into rising stocks of goods over and above likely 2H demand levels.

Watch the warehouses Finally, any zinc price outlook has to include a view on whether cash-and-carry deals and difficulties accessing metal in warehouses will change. Financing deals first became a feature of the aluminium market in 2009 but the appeal of inventory storage in zinc as a market has also grown. Zinc availability is very constrained, more than for any other base metal, with zinc inventories concentrated in the five LME warehouses suffering from long queues and 95% located in the affected warehouses.

Exhibit 205: Zinc financing yields are attractive, alongside those of aluminium Yield between 15 month and 3 month LME contracts

13.0%

Zinc

Aliuminium

11.0% 9.0% 7.0% 5.0% 3.0% 1.0% -1.0% -3.0% -5.0% 2008

2009

2010

2011

2012

2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Moreover, while both global and LME inventories are undeniably high, two-thirds of LME on-warrant warehouses are concentrated in New Orleans, where the queue to remove metal stretches over 150 days. An additional quarter is located in Detroit and Antwerp, each also with queues over 150 days; only 5% is in warehouses avoiding long load-out delays. This concentration has been exacerbated by trader activities. As expected, these efforts succeeded in achieving an increase in annual premiums and have also pushed up spot premiums in the US and Europe. Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Consumers are increasingly frustrated that the LME is failing to fulfill its role as a market of last resort. While the forward curve and interest rate configuration will continue to make cash-and-carry trade an attractive option, the risk of regulatory action in the EU or USA is growing. This may not emerge as a factor very soon but intervention looks increasingly likely, eventually; the subsequent release of large volumes of accumulated stocks could impact the market beyond the next 6-12 months, delaying zinc’s long-awaited price recovery.

Exhibit 206: Zinc forecast comparison

Exhibit 207: Zinc historical price and forecast

US$ per metric tonne

US$ per metric tonne

$2,200

CS Forecast

Forward Curve

Bloomberg Forecast Mean

$4,800

Zinc 3M

Quarterly Avg Forecast

$4,300

$2,100 $3,800

$2,000

$3,300 $2,800

$1,900

$2,300

$1,800 $1,800

$1,700

$1,300

$1,600 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

$800 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 208: Forecast zinc prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

LME zinc 3M

New New

US$/t US¢/lb

1Q-13

2Q-13f

3Q-13f

4Q-13f

2013f

1Q-14f

2Q-14f

3Q-14f

4Q-14f

2014f

2015f

2016f

LT

2,054 95

1,850 85

1,800 80

1,750 80

1864 85

1,800 80

1,800 80

1,750 80

1,700 75

1763 80

1,900 85

2,000 90

1,900 0.85

Source: Credit Suisse Commodities Research

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111

Commodities’ Forecast Update: The Return of “Fundamentals”

Exhibit 209: Global zinc supply and demand estimates In thousands of metric tonnes (kt)

World Zinc Supply & Demand Balance MINED ZINC SUPPLY North America (inc Mex ico) C & S America Europe CIS China India Other Asia Australia Africa Peru Highly Probable Projects Probable Projects Disruption Allowance & Market Adj. World Mined Zinc Production % Change REFINED ZINC SUPPLY North America (inc Mex ico) C & S America Europe CIS China India Japan South Korea Other Asia Oceania Africa Highly Probable Grow th Disruption Allowance Adjustments to refined zinc World Refined Production % Change Incl. Scrap/secondary Process losses/pipeline stocks Required mined zinc Concentrate Balance World Consumption REFINED SURPLUS/(DEFICIT)

2008

2009

2010

2011

2012

2013f

2014f

2015f

1,927 1,868 1,873 1,980 2,045 1,952 1,975 2,022 615 696 698 688 690 688 700 669 838 788 780 798 842 900 881 885 657 612 657 630 713 827 870 852 3,160 3,198 3,703 4,307 4,734 4,900 5,000 5,100 626 688 719 745 719 878 886 904 398 434 495 516 562 617 702 727 1,508 1,316 1,481 1,483 1,438 1,598 1,603 1,514 289 295 309 324 329 418 423 420 1,550 1,430 1,403 1,185 1,213 1,287 1,384 1,439 17 199 464 (563) (865) (872) 11,567 11,324 12,117 12,655 13,284 13,517 13,755 14,122 5.8% -2.1% 7.0% 4.4% 5.0% 1.8% 1.8% 2.7% 1,334 470 2,135 655 3,905 595 622 738 204 498 268 11,424 2.3% 888 647 11,183 384 11,114 310

1,224 417 1,804 543 4,246 646 541 722 223 525 279 11,169 -2.2% 773 637 11,033 291 10,136 1,033

1,266 536 2,090 600 5,100 727 593 779 247 499 275 12,712 13.8% 925 705 12,492 (375) 11,681 1,031

1,236 630 2,165 620 5,109 821 546 859 252 517 256 13,009 2.3% 956 711 12,764 (109) 12,608 401

1,274 651 2,149 670 4,817 810 590 920 283 507 253 12,924 -0.7% 976 698 12,646 638 12,946 (22)

1,284 671 2,225 675 5,700 933 607 960 283 539 185 (281) 13,780 6.6% 1,026 744 13,498 19 13,409 371

1,374 681 2,248 675 6,000 933 625 1,010 283 539 185 (437) 14,116 2.4% 1,076 762 13,802 (47) 13,964 152

1,374 701 2,278 695 6,300 933 635 1,010 283 539 185 (448) 14,485 2.6% 1,126 782 14,141 (19) 14,461 24

2008 2009 STOCKS LME 253 457 SHFE Stocks 63 172 Weeks Cons. (Exch. Stks) 1.5 3.2 Producer Stocks 365 317 Consumer Stocks 128 105 Merchant & US strategic 25 21 Reported stocks 834 1,072 Weeks Consumption 3.9 5.5 Price (US$/t) 1,874 1,543 ZINC CONSUMPTION BY COUNTRY USA 981 902 % Change -10.6% -8.0% Other North America 356 279 % Change -10.7% -21.7% C & S America 466 381 % Change 2.8% -18.2% Western Europe 1,931 1,466 % Change -17.8% -24.1% Eastern Europe 467 326 % Change -11.0% -30.1% China 3,795 4,100 % Change 7.5% 8.0% India 479 495 % Change 2.1% 3.3% Japan 562 421 % Change -6.2% -25.0% South Korea 528 426 % Change -1.3% -19.3% Other Asia 1,085 820 % Change 7.8% -24.4% Oceania 284 217 Africa 181 150 China SRB & Prov inces 494 Restocking World Consumption 11,114 10,136 % Change -2.9% -8.8% World Refining Capacity 14,299 15,286 Capacity Utilisation (%) 79.9% 73.1%

2010

2011

2012

2013f

2014f

2015f

701 311 4.5 313 97 19 1,441 6.4 2,094

822 364 4.9 366 204 42 1,798 7.4 2,193

1,221 311 6.2 315 126 21 1,994 8.0 1,952

1,864

1,763

1,900

948 5.1% 298 7.0% 433 13.6% 1,838 25.4% 385 17.8% 4,705 14.8% 561 13.5% 538 27.8% 522 22.3% 956 16.6% 223 165 (50) 200 11,681 15.2% 15,480 82.1%

1,012 6.7% 311 4.4% 456 5.5% 2,040 11.0% 446 15.9% 5,257 11.7% 597 6.3% 497 -7.6% 547 4.9% 1,045 9.2% 226 173 100 50 12,608 7.9% 15,768 82.5%

1,062 5.0% 320 2.7% 468 2.6% 1,959 -4.0% 449 0.6% 5,557 5.7% 615 3.0% 485 -2.5% 569 4.0% 1,059 1.3% 230 175 12,946 2.7% 16,159 80.0%

1,105 4.0% 329 2.9% 480 2.6% 1,961 0.1% 456 1.7% 5,880 5.8% 633 3.0% 490 1.0% 580 2.0% 1,079 1.9% 238 179 13,409 3.6% 16,524 83.4%

1,138 3.0% 339 2.9% 495 3.1% 1,974 0.7% 469 2.8% 6,250 6.3% 665 5.0% 497 1.5% 595 2.5% 1,113 3.1% 245 184 13,964 4.1% 16,949 83.3%

1,166 2.5% 348 2.8% 495 0.0% 1,984 0.5% 469 0.0% 6,632 6.1% 705 6.0% 502 1.0% 610 2.5% 1,120 0.7% 245 184 14,461 3.6% 16,799 86.2%

Source: Credit Suisse

25 June 2013

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25 June 2013

Lead – Heavyweight still on its feet … just After putting in a strong performance in the second half of 2012, lead prices have also wiped out more than half the gains they made during this run up. At US$2,100/t, the metal has better levity than its sister metal, zinc but a year of supply surpluses against a background of disappointing demand activity is leaving the metal vulnerable to a further downward leg in 2H 2013. The main culprit to this less upbeat outlook is softer Chinese demand, with 2Q’s muchanticipated surge being a bit of a damp squib. With the poorer mood, investors have also reversed positioning. As a result, we have once again lowered our price forecasts for the remainder of 2013 and expect the market to remain better supplied than previously expected. These factors represent short-term negatives for lead prices but they do not change lead’s brighter medium-term prospects, which we continue to consider to be stronger than for most LME metals. We hold to our position that the lead market will move into deficit next year and for the shortfall to expand in 2015. Indeed, although we have softened our projection for demand in 2013 in particular, we believe the risks on mine-through-refined supply lie to the downside in our tabulation. This will inevitably be the case if, as we expect, prices languish in the sub US$2,000 vicinity for a further few quarters through 2013-14.

Exhibit 210: Lead prices have channeled above US$2,000/t in 2012-13 but there are risks of an imminent break lower LME three-month lead prices, US$/t

4500 4000 3500 3000 2500 2000 1500 1000 500 0 2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Weakness persists in Chinese lead market China’s lead industry has had a rocky ride. Weak demand from autos and e-bikes (which together account for nearly two-thirds of Chinese demand), including stagnant auto production in 2H 2012, led to an oversupply of lead batteries. Lead battery producers responded by rationing production and attempting to run off a considerable inventory overhang. The result has been weak domestic lead prices, which continued to decline, even as LME prices saw their strongest rally in years. Chinese smelters, particularly smaller, more pricesensitive operations, responded with production curtailments in the final stages of last year. However, these cuts were too little and too late to prevent a surge in SHFE lead inventories. Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Worryingly, there has not been much of an upturn in battery demand in 2Q with the two major e-bike companies cutting prices in an effort to boost sales in a normally seasonally strong time of year. Sales have also been hampered by new rulings introduced in a number of cities aimed at toughening up on licensing and registration to improve safety. There are better fortunes in the mainstream commercial vehicle segment, with year-todate vehicle output up 13% compared to the same period of last year – original equipment battery demand is therefore in better shape but replacement activity is generally flat. Exports of batteries remain an important outlet, though impacted by flatter business in key European markets and a slowing down of the sector pace in the US. Demand for fixed storage units is also likely to improve as China Mobile’s countrywide rolling out of 4G networks accelerates this year.

Exhibit 211: Chinese auto production on a lower growth trend

Exhibit 212: Lead battery production has similarly moved sideways since last summer

Monthly, Natural log, SA

MVAH, monthly, SA 20,000

14.5

18,000

14.0

16,000 14,000

13.5

Expiration of subsidies

13.0

12.5

12,000 10,000 8,000

GFC

Enactment of subsidies

6,000 4,000 2,000

12.0 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

0 2006

2007

2008

2009

2010

2011

2012

2013

Source: Credit Suisse, China NBS

Growth constraints on Chinese refined output. A big forecasting variable The softness in demand is reflected in high monthly exports of lead, triggered by losses in production outside the country. Even so, primary lead refineries in China were operating at rates of just 55% in May, from 58% in April. With Yuguang the latest to announce extended maintenance work in June, utilization is expected to remain at relatively low levels in 3Q. Apart from flat lead prices, plants are suffering because of falls in byproduct silver prices and shortages of concentrate feedstock. Smaller mines exploiting lower grade ore-bodies have undertaken widespread closures. Larger mines, while still operating, appear to be rationing supply. The incentive to import concentrates has also been weak. Secondary smelters meanwhile face even steeper problems. These plants are much more sensitive to market weakness and switch on and off more readily than their primary counterparts. This is true of plants worldwide, especially at a time of relatively high costs of purchasing scrapped batteries. Virtually all secondary lead refineries in Shandong and Henan provinces in eastern China have suspended production. If anything, our projected supply for secondary output is a touch on the high side. Crucially, this skews supply risks to the downside but balanced against this is the chance that demand will turn out less buoyant than the 4% p.a. plus we are assuming for 2013-14.

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25 June 2013

Exhibit 214: Chinese lead prices have continued to fall, creating a disconnect with LME prices

Kt

RMB/t (lhs), US$/t (rhs)

Thousands

Exhibit 213: SHFE lead inventories – high but peaking out 160

20000

140

19000

120

18000

100

17000

80

16000

60

15000

40

14000

20

13000

Shaghai Lead Spot

LME Lead Cash

3500

3000

2500

2000

1500

0 Mar-11

Sep-11

Mar-12

Sep-12

12000 Jan-10

Mar-13

1000 Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Exhibit 215: Physical premiums are high in the US, reflecting tight supplies in the region

Exhibit 216: And tightness at the front of the LME curve has eased

US$/t

LME Cash – 3 month; US$/t

400

US

Europe

Singapore

100

350

Backwardation

80

300

60 250

40 200

20

150 100

0

50

-20

0 2004

2005

2006

2007

2008

2009

2010

2011

2012

Source: Metal Bulletin, the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

2013

-40 Jan-11

Contango Jul-11

Jan-12

Jul-12

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Western supply developments The early part of 2013 has seen a flurry of mines and plants restarting after periods of closure. These include the following: • Porto Vesme: Restart of Glencore’s 100 kt/y smelter in Sardinia, which had been closed since 2009. • Onsan: Return to full production of 280 kt/y South Korean refinery following a maintenance closure in 4Q 2012. • Lucky Friday: Return to production of this 28 kt/y US mine, which had been closed in 2012 in order to improve safety conditions. • Paroo Station (formerly Magellan): Ivernia recommenced operations in April and expects to recover 40-45 kt of lead in carbonate concentrate this year before returning to full annual rating at 90 kt in 2014. The mine was put on care and maintenance in 2011.

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As a result, the tightness that had developed in the ex-China lead market, driven by a squeeze emanating from insufficient US scrap supply and opportunistic trader activity, has abated.

The case for lead beyond 2013-14 … We maintain a more positive stance on future lead prices beyond 2014, although here too we have revised these lower. Greater price increase may eventuate but we suspect that moment will come later rather than within 2-3 years. This positive outlook is driven primarily by the difficulty in growing supply: • Closure of Herculaneum (120 kt/y) at the end of 2013, the US’s only remaining primary lead smelter, which will force Doe Run to seek alternate smelters to process its US concentrates. Should these be forced to China (or displace other concentrates that are in turn forced to China) due to lack of spare capacity in the rest of the world, this would materially tighten the ex-China market. • Linked to this, we do not believe the La Oroya smelter will contribute materially due to issues with environmental compliance and the smelters’ creditors. • Major mine closures over 2013-2016, totaling nearly 300 kt. These include Brunswick (50-70 kt/y; closure set for 2013), Lisheen (20 kt/y; shut in 2014), and Century (40-70 kt/y; off in 2016), although MMG is exploring options to extend mine life beyond that timeframe. • The low lead content of many of the largest zinc mine projects, including Bracemac McLeod, Perkoa, Lalor Lake, and Bisha. • The poor economics of developing lead-only mines, which has resulted in no such mines currently under development outside of China. Finally, environmental aspects are impacting Chinese lead, and for that matter, zinc production and events here are worthy of close monitoring. Most recently higher-thanpermitted levels of cadmium have been detected in rice in many provinces where lead and zinc mining is suspected of creating the health hazard. While in the past, incidents such as this have prompted slow responses, there is a growing likelihood that government agencies will step in and act against unlicensed exploration and mining activities that have a poor environmental track record. In short, supply-side risks are growing in the country across many commodity sectors. For lead, however, it could turn out that constraints on supply ultimately drag down demand, though affordable replacements for the long-serving lead acid battery are not immediately obvious.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 217: Lead forecast comparison

Exhibit 218: Lead historical price and forecast

US$ per metric tonne

US$ per metric tonne

$2,500

CS Forecast

Forward Curve

Bloomberg Forecast Mean

$2,400

$4,000

Lead 3M

Quarterly Avg Forecast

$3,500

$2,300

$3,000 $2,200

$2,500

$2,100 $2,000

$2,000

$1,900

$1,500 $1,800

$1,000

$1,700 $1,600 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

$500 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 219: Forecast lead prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

LME lead 3M

New New

US$/t US¢/lb

1Q-13

2Q-13f

3Q-13f

4Q-13f

2013

1Q-14f

2Q-14f

3Q-14f

4Q-14f

2014f

2015f

2016f

LT

2,307 105

2,050 95

1,950 90

1,900 85

2052 95

1,900 85

1,900 85

1,900 85

1,950 90

1913 85

2,200 100

2,300 105

2,000 0.90

Source: Credit Suisse Commodities Research

Commodities’ Forecast Update: The Return of “Fundamentals”

117

In thousands of metric tonnes (kt)

World Lead Supply & Demand Balance MINED LEAD SUPPLY North America (inc Mex ico) C & S America Peru Europe CIS China Other Asia Australia Africa Probable Projects Disruption Allowance World Mined Lead Production % Change REFINED LEAD SUPPLY North America (inc Mex ico) C & S America Europe CIS China Japan South Korea Other Asia Australia Africa Prim. ref. Pb adjustment required Sec. ref. Pb adjustment required Highly Probable Grow th Disruption Allowance World Refined Production % Change World Secondary Ref. Production World Production Primary Ref. Residues scrap available Metallurgical losses Required mined lead Concentrate Balance World Consumption DLA Stock Sales SURPLUS/(DEFICIT) LEAD

2008

2009

2010

2011

2012

2013f

2014f

2015f

589 131 320 245 90 1,231 133 605 101 3,443 2.7%

562 128 270 238 110 1,423 157 544 103 3,534 2.7%

549 119 235 215 139 1,857 168 648 114 4,043 14.4%

564 137 208 228 193 2,358 187 574 95 4,543 12.4%

581 127 224 238 204 2,550 212 597 92 4,826 6.2%

606 121 255 242 245 2,700 234 718 89 1 (156) 5,055 4.7%

615 117 254 248 242 2,800 283 762 91 57 (164) 5,305 5.0%

614 110 267 253 251 2,950 308 714 90 100 (170) 5,487 3.4%

1,798 391 1,699 196 3,187 225 276 680 280 110 8,842 5.8% 4,321 4,521 1,305 261 3,477 (34) 8,822 20

1,724 318 1,545 183 3,720 191 327 718 265 108 9,098 2.9% 4,510 4,588 1,325 261 3,524 11 8,894 204

1,844 312 1,581 232 4,056 219 320 739 217 106 9,626 5.8% 4,964 4,662 1,001 266 3,927 116 9,576 50

1,929 322 1,622 228 4,395 213 423 807 225 118 10,283 6.8% 5,096 5,187 1,046 294 4,435 108 10,030 253

1,923 328 1,645 203 4,676 200 380 860 193 96 10,505 2.2% 5,087 5,418 975 303 4,746 81 10,497 8

1,963 390 1,681 336 5,100 202 440 885 205 83 (259) 11,025 5.0% 5,200 5,825 1,049 326 5,103 (48) 10,976 49

1,843 430 1,772 336 5,500 202 440 885 240 123 (353) 11,417 3.6% 5,365 6,052 1,089 339 5,302 4 11,462 (45)

1,843 430 1,822 346 5,850 202 440 885 240 123 (365) 11,815 3.5% 5,486 6,329 1,139 354 5,544 (57) 11,958 (143)

2008 2009 STOCKS LME 45 147 SHFE Days Cons. (Exch. Stks) 6.5 7.6 Producer Stocks 146 135 Consumer Stocks 114 106 Merchant & US strategic 1 1 Reported Stocks 306 389 Days Consumption 12.7 16.0 Price (US$/t) 2,067 1,719 LEAD CONSUMPTION BY COUNTRY USA 1,560 1,390 Other North America 31 38 C & S America 619 563 Western Europe 1,514 1,254 Eastern Europe 315 259 China 3,049 3,662 India 375 433 Japan 211 153 South Korea 318 328 Other Asia 696 697 Oceania 26 22 Africa 108 95 World Consumption 8,822 8,894 % Change 5.0% 0.8%

2010

2011

2012

2013f

2014f

2015f

209

353 31 8.3 142 95 1 622 22.6 2,397

320 75 8.0 131 104 1 631 21.9 2,064

2,052

1,913

2,200

7.4 129 111 1 450 17.2 2,151

1,405 1,550 1,628 1,676 1,685 1,693 22 14 15 15 15 15 636 612 627 646 666 685 1,323 1,356 1,329 1,333 1,337 1,341 317 270 275 284 292 301 4,032 4,281 4,645 4,994 5,368 5,744 445 456 474 496 525 562 190 190 192 193 194 194 385 415 415 421 430 438 714 762 773 793 821 849 30 26 25 26 26 26 77 98 98 100 104 108 9,576 10,030 10,497 10,976 11,462 11,958 7.7% 4.7% 4.7% 4.6% 4.4% 4.3%

14,000 12,000 10,000 8,000

kt

Commodities’ Forecast Update: The Return of “Fundamentals”

Exhibit 220: Global lead supply and demand estimates

6,000

77

4,000 2,000 0 200 8 North America

200 9

201 0

201 1

Europe

other

Asia

201 2 China

201 3f

201 4f

Primary lead

201 5f

recycled lead

Source: Credit Suisse 25 June 2013

118

25 June 2013

Tin – Temporary headwinds As expected, the wind came out of tin’s sails in 2Q, with prices falling back close to the US$20,000/t mark, fully 40% down from the lofty peaks above US$33,000 in early 2011. Apart from softness in worldwide demand – for tin this is largely due to weakness in consumer electronics manufacture, especially in the main producing center, China – the short-lived price run-up in February to US$25,000 was sufficient to crank up supply again. The expression of tin’s shift into surplus in 2013 is the rise in LME stocks by 20% since the end of last year. The LME curve, which had severely squeezed during the second half of 2012, has moved into comfortable contango.

Exhibit 221: Tin prices have corrected, as with other LME metals, but most of the “super cycle” gains are still in place LME three-month tin prices, US$/t

35000 30000 25000 20000 15000 10000 5000 0 2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Yet the metal continues to retain much of the gains in prices achieved since 2006. In part this reflects improving “structural” demand, especially in its core market, solders, as well as a number of emerging high tech uses (for example, as a complimentary element in lithium ion batteries). Tin in solder is critical in the electronics industry and until recently was an alloy of both tin and lead. The mandated removal of lead from solders has benefitted tin immensely, with 90% tin component solders are the main type used in the industry today. Apart from cyclical weakness, the trend towards using smaller components and the effects of light-weighting are offsetting some of these gains.

Tin mine supply growth is constrained The other factor is fundamentally constrained mine supply over the medium and longer term, masked by strong recovery from 2012’s poor mine-through-refined performance. The surge of 7%-8% expected this year follows on from a plunge of 7% in mine supply in 2012 and a similar fall in 2011. Price flatness and simple easing of recovery momentum will give rise to much more modest increments in 2014, though higher prices should stimulate stronger growth in 2015, a year in which deficits will start to show more convincingly. While the market may be somewhat cleaner now from an investor positioning perspective, prices above US$20,000/t are more than high enough to incentivize producers that had curtailed output in 2012 to ramp-up production. We expect to see notable rebounds in production from Brazil, Malaysia, and Thailand, where production languished last year.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

After slowing in April, Indonesian tin exports advanced again in May, rising 18% mom to 9.2 kt. The cumulative exports in January-May stand at 43.9 kt, a 16.5% yoy increase. Indonesian producers appear to be maximizing production and destocking ahead of new regulations on refined metal quality coming into effect on 1 July. The new regulations, if strictly enforced, may halt shipments from small, independent smelters that do not meet the higher standards. Small mines in Bangka are reported to have halted work in recent weeks after altercations with police and demonstrations by workers at PT Timah, protesting illegal mining. The extent of these losses is not clear but tensions are running high in the run up to the July ruling.

Exhibit 222: LME stocks have climbed gradually as supply recovers from 2012’s slide

Exhibit 223: Moving the LME curve from a very tight 2H 2012 to increasing contango

kt

US$/t, LME cash – three-month

30000

Johor

150

Other Locations

Backwardation

25000

100

20000 50

15000 0

10000 -50

5000

Contango 0 2008

2009

2010

2011

2012

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

2013

-100 Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Meanwhile, Chinese production looks set to be recovering after 2012’s lull. Latest official statistics also show China imported 1.2 kt refined tin in April, down by 27% year-on-year and 24% compared to the previous month. Imports from Indonesia fell by 68% yoy. Concentrate imports in China in April also declined sharply from 11.8 kt in March to 3.2 kt in April. The large volumes in March were mainly from Myanmar and believed to be low in tin grade.

Demand insufficiently strong to create deficits until 2014-15 With respect to demand, we expect general improvement, particularly from the US and China, and an end to sequential drag from Europe and Japan, where 0% growth would represent significant improvements. We also believe the inventory overhang that had accumulated in consumer goods in China is now at more manageable levels. However, these improvements in demand are unlikely to be as dramatic as the resumption in curtailed and production and we could see tin prices dip below US$20,000 in 2H. This relative weakness could spill over into 2014, at least to the point at which inventories get drawn down. However, by the end of next year we expect tin’s now almost characteristic structural tightness to display itself again, with firm price rises possible in 2015-16.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 224: The China arbitrage has turned negative

Exhibit 225: Leading to a drop off in imports

US$/t

tonnes

8000

5,000

LME Cheap

6000

4,500

4000

4,000

2000

3,500

0

3,000

-2000

2,500

-4000

2,000

-6000

1,500

-8000

1,000 500

-10000

LME Expensive

-12000 Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

0 2008

Jan-13

2009

2010

2011

2012

2013

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Exhibit 226: Tin forecast comparison

Exhibit 227: Tin historical price and forecast

US$ per metric tonne

US$ per metric tonne

$25,000

CS Forecast

Forward Curve

Bloomberg Forecast Mean

Tin 3M

Quarterly Avg Forecast

$35,000

$24,000 $30,000

$23,000 $25,000

$22,000 $20,000

$21,000 $15,000

$20,000 $10,000

$19,000 $18,000 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

$5,000 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 228: Forecast tin prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

LME Tin 3M

New New

US$/t US$/lb

1Q-13

2Q-13f

3Q-13f

4Q-13f

2013f

1Q-14f

2Q-14f

3Q-14f

4Q-14f

2014f

2015f

2016f

23,230 10.55

20,500 9.30

19,000 8.60

18,500 8.40

20308 9.20

19,000 8.60

19,000 8.60

19,000 8.60

20,000 9.05

19250 8.75

23,000 10.45

25,000 20,000 11.35 9.10

LT

Source: Credit Suisse Commodities Research

Commodities’ Forecast Update: The Return of “Fundamentals”

121

Commodities’ Forecast Update: The Return of “Fundamentals”

Exhibit 229: Global tin supply and demand estimates In thousands of metric tonnes (kt)

World Tin Supply & Demand Balance kt 2008 MINE PRODUCTION China 121 Indonesia 96 Asia ex China, Indonesia 10 Boliv ia 17 Brazil 14 Peru 39 ROW 18 World Mine Production 316 Disruption Allow ance Required Adjustment World Mined Tin 316 % Change -8.1% Conc avail after direct use 316 Primary Smelter Production 296 Smelter Loss 7 Primary feed required 304 SURPLUS/(DEFICIT) CONC. 12 REFINED TIN PRODUCTION China Indonesia Malay sia Thailand Other Asia Boliv ia Peru Europe ROW World Refined Production Primary Production Secondary Production Required Adjustment World Refined Tin % Change DLA Sales

140 70 32 22 8 12 38 11 12 344 296 47 344 -2.0% 4

2009

2010

2011

2012f

2013f

2014f

2015f

128 84 9 20 10 37 29 316 316 0.0% 316 289 7 297 19

130 84 10 20 10 34 31 319 319 1.0% 319 298 7 305 14

127 78 11 20 11 29 25 301 301 -5.5% 301 303 8 311 (9)

116 78 11 19 11 26 21 281 281 -6.8% 281 290 7 297 (16)

127 80 11 20 11 28 29 307 (9) 5 302 7.6% 302 304 7 311 (9)

135 82 11 20 11 29 31 320 (10) 310 2.6% 310 304 7 311 (1)

142 82 12 21 11 30 35 333 (10) 323 4.2% 323 308 7 316 8

140 65 36 19 7 15 34 10 9 336 289 46 336 -2.3% -

149 64 39 24 7 15 36 13 10 357 298 60 357 6.5% -

156 73 40 24 9 15 30 12 10 370 303 67 370 3.5% -

148 78 38 22 10 14 25 14 10 359 290 70 359 -2.9% -

156 77 40 24 10 15 28 14 11 374 304 76 5 379 5.6% -

160 76 42 24 10 16 30 14 11 383 304 79 383 0.9% -

165 76 43 25 10 17 30 14 11 391 308 83 391 2.2% -

2008 2009 STOCKS LME 8 27 Producer Stock 12 8 Consumer/Others 13 12 Total Reported Stock 32 46 Weeks Consumption 4.76 7.35 LME Price (US/t) 18,457 13,599 KLTM Price (US$/t) 18,511 13,502 TIN CONSUMPTION BY COUNTRY China 145 149 Japan 32 23 Asia ex China, Japan 66 59 U.S.A 26 27 Germany 21 14 Other Europe 46 38 ROW 19 16 World Tin Consumption 355 326 % Change -1.0% -8.0% TIN CONSUMPTION BY USAGE Solder 182 172 % of total 51.4% 52.7% Tinplate 57 54 % of total 16.1% 16.5% Chemicals 48 43 % of total 13.5% 13.0% Brass & Bronze 20 18 % of total 5.7% 5.6% Float Glass 7 8 % of total 1.8% 2.3% Others 41 32 % of total 11.5% 9.9% Total 355 326 Required Demand Destruction Final Tin Consumption 355 326 % Change -1.0% -8.0% SURPLUS/(DEFICIT) (7) 9

2010

2011

2012f

2013f 2014f June 14 6 11 19 12 2.61 1.58 20,308 19,250

2015f

16 7 11 34 4.84 20,441 20,351

11 7 11 18 2.40 25,958 25,955

12 7 11 14 2.05 21,085

153 36 67 32 17 42 22 370 13.3%

181 27 59 32 20 46 21 387 4.6%

176 28 58 31 18 36 16 363 -6.2%

185 28 60 31 18 37 16 375 3.4%

196 28 62 32 18 37 17 390 4.0%

210 29 64 33 18 37 17 409 4.8%

194 52.6% 59 15.9% 51 13.8% 20 5.3% 7 1.9% 39 10.6% 370 370 13.3% (12)

201 52.0% 65 16.7% 54 14.0% 19 5.0% 8 2.0% 40 10.3% 387 387 4.6% (17)

192 53.0% 61 16.7% 51 14.0% 18 5.0% 7 2.0% 34 9.3% 363 363 -6.2% (3)

202 54.0% 63 16.7% 52 14.0% 19 5.0% 7 2.0% 31 8.3% 375 375 3.4% 5

215 55.0% 65 16.7% 55 14.0% 20 5.0% 8 2.0% 28 7.3% 390 390 4.0% (7)

229 56.0% 68 16.7% 57 14.0% 20 5.0% 8 2.0% 26 6.3% 409 409 4.8% (17)

(5) (0.68) 23,000

Source: Credit Suisse

25 June 2013

122

25 June 2013

Gold & Silver: RESEARCH ANALYSTS Commodities Research Tom Kendall [email protected] +44 20 7883 2432

Gold – Further falls ahead as investors capitulate Our bearish thesis on gold remains intact as described in Gold: The Beginning of the End of an Era in early February. We have now made hefty cuts to our price deck to reflect both today’s reality and what we think will be a period of persistent disappointment for gold bulls. We now forecast gold to average $1,250 in Q4 of this year and think equilibrium lies around $1,150, which we expect to see by H2 2014. Investors of course should always consider whether trading contrary to consensus is the correct strategy. And one glimmer of hope for those who remain long is that the bull camp is now much smaller than it was a year ago (and clearly with gold now having traded below $1,300/oz the downside is less than it was at $1,800). However, in our view they will have to face further downside: A. The ‘fear/safe-haven’ bid from a majority of western investors has fallen away, and is unlikely to return soon, for the reasons articulated on a number of previous occasions (see for example Gold: Think the Unthinkable).  Massive increases in money supply have not led to a breakout in prices. Inflation is flat or falling, inflation expectations remain well-contained (Exhibit 230).

The commodity price forecasts mentioned in this section have been provided by the Commodities Research analysts above.

 The US is not in great shape but it is the best performing developed economy (note the recent Standard & Poor’s shift from negative to neutral outlook).  Contrary to some of the media headlines of five to six years ago, the US dollar has not collapsed, its use as the world’s reserve currency is not under imminent threat.  Europe still faces sizable structural issues but the risks of imminent systemic financial collapse have greatly diminished.  There has been significant volatility recently in FX markets, particularly in EM currencies, but due to fears of the withdrawal of monetary stimulus and not as a result of “currency wars”. B. The opportunity cost of holding gold has increased as nominal yields have risen and real yields have moved close to flat (Exhibit 231). There has been no evidence that any of the money that has recently been leaving fixed income funds (Reuters reported outflows of $12.5 billion during the first week of June alone) or EM equity funds has moved into gold. We think it highly unlikely that gold would benefit from a further slide in bond markets – in general, investors do not want to be caught holding assets that will be hurt by a withdrawal of stimulus.

Commodities’ Forecast Update: The Return of “Fundamentals”

123

25 June 2013

Exhibit 230: Forward inflation expectations have stayed well contained

Exhibit 231: Real interest rates are heading in the wrong direction for gold bulls

%

Yoy, %

Univ. Michigan 1 year ahead

6.0

US 1 year real rate

6.0

Fed 5yr Fwd Breakeven rate

5.0

4.0

4.0

2.0

3.0

0.0

2.0

-2.0

US CPI

-4.0

1.0 '00

'02

'04

'06

'08

'10

'00

'12

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

'02

'04

'06

'08

'10

'12

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

C. This month’s FOMC meeting raised the prospects of QE tapering in July. That triggered further gold liquidation. Our economists continue to think it more likely to start in September (see US Interest Rate Weekly, June 13) and we do not believe the actuality of a reduced rate of QE is fully priced in to gold yet. D. ETF liquidation has been a visible expression of the change in broader investor sentiment and, we think, has been self-reinforcing. It has not yet ended in our view and those expecting gold to stabilize around the $1,400 level have been disappointed. E. Notwithstanding its recent decline, gold remains an expensive hedge, both in real historical terms and in relative terms. In recent months, other assets have looked increasingly attractive and are expected to continue to do so. Our equity strategists look for another 15% upside in S&P 500 by year end (see: Global Equity Strategy – Equities: another 15% upside).

Exhibit 232: Gold – inflation adjusted since the end of Bretton Woods

Exhibit 233: Gold versus other commodities – performance since before GFC

US$, adjusted by CPI

Indexed to January 2006 Index

$2,000

600

$1,800

500

$1,600 $1,400

400

$1,200 300

$1,000 Post Bretton Woods Average

$800

200

$600

100

$400 0

$200

Jan 06

Jan 07

Jan 08 Gold

$0 '70

'75

'80

'85

'90

'95

'00

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

'05

Jan 09

WTI Crude Oil

Silver

Jan 10

Jan 11

Jan 12

Jan 13

Dow Jones UBS Commodity Index

'10 Source: Credit Suisse

124

25 June 2013

Conversely, those of a bullish persuasion would argue that: 1)

Asian physical demand (investment + jewelry) accelerated as the price sold off, reaching record levels during late April/early May, and that this demand will continue to support/push the price.

2)

There is now much greater dispersion of positioning amongst hedge funds and other investors than there was at the start of the year. Hedge funds in general are now broadly neutral. The threat of further liquidation has diminished.

3)

Producers are feeling the pain – projects are being cancelled or deferred, mine plans are being redrawn. Many juniors will run out of cash in H2. Global mine production probably peaked last year and will now start to trend down.

4)

Certain central banks took the opportunity of the slump in the gold price to accumulate reserves, adding support. More central bank buying will follow.

5)

Even if the Fed does scale back QE, it will still be buying assets, its balance sheet will still grow. That money creation must ultimately lead to inflation (the quantity theory of money) as economic activity picks up.

6)

Higher rates will exacerbate the longer-term debt dynamics of the US/affect the ability of the US to fund its deficit.

Essentially, it boils down to where you think the equilibrium lies between (predominantly Asian) physical demand in both jewelry and investment form plus EM central bank buying versus primary supply plus scrap supply plus investor sales. From that point onwards you can construct bullish/bearish arguments based on your view of the macro outlook (primarily US economy, monetary policy and rates). Our view is that the equilibrium point lies some way below where the market is trading today. Why? To take the bullish arguments in order:

1) Physical demand With respect to physical demand from the Middle East, Asia and India, we think the pace of buying seen in late April and May is unlikely to be sustained and will fade through the summer, over and above the normal seasonal quiet patch. Indeed, there are clear signs that this is already happening, with regional premiums easing and flows through our own physical desk tapering. The Indian market in particular appears to be struggling to come to terms with aggressive action from the Reserve Bank to moderate the inward flow of gold. The restriction on the gold consignment trade into India has raised funding costs and price risk for Indian dealers, while the increase in import duty from 6% to 8% coupled with a sharp depreciation in the rupee has further added to the cost burden. Previous attempts by government to moderate gold imports have not met with much success – the efforts either failed to make it into law, were subsequently abandoned, or were inconsequential. We doubt that the current initiative will fundamentally change the Indian market at the retail level but it already represents the strongest, most sustained attempt to limit imports. The government’s determination to see more local demand satisfied by internal flows rather than imports appears firm and does seem likely to have an impact on trade over the short-to-medium term. Meanwhile, although Middle Eastern and Asian demand for physical gold has remained relatively robust in comparison, the almost frenzied buying of late April/early May has subsided. In fact, regional premiums for kilo bars and other small bars have started to ease and the arbitrage for importers into China, while still positive, is diminishing. We also believe there has been significant accumulation of inventory over the last two months – in effect a chunk of future demand has been brought forward.

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Exhibit 234: Indian duties, the consignment ban and weaker rupee are offsetting USD price falls

Exhibit 235: Chinese arbitrage falling from Q2 peaks

Rupees per 10 grams (lhs), USDINR (rhs)

Weekly average, US$/oz

Rs30

$60

US$/oz

60

Thousands

Rs35

$50 $40

55

$30

Rs25

$20

50

$10

Rs20

-$10

INR Curncy (rhs) Rs15 Jan-11

40 Jul-11

Jan-12

Jul-12

$0

45

Gold, Rs/10g

Jan-13

-$20 -$30 Jan-09

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Jan-10

Jan-11

Jan-12

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Over the longer term, rising disposable incomes in emerging markets and the ongoing liberalization of the gold market in China, coupled with a lower gold price should be expected to lead to a rise in jewelry demand. But that growth will come only after a significant lag in our view, particularly given the vulnerability of many emerging market economies (and consumer spending on discretionary goods) to rising nominal yields. We note that annual jewelry demand would need to grow by 20% to 25% yoy to absorb the ETF liquidation seen during just the first five months of this year. The correlation between price and jewelry demand is also not linear, is influenced by macro-economic forces, and is subject to sizeable lags, as illustrated in the following two exhibits. Jewelry demand grew substantially from 1999 to 1996 when the price was largely static, and had started to fall well before the bull market became entrenched.

Exhibit 236: Jewelry demand, annual versus price, a non-linear relationship

Exhibit 237: Jewelry demand, quarterly versus price – no clear correlation since 2008

Tonnes & US$/oz

Tonnes & US$/oz

3500

Jewellery

3000

Price, annual average

2500

900

Jewellery, Qtly

2000

800

Price, Qtly average

1800 1600

700

1400

600

2000

500

1500

400

1200 1000 800

300

1000

600

Source: Thomson Reuters GFMS, Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

0

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13

Jan-11

Jan-09

Jan-07

Jan-05

Jan-03

Jan-01

Jan-99

Jan-97

Jan-95

0

Jan-93

200

0

Jan-91

400

100

Jan-89

200

500

Source: Thomson Reuters GFMS, Credit Suisse

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Similarly, demand has apparently been relatively steady since September 2008 onwards, despite the very large run up in price and subsequent slump. One problem is the data do not capture the influence of scrap flows. Investment demand in China is also likely to be sustained at a robust level relative to history but we doubt that it will be sufficiently large to drive price. Chinese investors have been as unsettled as those in western economies by the poor performance of the price over the last 18 months and, over the next three to five years, will increasingly gain access to alternative investments – both at home and overseas. We do not think the launch of ETF-type products in China will have a material impact on investment demand for a number of reasons (over and above the obvious: investor demand will be limited when there is no certainty price has bottomed): • Individual investors already have access to liquid, low-cost physical gold investment products – it is notable that none of the leading Chinese banks have developed ETFs; they already market gold trading platforms, bullion savings accounts and accumulation plans, and gold coins, bars and collectibles to their clients. • Qualified institutional investors have been able to access overseas listed ETFs for some time. • The Chinese mutual fund industry is not structured and regulated in the same way as the fund industry in Europe or North America, and the marketing of new funds operates quite differently. We do not think there is likely to be much institutional appetite for a gold-linked exchange traded product, particularly given that the ETFs proposed will not accumulate bullion directly but will do so via contracts traded on the Shanghai Gold Exchange. That, perhaps, is reflected in the modest targets of the exchange traded funds that have been announced: Huaan Asset Management, for example, aims to attract $400 million in initial funding, which would represent less than 300,000 oz of gold at today’s price.

2) Reduced positioning Positioning amongst hedge funds and other investors has certainly been greatly reduced from the peaks. Non-commercial long exposure via Comex has dropped almost 50% to a little over 16 million oz, while shorts have risen to around 10 million oz, leaving the net position at just over 6 million oz. That sounds low relative to the post-Lehman period, when the net position was typically in the high 20 million oz area but as recently as Q1 2007 the net exposure was frequently below 10 million oz. Prior to the bull market starting the market norm was for net positioning to be flat to net short. If something were to occur to cause the shorts to cover en-masse then gold could stage a sharp rally but in our view such a move would be temporary and we do not think the prevailing macro-economic conditions favor that outcome. One manifestation of the reduced desire to hold gold as insurance against often poorly quantified risks of uncertain timing has been the rapid reduction in ETF holdings of metal. The on-going liquidation has already persisted for longer and in greater size than most would have predicted. This gold was, after all, supposed to be held by “sticky” hands. To date this year total ETF holdings of gold have been cut by ~515 tonnes, taking the total down to a still substantial 2,115 tonnes.

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Exhibit 239: ETF holdings – liquidation finished?

Million oz, futures+options, net positioning versus non-commercial shorts

Million oz

40

Net spec (m. oz)

Non-comm short

90

30

80

20

70

Millions oz

Exhibit 238: Comex net speculative positions

60

10

50 0

40 -10

30 Jan-09

Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse

Jan-10

Jan-11

Jan-12

Jan-13

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service,

Since 2005 the correlation between weekly changes in ETF holdings and changes in the gold price has been positive, though volatile and prone to periods of sharp reversal. Using a three-month rolling correlation of weekly returns gives an average over the eight-year period of 0.47 (Exhibit 240). Focusing in on this year, the correlation jumps to 0.83 – the link between ETF holdings and price has been sustained at a high level since the price correction began. The question of whether price drives ETF sales or ETF sales drive price is far less clear cut. The correlation increases if we lag changes in ETF holdings to price by one week the average positive correlation this year rises to 0.90, if we reverse the lag (price lags ETF holdings by a week) the correlation drops to 0.74. That tends to imply that a proportion at least of ETF flows are price following rather than price setting. That simplistic statistical analysis, however, is not rigorous and there are problems with the underlying data. Not least of those is the intermediation of market makers in ETF flows, who can hold substantial inventory of ETF shares between redemption and creation. Nevertheless, it could give comfort to bulls who believe that if other investor selling has run its course, and price stabilizes, then so will ETF holdings. We are not convinced. In early 2010 (pre-QE2) ETF holdings were ~1,930 tonnes. The factors that drove total ETF metal above 2,900 tonnes were a combination of the “fear” factors outlined above plus a degree of trend-following. Given that fear of events such as a rapid break-out in inflation or dollar depreciation has faded, and the trend has ended, it is not unreasonable to think that ETF holdings could return to pre-QE2 levels (accepting that there may well be some degree of investor inertia). One likely catalyst for that, over and above the ongoing gradual improvement in the US economy, will be if/when the FOMC votes to reduce the rate of QE. Our US rates strategists and economists expect that is likely to come in September (depending of course on data between now and then). Confirmation that conditions have improved sufficiently for stimulus to begin to be scaled back would be very likely to trigger a reacceleration in ETF liquidation. A fall in ETF holdings back to pre-QE2 levels implies a gold price back in the $1,150 to $1,200 region – highlighted by the red circle on Exhibit 241.

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Exhibit 240: 12 week rolling correlation – ETF holdings and gold price

Exhibit 241: ETF versus price, weekly, since 2005

Blue line = period average

Price, y-axis, $/oz. ETF holdings of gold, x-axis, millions oz

1

$2,000 R² = 0.9292 $1,800

0.75

$1,600 0.5

$1,400 $1,200

0.25

$1,000

0

$800 -0.25

$600 $400

-0.5

$200

-0.75

$0 -1 Jan-05

0 Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Jan-12

10

20

30

40

50

60

70

Jan-13

80 90 Millions oz

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

3) Producers feeling the pain The argument that rising costs over the past several years means that a significant portion of mine supply will be uneconomic at prices not far below spot, and therefore price will not fall far below spot (or if it does it will only be for a short period of time), is one that does not stand up to scrutiny in our view. There are a number of problems with trying to assess cost support for gold using marginal cost of production metrics. The primary one of these is that above-ground refined inventories of gold are massive relative to mine supply. That is not new; Newmont Gold’s 1993 annual financial report summed the situation up rather well: “The demand for and supply of gold affect gold prices, but not necessarily in the same manner as supply and demand, may affect the prices of other commodities. The supply of gold consists of a combination of new mine production and existing stocks of bullion and fabricated gold held by governments, public and private financial institutions, industrial organizations and private individuals. As the amounts produced in any single year constitute a very small portion of the total potential supply of gold, normal variations in current production do not necessarily have a significant impact on the supply of gold or on its price.” We concur. The above-ground refined stock of gold is currently estimated at ~177,000 tonnes (data sourced from ABARES and GFMS). Of that total, investment accounts for ~25%, central banks ~20%, jewelry ~45%, and industrial applications the remainder. If we are conservative and assume that only one-third of gold held for investment purposes and only 15% of jewelry stock is near-market, that alone gives us around 27,000 tonnes of potential metal flow or 10x annual mine production (Exhibit 242).

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Exhibit 242: Above-ground gold inventories dwarf mine supply tonnes

35,000

Total inventory Jewelry, 79,650

Near market stocks vs supply

30,000 Near market jewelry

tonnes

25,000 Industrial, 17,700

20,000 15,000

Near market investment

10,000 5,000

Central banks, 36,100

Investment, 44,250

Annual mine supply

0

Source: Gold Fields Mineral Services, ABARES, Thomson Reuters GFMS, Credit Suisse estimates

Even if one could construct an argument why marginal costs should be relevant to the gold price in the shorter term, costs are not static. They go up as well as down. In particular there have been large moves in FX rates recently that will have benefited the margins earned at operations in countries like Australia (AUD depreciated by ~9% in two weeks in June) and South Africa (ZAR depreciated by 19% over the last nine months). And perhaps more pertinently, in a falling price environment we would expect the trend of falling grades/rising costs per ounce to be reversed as cut-off grades rise and reserves fall. We do think gold production costs are relevant to the price of the metal but over a time span measured in years, in contrast to a commodity such as iron ore, where above ground stocks are measured in weeks, not decades. Note also that in the 1980s – the last gold bust – cost of production proved less of a barrier than most had anticipated, with costs falling steadily right through to 2000 (in both nominal and real terms). It is also notable that the industry spent several years from the mid-1990s onwards with the price of gold in real terms very close to, or below, the average C3 cash cost in real terms (see Exhibit 243).

Exhibit 243: Average gold mining industry cash costs versus gold prices (real) Deflated to 2012 US dollars. Shaded section highlights price close to or below cash costs.

1800

C3 costs (real) Average gold price (real)

1600

$/oz Au

1400 1200 1000 800 600 400 200 1980

1985

1990

1995

2000

2005

2010

Source: Credit Suisse, Wood Mackenzie

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4) Central banks will buy more Other than developing market gold producing nations such as Russia and Kazakhstan, central banks appear to have largely stepped away from the gold market as the price has fallen (they may not be active sellers but neither does it appear that they are they buying). According to IMF data, Mexico and the Philippines, for example, last bought in Q1 2012 when the metal was trading >$300/oz above where it is today. The last major purchase recorded by the IMF was by South Korea, which bought 20 tonnes in February this year. In fact, changes in central bank reserves have been very modest in the context of the wider gold market since Q2 2010 (Exhibit 244).

Exhibit 244: Changes in bank gold reserves QoQ, tonnes

500

Change Q on Q

400

tonnes

300 200 100 0 -100

Source: the World Gold Council, IMF, Credit Suisse

The exception may be China. It is possible that the PBoC, via other state entities, has accumulated a substantial volume of gold in recent months that will only appear on the Bank’s balance sheet at a time of its choosing – in 2009, the PBoC announced the transfer of 454 tonnes from SAFE to its books. However, even if Chinese official buying has been occurring it has not been sufficient to keep gold supported. It took a long time for central bank reserve managers to enter the market on the buy-side. We don’t think they are likely to reverse their diversification policies and will remain net buyers, but are unlikely to step in while price is still falling (that would run counter to the historical pattern of purchasing) and not in sufficient volume to drive prices higher. Central banks are very keen for their activities not to disrupt (or even give the appearance of disrupting) the markets in which they operate.

5) Fed balance sheet growth = inflation The bullish gold argument goes that even if the Fed does scale back QE, it will still be buying assets and its balance sheet will continue to grow. That money creation must ultimately lead to inflation (the quantity theory of money) as economic activity picks up. The Fed will then be behind the curve, fearing another recession if it raises rates too soon. The lack of inflation, several years into zero short-term interest rates and quantitative easing, remains a puzzle to some gold bulls. Why, when the Federal Reserve’s balance sheet has increased by something like 250% over 4½ years and is on course to exceed $3.5 trillion around year-end, has core inflation fallen and inflation expectations tracked

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sideways? Perhaps more than in any other, the concept that inflation is always a monetary phenomenon (as Milton Friedman described it) is alive and kicking in the gold market; i.e., an increase in money supply should result in rising velocity of money and consequently a general rise in prices.

US$ trillion

Exhibit 245: Federal Reserve balance sheet versus gold – a questionable relationship 4.0

$2,000 Fed Reserve balance sheet (lhs)

3.5 3.0

$1,750 Gold

$1,500

2.5

$1,250

2.0

$1,000

1.5

$750

1.0

$500

0.5

$250

0.0 Jan-99

$0 Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Leaving aside the philosophical and economic arguments between monetarists and their opponents, there are two particular problems for inflationistas at present; one practical, the other of perception. The practical issue essentially rests on the fact that although money supply has expanded rapidly, demand for it has not, primarily because: • Fiscal tightening (austerity) has been prescribed as the medicine of choice for indebted economies and governments; • Public and private deleveraging is ongoing; • The banking sector is still going through a massive recapitalization program, shrinking balance sheets, decreasing leverage, and holding more capital against risk – a significant portion of the rise in Fed balance sheet has been mirrored by a rise in bank holdings of cash and Treasuries. And so although growth in money supply has been stellar, growth in economic output and credit has not – the Fed can create money, it is much more difficult to force banks to lend it into a still soft economy (in economics-speak, the money multiplier has declined). The divergence since the collapse of Lehman Brothers is illustrated in Exhibit 246.

Exhibit 246: Money supply and inflation – a broken relationship Average annualized growth, Q3 2009 to Q1 2013

Region US UK Euro area Japan

Monetary base, %

M2, %

Core CPI, %

26.2 32.8 11.7 9.4

6.4 4.7 3.2 2.8

1.6 3.5 1.4 -0.9

Source: Federal Reserve, Bank of Japan, Bank of England, ECB, US Bureau of Labor Statistics, UK ONS, EuroStat, Japanese Ministry of Internal Affairs and Communications – via Federal Reserve of St Louis

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Consider the US example: economists of a Keynesian leaning would argue that the initial post-GFC stimulus peaked too soon, a mistake that was subsequently exacerbated by deep cuts to state and local government budgets, followed by the Congress-enforced Federal spending cuts via the sequester. True, in absolute terms Federal spending is projected to continue to rise but it will do so more slowly, while spending as a proportion of GDP (whether actual or potential) is falling at a time when spare capacity across much of the economy remains substantial. As our economists wrote in a recent report (see Global Inflation Watch, 28 May) “the mediocre recovery from the Great Recession depths has not closed the output gap in any substantial way. The Congressional Budget Office’s measure of the gap remains deep in the red.” In addition, corporate and consumer demand for credit is expanding but only at a moderate pace (one that lags well behind the credit growth seen after the 1990/91 recession for example). And, at the margins, an environment in which energy prices are tracking sideways and many other commodities are shifting downwards, will also act to moderate inflationary pressures. There is now a large body of literature that questions the reliability of monetary aggregates in forecasting prices. Problems include difficulties in measuring money supply and the non-linear and variable lead-lag relationships between money supply and the broader economy. The debate has also been further clouded by the idea that increased securitization of debt and the ability to use of those securities as collateral has shifted the supply of credit away from commercial banks to the shadow banking sector. In summary, growth in monetary aggregates is not in our view a good predictor of future inflation – the rate of increase in demand for credit, particularly short-term collateralized borrowing may be better series to watch. Which comes back to the point that until there is a significant upturn in the demand for credit, the growth in money supply (whether expressed as the Feds balance sheet or M2) will remain largely irrelevant as far as PCE, CPI or any other measure of inflation is concerned. The problem of perception relates, in the US example, to the Federal Reserve. The Fed is treading a fine line between monetary policy and politics: the need to avoid deflation/generate growth at almost any cost is driving the former but that has to be put in the context of heightened political scrutiny to ensure that the Fed is not ‘going soft’ on inflation. Considerable effort has been made by the Chairman of the Fed and members of the FOMC to reassure the domestic audience that the Fed has the tools to withdraw stimulus when conditions justify it and has the determination to use them. The recent steep market corrections, triggered by suggestions that the pace of QE might be slowed, illustrate the difficulties of navigating this course. That, and the lack of a sustained move up in inflation expectations, suggests that the Fed may have been too successful in reassuring the right of the political spectrum that it will withdraw accommodation in good time. However, in contrast to some central banks (an example being the Bank of England) the Fed is not able to “credibly promise to be irresponsible” – that is, signal to investors that it will let inflation rise (temporarily) above target in order to shift inflation expectations upwards. According to our economists’ projections, core CPI in the US is expected to remain within a 1.6% to 1.9% range for the next 12 months, and will only slowly move above 2.0% in the latter part of 2014. That is not an encouraging scenario for gold. Numerous questions and uncertainties remain over the longer-term ability of the US to run a balanced budget and, related to that, to reign in federal spending. However, over the next several years the outlook is one of improvement, according to the latest Congressional Budget Office projections. Federal spending as a percentage of GDP has reversed sharply, the percentage of debt held in public hands, while still high, is likely to ease back a little, and the annual deficit is set to shrink markedly over the next two years. The can (and any potential crisis point) has been kicked firmly down the road.

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Exhibit 247: Federal spending and debt held by the public to stabilize as % of GDP

Exhibit 248: US annual deficit projected to shrink rapidly over the next two years

% of US GDP

US$ billions

Federal outlays, % of GDP (lhs)

30

Forecasts

0

90

Federal Debt Held by the Public, % of GDP

80

-200

60 50 20 40 30 15

US$ billions

70

25

-400 -600 -800

20

Source: Congressional Budget Office, Credit Suisse

2023

2022

2021

2020

2019

2018

2017

2016

2015

2014

-1,200

2013

2023

2018

2013

2008

2003

1998

1993

1988

1983

1978

0

1973

10

-1,000

2012

10

Source: Congressional Budget Office, Credit Suisse

Outside the US, there is evidence that the tide of austerity may be turning, notably in Europe. And in Japan, of course, the BoJ is trying to lead investors down the opposite path. But it is the US that matters most to gold. If political opinion shifted to the extent that the Fed felt able to signal a more relaxed stance on forward inflation, or if Congress were to back more direct incentivization of lending, then the outcomes could potentially be quite bullish for gold. That, however, seems highly improbable – much more likely in our view is that the status quo (a ponderous recovery with little pressure on goods and services prices and wages) continues for some time to come.

6) What about the effect of rising rates on the debt burden of the US? Further down the line, markets may begin to question the effect that higher interest rates could have on the cost to the US of servicing its debt burden. Associated with that is the potential political fallout of the Fed realizing losses on the value of its MBS and Treasury holdings. Our economists recently illustrated the effect of rising rates on the US federal debt in a chart that we have reproduced in Exhibit 249.

Commodities’ Forecast Update: The Return of “Fundamentals”

Exhibit 249: Forecast interest rate impact on US federal debt 0

US$ billions

Although over the long run, higher rates will see the US debt situation worsen, over the next two to three years the effect will be minimal: a 1% rise would have the effect of increasing the total debt outstanding by less than $200bn over the next three years (Exhibit 249). In short, higher rates are far more likely to pressure gold lower as real rates climb back into positive territory than they are to push gold investment demand up on concern about the US debt burden.

-1000

+1%

-2000

+2%

-3000

+3%

-4000

+4%

-5000

+5%

-6000 '12

'13

'14

'15

'16

'17

'18

'19

'20

'21

'22

Source: Congressional Budget Office, Credit Suisse estimates

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25 June 2013

Silver – Is relative stability too much to hope for? Given its historical volatility it could be considered foolish to forecast an extended period of price stability for silver, particularly when we are still bearish gold. However, in a low inflation moderate growth environment relative stability over the medium term may just be what the market gets – notwithstanding some near term volatility. Our forecast deck has been cut back to reflect the realities of the current price (of both silver and gold) but we see only limited downside from here on. That outcome will depend on silver moderately outperforming gold over the next 12 to 18 months. That in turn will require global growth to perform in the stable manner that our economists expect (refer back to Exhibit 10) and for investors therefore to see better value in the more industrial white precious metal relative to gold. So there are clearly a number of big “ifs” in that scenario, and some significant risks that are in our view skewed to the downside – another global slow-down scare would very likely see silver underperform again. Chinese economic activity slowing by more than anticipated would also present a sizeable risk and, critically, we will be looking for a rebound in Chinese net trade in silver in May, which was subdued during the previous two months (Exhibit 250).

Exhibit 250: Chinese trade in silver; looking for imports to bounce in May/June

tonnes

tonnes

400

Net imports

200 0 -200 -400 Net exports

-600 05

06

07

08

09

10

11

12

13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse, CEIC

There is also no conceivable cost support for the metal until at least the mid-teens. Major end users have also shown little appetite for hedging at current levels and investor holdings of metal (both via ETFs and small bars / coins) remain very large. But while we recognise that we may be guilty of a degree of over-optimism, if global markets can avoid another severe risk-off event there are reasons for thinking the worst might be over for the silver price. In particular, it appears that growth in industrial demand has probably passed the low point. The global solar (photovoltaic) cell industry has been grappling with overcapacity and falling prices for some considerable time. Now, however, it appears that pricing may have turned a corner, the industry is in our view through the worst of a painful restructuring period, and although trade conflicts persist, recent EU antidumping duties were less onerous than anticipated. Meanwhile the use of silver in medical applications continues to expand rapidly. At the same time combined mine and scrap supply is likely to slip lower this year before stabilizing (byproduct losses from a shrinking gold sector being offset by growth from lead/zinc operations). Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

So although ongoing support will be required from investors to absorb the surplus, it does look likely to shrink over coming years (Exhibit 251).

Exhibit 251: Silver supply demand forecast – a less dysfunctional market ahead Million ounces

1,200

Price spikes: scrap supply & producer hedging surges

1,100 1,000 900 800 700 600

Global Financial Crisis: demand collapses

Total supply

500

Total fabrication demand

400 2005

2007

2009

2011

2013

2015

Source: Thomson Reuters GFMS, Credit Suisse

Solar demand – light at the end of the tunnel? The global solar cell manufacturing industry has been through a torrid time of late, with massive overcapacity contributing to a collapse in product prices, leading to wholesale restructuring of the sector. That, combined with cuts to subsidies for solar generation in some key markets meant a sharply reduced rate of growth in solar power installations in 2012. Silver consumption took a double hit as new conductive pastes containing much reduced precious metals content were commercialized.

Exhibit 252: Crystalline silicon PV prices appear to have turned the corner

Exhibit 253: Installation of solar generating capacity is on the up

Average crystalline silicon photovoltaic cell price, US$/Watt

Megawatts of capacity installed

megawatt

$1.60 $1.40 $1.20 $1.00

35 30 25 20

$0.80 15

$0.60 10

$0.40 $0.20

5

$0.00 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13

0

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

2004

2006

2008

2010

2012

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse forecast

Now, however, we think that the worst may be over. Product pricing appears to have turned a corner as numerous bankruptcies have removed spare capacity, and the rate of installations globally is forecast to accelerate.

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Consequently, it looks as if the solar power sector’s demand may be about to become a source of growth in demand for the metal again, albeit at a much reduced rate compared to 2009-2011.

Exhibit 254: Consumption of silver in photovoltaic cells tonnes

2,500 2,000 1,500 1,000 500 0 2000

2002

2004

2006

2008

2010

2012e

2014f

Source: Credit Suisse estimates

Positioning – funds out, physical still in Funds trading silver via Comex futures and options have pared long positions back this year, with non-commercial reporting entities reducing longs by 20 million oz to around 175 million oz and non-reportable long positions falling by 35 million oz to ~108 million oz. Meanwhile non-commercial shorts have climbed from less than 40 million oz at the start of the year to almost 160 million oz today, and non-reportable shorts have also risen. The majority of those shorts were added between mid-February and mid-April as the price broke down through $30 and then $25, and holders appear content to wait for another sharp move lower. Clearly if something were to occur to cause the majority of those shorts to close their positions the price would most likely spike several dollars but we think that such mass-short covering is unlikely at present. The net result, however, is that in aggregate Comex speculators are the least long silver since 1997 (Exhibit 255).

million oz

Exhibit 255: Silver – Comex fund positions non-rep long non comm long non-rep short non-comm short 600 net spec position 500 400 300 200 100 0 -100 -200 Jan-13

Jan-12

Jan-11

Jan-10

Jan-09

Jan-08

Jan-07

Jan-06

Jan-05

Jan-04

Jan-03

Jan-02

Jan-01

Jan-00

Jan-99

Jan-98

Jan-97

Jan-96

-300

Source: CFTC, the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

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Conversely, and in contrast to the gold market, silver ETF holdings of metal have remained relatively static. Total silver held against ETF shares is around 608 million oz (18,911 tonnes), down less than 5% from the peak in March of 635 million oz. Recent liquidation appears to have abated, at least for the time being. Gold ETF holdings in comparison are more than 19% off the peak and liquidation has been seen throughout most of June. The behaviour of the holders of physical inventory, both OTC as well as ETF, will be critical to price direction in coming weeks.

Exhibit 256: Investor long positions in silver ETFs and Comex futures versus price

Million oz

Million oz and $/oz

iShares SLV

ZKB ZSIL

Others

Swiss Global

Comex net long

Price

1,000

$50

800

$40

600 $30 400 $20

200 0 Jan-10

$10 Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse

Exhibit 257: Silver supply/demand balance looking better Million oz

2009

2010

2011

2012

2013

2014

2015

2016

Supply Mine production Net official sector sales Silver scrap Producer hedging Total supply

710 14 166 0 889

750 45 225 61 1,081

758 13 254 35 1,061

785 9 215 25 1,034

801 9 198 10 1,018

817 7 187 5 1,016

830 6 179 5 1,020

846 6 178 5 1,035

Demand Industrial applications Photography Jewelry & silverware Coins & medals Total fabrication demand Net official sector purchases Producer de-hedging Implied net investment (ETF's+OTC) Total consumption

352 83 216 79 730 0 22 137 889

487 73 217 101 879 0 0 178 1,057

498 68 208 122 895 0 0 166 1,061

513 63 210 97 883 0 0 151 1,034

536 60 214 92 902 0 0 116 1,018

568 59 220 90 936 0 0 79 1,016

596 57 227 88 968 0 0 52 1,020

623 55 231 89 998 0 0 36 1,035

Source: Credit Suisse forecasts, Thomson Reuters GFMS, WBMS, the BLOOMBERG PROFESSIONAL™ service

Commodities’ Forecast Update: The Return of “Fundamentals”

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Forecasts: Exhibit 258: Gold forecast comparison

Exhibit 259: Gold historical price and forecast

US$ per metric tonne

US$ per metric tonne

$1,600

CS Forecast

Forward Curve

Bloomberg Forecast Mean

$2,100

Gold (Spot)

Quarterly Avg Forecast

$1,900

$1,500 $1,700 $1,500

$1,400

$1,300

$1,300 $1,100 $900

$1,200

$700

$1,100 $500

$1,000 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

$300 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 260: Silver forecast comparison

Exhibit 261: Silver historical price and forecast

US$ per metric tonne

US$ per metric tonne

$29

CS Forecast

Forward Curve

$55

Bloomberg Forecast Mean

Quarterly Avg Forecast

Silver (Spot)

$28 $45

$27 $26

$35

$25 $24

$25

$23 $22

$15

$21 $20 Q3 13

Q4 13

Q2 14

Q1 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

$5 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 262: Forecast Gold and Silver prices US$ per ounce, long-term prices based on 2012 real prices

Gold US$/oz Silver US$/oz

1Q-13

2Q-13f

3Q-13f

4Q-13f

2013f

1Q-14f

2Q-14f

3Q-14f

4Q-14f

2014f

2015f

2016f

2017f

LT

1,630 30.10

1,410

1,310

1,250

1,400

21.20

24.20

1,220 21.40

1,190 21.60

1,150 20.90

1,150 21.30

1,180 21.30

1,200 22.60

1,250 23.10

1,340 24.40

1,300 22.80

23.40 22.20

Source: Credit Suisse Commodities Research

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Platinum Group Metals RESEARCH ANALYSTS Commodities Research Tom Kendall [email protected] +44 20 7883 2432 Supply Model Contributors Equity Research Liam Fitzpatrick [email protected] +44 20 7883 8351

The commodity price forecasts mentioned in this section have been provided by the Commodities Research analysts above.

Platinum – Great expectations (of disruption) Questions about the future rate of supply growth from South Africa have been at the forefront of investors’ minds for some time. At the start of the year, the potential for heightened disruption to supply from industrial disputes was a key driver of investment flows and price. The expectation was that a combination of deep cuts to capacity at Anglo American Platinum (Amplats) plus inter-union rivalry and looming wage negotiations would be a very positive combination for price. Those expectations were instrumental in driving a strong rally from $1,550 at the start of the year to almost $1,750 five weeks later. Since then, however, it has been mostly downhill for the platinum price as tensions in the country have been dampened by a more conciliatory approach from producers and a more interventionist role being taken by government to avoid a repeat of the violence and lost revenues of H2 last year. Specifically, following a detailed consultation with government and unions, Amplats reduced the scale and speed of implementation of its restructuring program, while ministers have pushed “sustainable mining” framework that highlights the need for stability and respect for labor laws. So for now the risks of widespread production losses due to industrial action appears to have receded somewhat. Meanwhile, output has been recovering somewhat from the Q3 2012 lows, when so much output was lost to strikes, while a sharp depreciation of the rand (down ~11% in May alone, and ~19% since last September) has helped drag margins for producers up off the lows (Exhibit 263).

Exhibit 263: Depreciating rand has lifted PGM basket price off the lows

16,000

$/oz

18,000

Rand/oz

Basket of Pt+Pd+Rh in ZAR/oz (lhs), platinum price in USD/oz (rhs)

2,000

14,000 12,000

1,500

10,000 8,000

1,000 3-PGM Basket, ZAR/oz

6,000

Platinum, US$/oz (RHS) 4,000 Jan-07

500 Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

The net result is that the threat of imminent loss of ounces due to industrial action and wholesale shaft closures has receded. In addition, while most (perhaps all) greenfield projects if initiated today would not generate sufficient internal rates of return to justify investment, two new large mines where the majority of capex has already been sunk are moving close to delivering additional ounces to the market – Northam’s Boysendaal operation and the Western Bushveld Joint Venture.

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So the temperature has been reduced and the platinum price has come off the boil – not least because demand from the key European autocatalyst market remains anemic. But in our view the necessary supply response to weaker metal prices and thin to negative margins has only been deferred, not abandoned, while the potential for industrial action to flare up again is still high (as recent unauthorized stoppages at both Amplats and Impala Platinum operations suggest). In the current wage negotiation round, unions are pushing for annual increases in excess of 10%. And the situation is made more unpredictable by the fact that the leading producers will be negotiating with the AMCU as the largest union on the mines for the first time. For its part, we think it likely that AMCU leaders will be under considerable pressure to deliver substantive increases for its newly enlarged membership. From the mining companies’ perspective, wage settlements in the order of 9% to 11% (which have become the norm in recent years) would worsen the already precarious economic state of a significant number of shafts. The pressure to close or restructure loss-making mines would intensify again. On the demand side of the coin the European autocatalyst industry remains very weak but may now have at least be in the process of bottoming. If the best we can say about the second largest market for platinum is that the rate of contraction is slowing, that is not exactly a ringing endorsement of a bullish price view. However, emissions legislation (particularly of the heavy duty trucking sector) will likely provide some growth in demand. Lower prices have also provided a fillip to Chinese jewelry demand, the largest single sector of consumption. Meanwhile, speculative positioning in futures and options is substantially off the highs, and the launch of South African-listed physical ETF has been getting an enthusiastic reception from local investors. Consequently we believe the downside to price below $1,400 is limited and retain a positive outlook, albeit slightly less so than in our previous forecast update.

European car sales may have reached the bottom! Car sales across the EU15 countries gave back some of the previous month’s strong gains in May. That, however, is consistent with the volatile month to month nature of the data and the smoother trend does still suggest (albeit not convincingly yet) that a bottom may have been found (Exhibit 264).

Exhibit 264: EU15 light vehicle sales may have hit the bottom, but the recovery is likely to be a long and bumpy road EU15 car sales, monthly, sa with trend

Monthly, sa

1,400

Trend

1,200

1,000

800 1990

1995

2000

2005

2010

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

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Perhaps that is grasping at straws but when put alongside bouncing eurozone IP and new orders, perhaps not. And platinum demand will also get a moderate but welcome boost from the phase in of Euro 6 emissions regulations (from Jan 2014 onwards) as well as from the continuing spread of platinum-containing catalysts throughout the non-road vehicle sectors in developed markets. The rate of that non-road demand growth will be tempered this year by a slow down in mining equipment sales but more importantly in the near term, US truck production continues to be a source of strength (Exhibit 266) and still has significant potential upside we think.

Exhibit 266: EU truck sales show signs of life

Seasonally adjusted annualized rate, millions

Commercial vehicles, ’000 of new registrations per month, seasonally adjusted

60

0.6

Thousands per month, sa

Millions, SAAR

Exhibit 265: US truck assembly a source of strength

0.5 0.4 0.3 0.2

50 40 30 20

0.1 0 Jan-05

Jan-07

Jan-09

Jan-11

10 Jan-05

Jan-13

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Jan-07

Jan-09

Jan-11

Jan-13

Source: Credit Suisse, AECA

Chinese jewellery demand responding to lower prices More clearly positive than autocatalyst demand for platinum has been the response of the Chinese jewelry market to lower prices. It appears that the damage to platinum’s brand value from the fall in price below that of gold (in the market, if not at retail level) was temporary. Jewelry manufacturers, who still enjoy better margins on platinum products, have been strong buyers, particularly following the February and April falls in price (Exhibits 265 and Exhibit 266).

Exhibit 267: SGE platinum volume versus price

Exhibit 268: SGE platinum, year to date volume

SGE volume, oz

20

SGE price, RMB/g (LHS)

400

15

350

10

300

5

1,200

2008

2009

1,000

2010

2011

2012

2013

800 600 400 200

250 Jan-11

0 Jul-11

Jan-12

Jul-12

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

Thousands oz

450

Thousands oz

Weekly, cumulative, ’000 oz

week

0 1

5

9 13 17 21 25 29 33 37 41 45 49

Source: Credit Suisse

142

25 June 2013

The volume of platinum purchased via the Shanghai Gold Exchange is still a reasonable indicator of jewelry demand we think. Turnover on the exchange for the year to date totals 600k oz, up 20% yoy.

Positioning – South African ETF gives fresh impetus The absence of more meaningful cuts to supply or labor disruption to operations has, it appears, disappointed funds who had taken long positions via Nymex futures and options in anticipation of a difficult South African winter. We were amongst many who felt that the labor relations environment would be more difficult than it has so far proven to be: our Q2 forecast was $1,630, some 9% above where the price will have averaged during the quarter. The relatively minor disruptions to production seen so far, combined with Amplat’s scaled back restructuring program, resulted in the net long position being cut in half from a peak of almost 3 million oz in mid February to less than 1.5million oz by mid June (Exhibit 269).

Thousands oz

Exhibit 269: Disappointed speculators have liquidated… 3,000

Net spec ('000 oz)

Non-comm longs as %OI

80 %

2,500

70

2,000

60

1,500

50

1,000

40

500 Jan-10

30 Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse

In contrast to funds trading Nymex derivatives, the physical investor base received a substantial boost from the launch of a South African listed platinum ETF. The ABSA NewPlat ETF was only launched in late April but has already amassed almost 400k oz of platinum (Exhibit 269). Clearly domestic investors, who until now have been unable to access overseas listed ETFs due to regulatory restrictions, have welcomed the opportunity to trade the metal rather than the mining equities (or trade the metal against the mining equities). ETF flows outside of South Africa, however, have been muted since the start of the year, with very little change in the net amount of bullion held.

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Exhibit 270: While investment into the South African ETF has surged; investors outside the country have yet to re-engage. Net result = little price reaction 000 oz of metal held (lhs), price $/oz (rhs)

Thousands oz

2,250

$2,250 Plat. Ldn Pt other ABSA

2,000

Bskt Ldn Plat. US Plat, spot

Plat. ZKB Plat. Swiss

$2,000

1,750 $1,750 1,500 1,250

$1,500

1,000

$1,250

750 $1,000 500 $750

250

Apr-13

Jan-13

Oct-12

Jul-12

Apr-12

Jan-12

Oct-11

Jul-11

Apr-11

Jan-11

Oct-10

Jul-10

Apr-10

Jan-10

$500

Oct-09

0

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Palladium – Delayed gratification We retain our long-term bullish outlook for palladium but given a slowing China and high level of speculative and investor positioning we have trimmed our forecasts. Demand for the metal should continue to be driven by emerging market car sales (China is still growing, just less quickly) and emissions legislation, while supply growth is likely to be muted and dependent on South African and Zimbabwean projects. Consequently we see annual deficits persisting through to 2016, even though we already factor ongoing demand destruction in dental alloys and electronics applications, as well as reduced investor demand over the medium term as some take profit into a rising price. In the short term, however, we repeat our previous note of caution about the high level of long positions in the metal that investors already hold and reiterate that we think it will be 2014 before the market begins to tighten appreciably. Still, the majority of those investor positions appear to be held for the long term – they have remained largely intact through several eurozone risk-off scares, and investors generally appear able to withstand sizeable pockets of volatility. If the June emerging market sell-off persists into July they may have to brace themselves for another one – we don’t rule out another sharp correction back to the Q2 lows around $650. However, given that supply is constrained, autocatalyst demand is relatively inelastic, and the palladium market is small by most standards, the price reaction if (when?) global growth finally gets some traction could be substantial. Indeed, we think that is one of the reasons why so many longs are prepared to weather the short-term squalls. The problem is that the point of gratification just got delayed, again.

Supply growth slowing, Russian sales in March a one-off? The South African PGM supply issues have been widely discussed and affect palladium as well as platinum. After a recovery this year from a 2012 that was heavily disrupted by labor unrest, we think growth in South African palladium output will likely slow to a crawl. Rand depreciation has given some near-term relief to producers but we do expect to see further rationalization of capacity over the next 12 to 18 months. North American production is unlikely to deliver the growth in ounces that seemed possible a year ago.

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The other, perennial, question mark is over Russian sales of metal from state inventories. The delivery into Zurich of just under 300k oz in March this year came as a surprise to the market but is likely to have been a one-off in our view. We understand the metal had been shipped from Russia some time previously to bonded storage and does not, in our view, signal a resumption of significant exports of state metal.

Exhibit 271: Swiss imports of Russian palladium – March flow a one-off ? Unwrought palladium (HTS 7110.21), kg per month

70,000 60,000 50,000

kg

40,000 30,000 20,000 10,000 0 Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

Jan-13

Source: Global Trade Atlas, Credit Suisse

Rate of growth in Chinese car sales may ease back but emission limits will tighten The Chinese light vehicle market has been robust so far this year, posting year to date gains of 13.3% and fluctuating around the trend that has been in place since the 2009 stimulus faded. The Chinese vehicle market will not be immune from a broader slowing in activity but should, in our view, be insulated from the worst effects. Personal mobility remains a key aspiration of the expanding middle class, the vehicle park is still low relative to population, and cash is still more commonly used than credit for purchases. Vehicle ownership has been made more expensive via licensing and taxation in the congested eastern seaboard but not in the center and west. And when considering the imperatives of rebalancing the Chinese economy away from and investment/export led model towards domestic consumption, vehicle production will be near the forefront of that. So we are a little circumspect in the short term – sales may well fall below trend again over the next several months – and we apply a judicious haircut to the more bullish auto analyst projections of longer term growth, but growth there will still be. And with respect to palladium demand, the urgent need to improve air quality will continue to act as a powerful force for tighter auto emission limits. That will, over the medium term, see average palladium loadings in Chinese vehicle catalysts trend upwards.

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25 June 2013

millions per month

Exhibit 272: Chinese auto sales remain on trend 1.80

China auto sales (passenger cars), SA millions China auto sales (passenger cars), nsa

1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

US auto market recovery still on track, with truck sales a highlight The US, meanwhile, remains a bright spot for the auto industry and palladium demand. Total light vehicle sales have continued to recover, with pick-up trucks maintaining a high market share. The commercial vehicle sector also appears to be in good health, with the rate of production of medium and heavy duty trucks accelerating in May. That should drive a 5% (90k oz) increase in US autocatalyst demand for palladium in 2013 to 1.85 million oz, more than one-fifth of total global demand.

25

Cars, total

Exhibit 274: US heavy duty sector also doing better Millions, SAAR

millions, SAAR

Exhibit 273: US light vehicle sales – recovery continues with pick-up trucks leading the way Light trucks, total

20

15

0.6 0.5 0.4 0.3

10

0.2

5

0 2005

0.1

2006

2007

2008

2009

2010

2011

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

2012

2013

0 Jan-05

Jan-07

Jan-09

Jan-11

Jan-13

Source: Credit Suisse

146

25 June 2013

Positioning still high and wide More so than platinum, fund positioning in palladium remains high, with Nymex net long futures and option positions off about 25% from the April peak of just over 3 million oz (Exhibit 275). Combined with ETF holdings, investors and funds own the equivalent of ~50% of annual demand. Palladium, therefore, is in our view more vulnerable than platinum to a sharp correction if fears about the macro-economic environment deepen.

Millions oz

Exhibit 275: Palladium investor positioning – closer to the top 6.0

Pall. Ldn

Bskt Ldn

Pall. ZKB

Pd Other

Pall. US

Pall. Swiss

Sprott

Nymex net long - Pd

Pall, spot

5.0

$1,000

$800

4.0 $600 3.0 $400 2.0 $200

1.0

0.0 Jan-09

$0 Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source: CFTC, the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Market stocks will be reduced over the next three years If global economic growth takes a step down below our assumptions then palladium demand growth will naturally slow. And China is a key risk for all those who are long – leverage to Chinese growth has been a strong positive for palladium investors since early 2009, it could flip to being a strong negative if the Chinese economy (or investors’ perceptions of it) slows more than anticipated. But absent a marked deceleration at the global level, above-ground inventories of palladium should be steadily drawn down over the next three to four years as mine supply lags demand (see supply/demand table on the following page). At some point the market will actually begin to tighten (which will be visible in the forward market and in the sponge to ingot spread) – it is then that investors should get their rewards but they may need to be patient for some considerable time yet.

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Exhibit 276: Platinum forecast comparison

Exhibit 277: Platinum historical price and forecast

US$ per metric tonne

US$ per metric tonne

$1,850

Forward Curve

CS Forecast

Bloomberg Forecast Mean

$1,800

$2,500

Platinum (Spot)

Quarterly Avg Forecast

$2,250

$1,750

$2,000

$1,700

$1,750

$1,650 $1,500

$1,600 $1,250

$1,550 $1,000

$1,500

$750

$1,450

$500 2005

$1,400 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 278: Palladium forecast comparison

Exhibit 279: Palladium historical price and forecast

US$ per metric tonne

US$ per metric tonne

$900

CS Forecast

Forward Curve

$900

Bloomberg Forecast Mean

Palladium (Spot)

Quarterly Avg Forecast

$850 $700

$800

$500

$750

$700 $300

$650

$100 2005

$600 Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 280: Forecast Platinum and Palladium prices US$ per ounce, long-term prices based on 2012 real prices

Platinum US$/oz Palladium US$/oz

1Q-13

2Q-13f

3Q-13f

4Q-13f

2013f

1Q-14f

2Q-14f

3Q-14f

4Q-14f

2014f

2015f

2016f

2017f

LT

1,630 745

1,490

1,500

1,540

1,540

1,550

1,580

1,580

1,630

1,585

1,700

1,770

1,850

750

740

760

780

780

820

790

850

870

900

1,800 850

730

720

Source: Credit Suisse Commodities Research

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 281: Platinum and palladium supply / demand forecast summary ’000 ounces. CAGR from 2008 to 2016f

PLATINUM Supply Mine supply Autocat recycling Total supply YoY, % CAGR, %

2007

2008

2009

2010

2011

2012

2013f

2014f

2015f

2016f

6,546 920 7,466

5,943 1,150 7,093 -5.0%

6,053 882 6,935 -2.2%

6,050 1,090 7,140 3.0%

6,385 1,179 7,564 5.9%

5,649 1,105 6,754 -10.7%

5,706 1,183 6,890 2.0%

5,880 1,226 7,106 3.1%

5,948 1,207 7,155 0.7%

5,959 1,255 7,214 0.8% 0.2%

4,169 0 1,520 1,420 494 7,604

3,848 0 1,368 1,280 461 6,956 -8.5%

2,255 0 965 2,000 366 5,586 -19.7%

2,934 22 1,312 1,700 398 6,366 14.0%

3,012 56 1,507 1,675 411 6,662 4.6%

3,107 98 1,183 1,826 419 6,634 -0.4%

3,095 140 1,262 1,965 453 6,915 4.2%

3,152 181 1,346 1,873 467 7,019 1.5%

3,263 190 1,437 1,760 487 7,137 1.7%

3,356 210 1,485 1,590 511 7,151 0.2% 0.3%

-138 135 7,739

137 433 7,389

1,349 827 6,413

774 765 7,131

902 198 6,860

121 348 6,982

-25 590 7,505

87 426 7,445

19 282 7,419

63 240 7,391

Final balance

-273

-296

522

9

704

-227

-615

-339

-263

-177

PALLADIUM Supply Mine supply State stock sales Autocat recycling Total supply YoY, % CAGR, %

2007

2008

2009

2010

2011

2012

2013f

2014f

2015f

2016f

6,925 1,125 950 9,000

6,381 960 1,132 8,473 -5.9%

6,232 850 1,000 8,082 -4.6%

6,345 650 1,310 8,305 2.8%

6,613 400 1,605 8,618 3.8%

6,330 200 1,556 8,086 -6.2%

6,492 100 1,898 8,490 5.0%

6,626 0 2,175 8,801 3.7%

6,602 0 2,240 8,842 0.5%

6,592 0 2,315 8,907 0.7% 0.6%

4,557 0 1,454 870 658 78 7,617

4,425 0 1,301 886 633 81 7,326 -3.8%

4,085 0 1,169 715 597 83 6,649 -9.2%

5,529 6 1,188 528 570 92 7,912 19.0%

5,931 14 1,226 340 526 90 8,127 2.7%

6,427 24 1,283 300 468 95 8,598 5.8%

6,751 35 1,201 305 407 102 8,801 2.4%

7,076 45 1,175 285 373 106 9,060 2.9%

7,456 47 1,154 272 338 108 9,376 3.5%

7,629 53 1,114 275 317 116 9,505 1.4% 3.3%

Running balance Investment Total Demand

1,383 345 7,962

1,147 465 7,791

1,433 700 7,349

393 1,145 9,057

491 -505 7,622

-512 455 9,053

-311 405 9,206

-259 263 9,323

-533 -50 9,326

-598 -120 9,385

Final balance

1,038

682

733

-752

996

-967

-716

-522

-483

-478

Demand Autocat Autocat off-road Industrial Jewellery Other Demand, ex-investment YoY, % CAGR, % Running balance Investment Total Demand

Demand Autocat Autocat off-road Industrial Jewellery Dental Other Demand, ex-investment YoY, % CAGR, %

Source: Credit Suisse forecasts, Johnson Matthey Platinum 2013, company reports

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25 June 2013

Mineral Sands RESEARCH ANALYSTS Equity Research Matthew Hope [email protected] +61 2 8205 4669 Paul McTaggart [email protected] +61 2 8205 4698 Commodities Research Tom Kendall [email protected] +44 20 7883 2432

Zircon firing, TiO2 feedstock spluttering With the benefit of producers’ quarterly reports, we see that zircon demand is stronger than we previously believed. We have upgraded our demand forecasts for the first half and remain confident that prices have begun to creep upwards in China and are likely to move more significantly in 2H. On the other hand, it is now clear that demand for high-grade TiO2 feedstock remains extremely weak and is probably six months behind zircon on the recovery trail. We are no longer as confident that demand and pricing will pick up in 2H. While pigment demand is improving, and producer destocking is well underway, there will be a further delay for pigment plants to lift capacity utilisation and wind down feedstock inventories until they need to buy. We now expect it will be DecQ before there is a significant lift in feedstock demand and potential for some pricing action.

Exhibit 282: Mineral sands price forecasts Zircon bulk

New Old Chg Rutile bulk New Old Chg Synthetic Rutile New Old Chg Ilmenite New (sulphate 54%) Old Chg Titanium slag New (SA Chlor 86%) Old Chg Titanium slag New (Sulphate 80%) Old Chg Titanium slag New (UGS 95%) Old Chg

US$/t US$/t % US$/t US$/t % US$/t US$/t % US$/t US$/t % US$/t US$/t % US$/t US$/t % US$/t US$/t %

1Q-13

2Q-13

3Q-13

4Q-13

2013E

1Q-14

2Q-14

3Q-14

4Q-14

2014E

2015E

2016E

2017E

LT

1,230 1,150 7% 1,450 1,450 0% 1,300 1,300 0% 285 250 14% 1,150 1,150 0% 850 850 0% 1,400 1,300 8%

1,250 1,250 0% 1,450 1,450 0% 1,300 1,300 0% 275 250 10% 1,150 1,150 0% 850 850 0% NA 1,300

1,500 1,500 0% 1,450 1,550 -6% 1,300 1,400 -7% 225 300 -25% 1,150 1,250 -8% 850 1,000 -15% NA 1,450

1,500 1,500 0% 1,500 1,550 -3% 1,350 1,400 -4% 250 300 -17% 1,200 1,250 -4% 850 1,000 -15% NA 1,400

1,370 1,350 1% 1,463 1,500 -3% 1,313 1,350 -3% 259 275 -6% 1,163 1,200 -3% 850 925 -8% 1,400 1,400 0%

1,700 1,700 0% 1,550 1,350 15% 1,450 1,250 16% 250 250 0% 1,300 1,100 18% 950 950 0% 1,500 1,300 15%

1,700 1,700 0% 1,550 1,350 15% 1,450 1,250 16% 250 250 0% 1,300 1,100 18% 950 950 0% 1,500 1,300 15%

1,700 1,700 0% 1,350 1,350 0% 1,250 1,250 0% 250 250 0% 1,100 1,100 0% 950 950 0% 1,300 1,300 0%

1,700 1,700 0% 1,350 1,350 0% 1,250 1,250 0% 250 250 0% 1,100 1,100 0% 950 950 0% 1,300 1,300 0%

1,700 1,700 0% 1,450 1,450 0% 1,350 1,350 0% 250 250 0% 1,200 1,200 0% 950 950 0% 1,400 1,400 0%

1,650 1,650 0% 1,175 1,175 0% 1,075 1,075 0% 225 225 0% 925 925 0% 825 825 0% 1,125 1,125 0%

1,650 1,650 0% 1,100 1,100 0% 1,000 1,000 0% 225 225 0% 850 850 0% 750 750 0% 1,050 1,050 0%

1,625 1,625 0% 1,075 1,075 0% 975 975 0% 225 225 0% 825 825 0% 725 725 0% 1,025 1,025 0%

1,500 1,500 0% 1,000 1,000 0% 890 890 0% 200 200 0% 760 760 0% 650 650 0% 960 960 0%

Source: Credit Suisse Equity Research

Pricing

The price forecasts mentioned in this section have been provided by the Equity Research analysts above.

The pricing in China is meaningful for zircon, but not so important for chloride feedstocks. China is the only major player in the zircon market given that Europe remains out of action. However, for TiO2 feedstocks, differences in pigment production processes and feedstock preferences between China and ROW means that China pricing may not reflect ROW prices for anything other than ilmenite. Lifted 1H zircon price We have adjusted our 1H’13 zircon price upwards. We previously believed zircon had slipped to $1150/t by the end of MarQ, but it is now apparent that the zircon sand price in China was steady at roughly $1230/t since February.

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We maintain our view that the zircon price is climbing. Metal Pages has already reported incremental price rises for zircon sand in China of less than 10%. We note from recent discussions with ILU management, that Chinese customers are predisposed for a price rise, questioning ILU as to when it will occur. We expect the zircon price will rise to around $1500/t in 2H and further to $1700/t in 2014. Removed high grade TiO2 feedstock price increase from 3Q However, we have moderated our view on high grade TiO2 price rises in 2013. We expect only a modest price rise of $50/t in 4Q’13 for rutile, but a further $50/t increase to $1550/t in 1H’14, before receding slowly back towards our LT price of $1000/t (real).

Exhibit 283: Zircon and Rutile prices actual (trade stats) and Credit Suisse forecast 3000

Zircon price (US$/t)

2500 2000 1500 1000 500

Aug 09 Oct 09 Dec 09 Feb 10 Apr 10 Jun 10 Aug 10 Oct 10 Dec 10 Feb 11 Apr 11 Jun 11 Aug 11 Oct 11 Dec 11 Feb 12 Apr 12 Jun 12 Aug 12 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 Dec 13 Feb 14 Apr 14 Jun 14 Aug 14 Oct 14 Dec 14 Feb 15

0

Bulk zircon from Australia

Bulk zircon to China

Buk rutile from Australia

Source: Credit Suisse, TZMI

High grade TiO2 feedstocks In our view, the situation for high grade TiO2 feedstocks is not as bullish as zircon. Recovery in this market appears to be six months behind zircon on our best estimate. The weakness has been pigment, which was over-produced in the front end of 2012. Pigment appears to be on the path for recovery, but feedstocks are further up the supply chain and will take longer to feel the demand pull. The genesis of the poor market The difficult conditions now being experienced in the pigment market were initiated in 2011 when the pigment market was tight and prices were rising substantially every quarter. Customers became anxious about obtaining sufficient supply and ever-rising prices so they over-ordered, accentuating the tightness of the market even further. Chloride pigment producers rolled into 2012 with plants operating at stretch capacity to meet excessive demand, and paying premium prices for high-grade rutile to squeeze higher production out of their plants. By 2Q the painting season should have started, but demand did not pick up. Global macro weakness in every region had struck, IP fell away, finished goods were not painted and discretionary re-painting of houses was delayed. Pigment consumers had plenty of supply in a weak demand environment, having overstocked in 2011. They did not buy from pigment-makers hence the latter’s inventories blew out to as much as 120 days before capacity utilisation of plants was slashed.

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Demand for TiO2 feedstocks died in 2H’12, particularly for the premium high-grade products of rutile and synthetic rutile. Pigment makers wanted to cut production and did not need premium grade products at premium prices. 2012 Pigment demand We believe that pigment consumption dropped by 16% in 2012 (Exhibit 284). This was not purely due to a demand slow-down on weak construction and sluggish economic activity globally. It also reflected destocking by pigment consumers through the year. Pigment makers views on the pigment market Looking at recent commentary from four of the five big Western pigment makers – DuPont, Huntsman, Tronox and Kronos; ■ All agree that customers-destocking has ended. This is important – Tronox estimates that customer destocking accounted for 70% of the drop in pigment purchasers in 2012. ■ All seem unanimous that demand is improving – 23% sequentially for Tronox in 1Q’13, and DecQ marked the demand trough. ■ All seem cautiously confident that 2H’13 will be better and 2014 strong. Four stages of pigment market recovery Tronox has mapped out the four stages of recovery in the pigment market: ■ Sales volume increases and customer destocking ceases; prices continue to soften as demand is met with producer inventory. ■ Pigment prices stabilise as producer inventory reaches normal levels of around 50 days’ supply. ■ Plant utilization rate increase as excess inventory is sold out and margins benefit on lower unit costs. ■ Prices recover after inventories normalise and utilization rates increase. Our estimate is that the pigment industry is at stage 2 and may move to stage 3 in SepQ. Producers have wound back capacity utilisation to about 70% across the Western industry. Finished inventories are normalised for DuPont, low at 45 days for Huntsman, but still high at 71 days for Tronox. Huntsman believed the Industry was at 75 days by the end of MarQ, down from in excess of 100 days late in 2012. Although Tronox suggested prices would only increase in stage four of recovery, as capacity utilisation picks up, both Dupont and Tronox have already announced price increases of $175-$200/t effective 1 July. It remains to be seen whether these price increases will take hold. If they do not, they should at least stabilise current prices by pointing to the direction pigment producer feel prices are moving to. Not expecting feedstock demand pull until DecQ’13. We now expect stage 3 will occur in SepQ, with plant utilization levels lifting and pigment prices perhaps beginning to pick up, but it will be DecQ before the feedstock market feels demand pull. Huntsman in particular noted that it had sufficient slag inventory left from a legacy contract to avoid buying any feedstock until SepQ. High grade products are taking the brunt Given that capacity utilization is low to minimise production while producers destock, pigment-makers are still not interested in buying premium grade natural rutile or synthetic rutile. In its MarQ report, Iluka noted that demand for high grade TiO2 feedstocks were sluggish in MarQ’13 as expected, with subdued sales associated mainly with low pigment plant utilisation.

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Longer term we remain cautious and do not forecast a climb back to the LT trend Over the long term, pigment demand growth has matched global GDP. Going forward it’s a little difficult to know what global GDP growth rate will be. If the LT trend through the 1990s and 2000s apparent in Exhibit 284 continued, we would be looking pigment demand to reach 6Mt by 2016. However, we are more cautious and our pigment consumption does not match the boom year of 2011 (which now appears to have included stocking-piling) until 2015. By 2016, we remain 300kt below the 6Mt implied by the LT trend.

Exhibit 284: Global pigment demand (actual and forecast) 6000

Global pigment demand (kt)

5000 4000 3000 2000 1000

2016f

2015f

2013f

2014f

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

0

Source: Credit Suisse, TZMI

Real pigment consumption trends In terms of real pigment consumption, some signs are improving in 2013 although growth is patchy. In the US, housing sales have picked up, which is a key driver for repainting houses, the major use of architectural paint in developed economies. We hold out no hope for a revival in Europe as yet, with the credit crisis rolling along and austerity measures remaining in full force. Discretionary spending, such as repainting, looks likely to remain curtailed for an extended period. In China, new housing construction is a larger demand sector than repainting. Strong residential price increases in Tier 1 & 2 cities has not rescued the sagging Chinese pigment market while there is weakness in the industrial sector. High grade TiO2 feedstocks balance Looking at balances in the high grade market, despite the heavy production cuts done by Iluka, we still expect a surplus of 140kt being generated through 2013. There is little more that Iluka can do so we expect that surplus will be picked up as an inventory build by a producer, and most likely in the chloride slag segment of the market. Balances in 2014 onwards remain hard to read because it depends very much on which projects are restarted as prices improve. If Iluka’s projects resume, we consider there would be a 500ktpa surplus in 2014 and 300kt in 2015. We doubt projects will restart if this is the likely result, but nevertheless the potential for overhang remains significant so we expect any price surge is unlikely and we expect prices to wind down towards LT in the years ahead.

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However, our forecast is based on a cautious view of future pigment demand. With the break down in long-term contracts, demand and pricing are both becoming exceedingly volatile and it is entirely plausible that we may instead see an acceleration in demand and a restocking cycle that would draw down inventories and wipe out surpluses.

Exhibit 285: High-grade TiO2 feedstock production 4,000 3,500 3,000

TiO2 units

2,500 2,000 1,500 1,000 500 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f 2014f 2015f Iluka

Rio Tinto

Tronox (Exxarro)

ROW

Source: Company reports, Credit Suisse

Sulfate slag balance We expect 25% growth in sulfate slag output in 2013, due largely to Rio Tinto’s reduction in UGS output in favour of Sorel sulfate slag. Some 80kt of Western sulfate slag is likely to be sold into China, so we expect the Western market to be broadly balanced. The Chinese slag producer appear to be slowing output because the Chinese titanium metal producers, the main slag users in China, are facing weak demand. We note that Chinese slag prices have been falling since November (Exhibit 286). Production of titanium metal early in 2013 has been weak in China due to a large inventory build in 2012 caused by delayed aircraft build programs and slowing desalination projects. Another outlet for China slag, sales to Europe seem to have been cut off. With Sachtleben’s takeover of the Crenox pigment plant in Germany, the contracts to buy Pangang slag was not renewed. In 2013, Norway’s Tyssedal smelter won sulfate slag contracts with some large pigment producers in China, and Tyssedal expects to export 50kt to China through the year. Rio Tinto has joined Tyssedal in aggressively marketing Sorel slag from Canada into China. Beyond 2013, we continue to see tight market conditions and a potential 130kt deficit for non-China sulfate slag provided Rio Tinto restarts UGS production. If it does not, and continues elevated output of Sorel sulfate slag, the market may become slack and continued hefty exports to China may be needed to balance the market.

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Exhibit 287: China ilmenite prices (Ex VAT)

1,400

400

1,200

350

China Price (US$/t ex VAT)

China Price ex works (US$/t ex VAT)

Exhibit 286: China TiO2 slag prices (Ex VAT)

1,000 800 600 400 200

300 250 200 150 100 50

6-Sep-12

6-Nov-12

China TiO2 slag 92%

6-Jan-13

6-Mar-13

6-Sep-12

6-May-13

6-Jan-13

China Ilmenite price (50%)

China TiO2 slag 90%

Source: Metal Pages, Credit Suisse

6-Nov-12

6-Mar-13

6-May-13

China Ilmenite price (46%)

Source: Metal Pages, Credit Suisse

Chinese ilmenite market The improving trend seen for pigments is not reflected in China at this stage. According to Metal Pages reports, pigment demand has weakened and producers are ceasing production. The price of anatase has dropped 16% to RMB 12,000 from 14,250 last October. Metal Pages reported a producer in Guanxi saying 60%-70% of producers have stopped production. A producer source in Sichuan noted that most producers are cutting production to stabilise prices and that the market may improve in September and October, which is the peak season for decorating houses. Given pigment plants are idling, prices for ilmenite feedstock are also sliding in China, although trade is thin on weak demand. Prices for domestic 46% TiO2 ilmenite are down $70/t from the start of the year (Exhibit 287) to reach the lowest point in the past couple of years. Metal Pages reported a source saying capacity utilisation of mines in Sichuan Province was lower than 30% with trade sparse. Sichuan is the main source of Chinese ilmenite, from the giant hard rock deposit at Panzihua. There will be further pressure on pigment producers because the Vietnamese government is reportedly planning to lift its export tariff for ilmenite to 40% from 30% on 19 June, which will lift ilmenite prices. Vietnamese 50% TiO2 ilmenite is already trading at $80/t–$100/t premium to domestic 46% ilmenite ex-VAT, so we expect that in the short-term Vietnamese imports may ease. Domestic 46% ilmenite accounts for 86% of ilmenite use in China and its share may rise further . On an Ex VAT basis, 50% ilmenite prices from Vietnam have fallen to $237/t from $285/t at the start of the year. We have lowered our 3Q price to $225/t to account for current weakness before lifting it back to $250/t as we expect conditions to improve late in the year.

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Zircon demand moving into a restock To date, there has been little sign of a quarterly contract price emerging and zircon has been trading on spot. With Europe remaining out of action, demand has been driven by China. Tronox and Iluka report strong demand Producer reports indicate that zircon demand in China has recovered strongly. Tronox revealed that its 1Q’13 zircon sales volumes increased 47% sequentially following a 93% increase in 4Q’12. Put together, these figures indicate that Tronox’ 1Q’13 sales to 30 April were 184% higher than its 3Q’12 sales to October, with the latter appearing to have been the cyclical low point. Tronox stated in the conference call that it believes recovery in sales volumes is reflecting a real demand increase. In its MarQ, Iluka reported stronger customer inquiries and orders in its main markets apart from Europe, but did not quantify demand or sales. Iluka noted China has shown the most marked improvement centred around the ceramics sector and with recovery in refractory and foundry demand. This anecdotal evidence matches the heavy inventory draw-downs apparently occurring in China as we recently noted in our sector note of 30 April 2013 “Mineral Sands Sector – Zircon tightening in China”: Metal Pages in April reported that Iluka’s warehouse in Fujian Province had only 10kt of zircon in stock, down from 120kt a year earlier. China strength In China, strong residential price increases in Tier 1 & 2 cities have apparently driven strong demand for zircon in tiles. Continued strength in the residential market remains a risk factor as Chinese leaders weigh up growth versus inflation. However, our Chinese analysts are detecting that tightening measures imposed by the out-going Chinese premier do not appear to have been enforced by the new administration and may have been watered down in every city other than Beijing. It appears the new administration may be drawing up plans for wider changes for the entire economy and is content to let housing continue at the moment given it seems to be the main growth factor operating in China.

Exhibit 288: China housing construction, completions and sales

Source: Company reports, Credit Suisse

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Normalised zircon sales volumes The problem we now face is estimating the new normalised level of zircon demand. 2010 and 2011 sales volumes were abnormally high on stimulus With the benefit of hindsight, we can now see that China’s zircon consumption in 2010 and 2011 was excessively high (Exhibit 289, Exhibit 290) driven by the massive infrastructure stimulus and a consequent surge in tile demand and production. After enjoying 2010 and 2011 with +30% pa tile volume growth rates, China’s tile producers were caught out when demand gave way and growth rolled over to 1%, under the influence of Beijing’s clamp down on property investment and funding in 2012 (Exhibit 289). Excessive inventory of zircon and tiles needed to be worked off over the course of 2012, a process that now appears to be complete. Simultaneously in 2012, Europe’s recession began to bite and the zircon demand by the tile manufacturers in Italy and Spain fell away to levels less than the global financial crisis of 2009 ( Exhibit 290 ).

1200 1000 800 600 400 200

Source: Company reports, Credit Suisse

China Japan

Europe Other

2016f

2015f

2014f

2012

2013f

2011

2010

2009

2008

2007

2006

2005

2004

Fused zirconia Foundry Ceramics

2003

0

2002

Unspecified zircon demand Zirconia & chemicals Refractories tile production (RHS)

1400

Zircon consumption (kt)

0

1600

Tile production (billions of sq m)

0

Exhibit 290: Global zircon demand actual and forecast

2016f

2

2015f

100

2014f

4

2013f

200

2012

6

2011

300

2010

8

2009

400

2008

10

2007

500

2006

12

2005

600

2004

14

2003

700

2002

Zircon consumption (kt)

Exhibit 289: China zircon consumption by sector

Other Asia Pacific North America

Source: Credit Suisse, TZMI

Assessing normalised sales volumes Early in 2013, global zircon demand has not yet returned to a normalised level. Europe remains in recession. China has picked up and appears to be strong, but it will undoubtedly include an element of cyclical restocking. We expect restocking from Chinese buyers. We have seen the behaviour of the iron ore market. Customers will not buy when there is a good chance that the next ship-load will be cheaper. Customers need to have input costs at least equivalent to competitors to stay in business. Once it appears prices have bottomed, customers will buy heavily to gain cheap stocks before the price steps up. Chinese customers will usually buy in a rising market, not a falling one. To assess the new normal, we also need to be aware of structural changes:

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Structural demand decrease As best we know, there has been a reduction in zircon intensity in China’s tiles, which in our estimate will exceed natural growth in non-ceramic applications. We expect China’s 2013 zircon demand to be 60kt below 2011 levels. The structural changes occurred as China’s tile manufacturers caught up with European technology and progressively altered porcelain tile manufacturing from full body (zircon though the entire tile thickness) to double-charging that puts zircon in the top layer only. We examined the issue in our sector note of 18 December 2012 Mineral Sands Sector – Quantifying the zircon demand gap and estimated that the reduction in zircon intensity reduced China’s zircon demand by 130kt in 2012 or 20% of 2011 levels. This is probably a high estimate – we believe Iluka’s estimate would see the same level of demand destruction spread over several years rather than one year. Iluka considers the modernisation now looks to be complete, but nevertheless, there should have been a step down in zircon demand for ceramics from 2011 (as we forecast: Exhibit 289) and consequently we expect an underlying demand decrease relative to 2011. Chinese demand We build up our forecast Chinese demand by market segments, starting with a tile estimate (Exhibit 291) and the structural change to reduced zircon intensity of use in porcelain tiles through double-charging. We expect 570kt of zircon demand by China in 2013, up 9% from 2012, but below 2010 at 578kt ( Exhibit 297)

Exhibit 291: China monthly tile output actual and Credit Suisse forecast

1200 1000 800 600 400 200

Jul 16

Jul 15

Jan 16

Jul 14

Jan 15

Jul 13

Jan 14

Jul 12

Jan 13

Jul 11

Jan 12

Jul 10

Jan 11

Jul 09

Jan 10

Jul 08

Jan 09

Jul 07

Jan 08

Jul 06

Jan 07

Jul 05

Jan 06

Jul 04

Jan 05

Jul 03

Jan 04

0

Jan 03

China monthly tile output (mn sq mtr)

1400

China Tile Manufacturing (million sq m) 6 per. Mov. Avg. (China Tile Manufacturing (million sq m)) Source: NBS, Credit Suisse

On a larger scale we can now begin to see the shape of forward global zircon demand. The GFC triggered a sharp decline followed by pronounced rebound; 2013 is now looking like a broad slow downturn with demand moving in fits and starts.

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Exhibit 293: Zircon imports in China

140

700

120

600

100

500

Thousand tonnes

Zircon demand (kt)

Exhibit 292: Zircon imports

80 60 40

400 300 200

20 100

China

Other Asia

W Europe

N America

Jan-13

Sep-12

May-12

Jan-12

Sep-11

Jan-11

May-11

Sep-10

Jan-10

May-10

Sep-09

May-09

Jan-09

Sep-08

Jan-08

May-08

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2008 2011

Other Europe

Source: TZMI, Credit Suisse

2009 2012

2010

Source: TZMI, Credit Suisse

Zircon demand in Europe has remained weak. Local demand for tiles has ceased due to the down-turn in Europe and demise of the Spanish property boom. We understand that the export market was all that is available and with global weakness and the Arab Spring in 2012, even that market struggled. Judging from zircon imports, Europe must be heavily destocked, so we expect a 33% demand recovery in 2013, although that still remains 30% lower than demand in 2011. We do not look for a resumption of even 2009’s production given that a resurgence of building in the Mediterranean sun-belt seems distant.

Exhibit 295: Zircon exports 140

50

120

60

Italy

Spain

Ger, Neth, Belg

France

Source: TZMI, Credit Suisse

Other Europe

Australia

South Africa

Indonesia

Ukraine

Vietnam

Sep-12

May-12

Jan-12

Sep-11

May-11

Jan-11

Sep-10

-

Jan-10

-

May-10

20

Jan-08

10

Sep-09

40

Jan-09

20

80

May-09

30

100

Sep-08

40

May-08

Zircon supply (kt)

60

Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13

Zircon demand (kt)

Exhibit 294: Zircon imports to Europe

Other

Source: TZMI, Credit Suisse

Globally, we expect zircon demand in 2013 will reflect recovery of 16% on the exceptionally depressed demand of 2012. Zircon supply As in the TiO2 feedstock segment, the weak demand experienced for the past 18 months, has seen producers take action to cut zircon output as we outlines in our last Qtly.

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Global output run-rate over 40% below 2011 Our present estimate is that global finished zircon production for 2013 will operate at a run rate of 888ktpa, 44% down on the peak output of 1600kt in 2011. Whether this run rate is sustained or output reaccelerates later in the year will depend on demand strength during 2013. Indonesia may disappear from supply One element that may be changing is the waning of Indonesian supply. Indonesia has been a favourite supply source for China as it provides concentrate that China’s under-utilised mineral separation plants on Hainan Island can import and treat, then sell to mainland buyers at spot prices. However, it now looks as if Indonesian supply is drying up. Indonesia’s exports are hard to predict as they are largely provided by small private companies and artisans. There was a surge of Indonesian shipments to China ahead of the Indonesian export restrictions in May 2012; then nothing through SepQ; and then high shipments again in DecQ’12. In the early months of 2013, shipments have dried up again. One interpretation of this pattern is that the export restrictions in Indonesia has affected illegal mining and the 20% export tax has stripped incentive from the industry. The DecQ’12 shipments may have been the last of the pre-ban mine production washing through as export permits were received by legal companies. Exports may be weak in 2013, and if so, may reduce supply to China by ~60kt of contained zircon. This would provide an opportunity for major producers to destock their inventory. Producer inventory Major producers have substantial zircon inventory to meet global demand. ■ From production and sales, we can estimate that Iluka accumulated over 200kt of finished zircon by the end of 2012, and also has 12 months of HMC concentrate with a 50% zircon grade at Jacinth Ambrosia. ■ Tronox indicates that zircon sales in 2012 were 74% below 2011, so we estimate it accumulated 170kt of zircon in 2012. ■ Rio Tinto has said nothing about inventory. However, we understand from Management comments that it accumulated a year’s supply or 200kt. Together, we estimate that the three major zircon producers may have entered 2013 sitting on 590kt of finished zircon inventory. This may be over half the total demand this year, and will evidently take a long period to unwind, particularly as none of the large mines have actually closed yet. They are just not producing finished zircon. Zircon pricing Through to March, import data suggests that zircon pricing was about $1230-1240/t. We understand it was steady since February. In May Metal Pages reported that producers had lifted prices $50/t, which would be consistent with the strong buying and restocking that appears to be occurring. We continue to forecast that 2H’13 will see a local peak and then prices will subside towards LT rate of $1500/t in future years as production and consumption readjust and match.

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Exhibit 296: TiO2 feedstock supply & demand kt 2008 2009 TiO2 UNITS SUPPLY Australia 1,583 1,168 South Africa 1,090 854 Other Africa 248 340 Canada 896 696 China 597 550 Other Europe 758 737 US 187 151 ROW 690 903 Total TiO2 units 6,050 5,400 Disruption Allowance Total Production 6,050 5,400 % change -6.7% -10.7% CONSUMPTION Total TiO2 consumption 5,906 5,200 % Chg y-o-y -3.2% -12.0% SURPLUS/(DEFICIT) 144 200 Estimated Total Stocks 194 394 weeks Consumption 1.7 3.9 FEEDSTOCK SUPPLY Ilmenite (Sulphate) 4,102 4,219 Ilmenite (Chloride) 1,053 757 Rutile 621 552 Leucoxene 181 168 Synthetic rutile 767 671 Slag (Chloride) 1,430 1,149 Slag (sulphate) 1,023 830 TiO2 SUPPLY BY FEEDSTOCK PRODUCT Ilmenite (sulphate) TiO2 1,888 1,972 Ilmenite (Chloride) TiO2 636 458 High grade TiO2 1,442 1,278 Chloride slag TiO2 1,260 1,016 Sulphate slag TiO2 825 677 Sulfate supply TiO2 units 45% 49% Chloride supply TiO2 units 55% 51% TiO2 PIGMENT SUPPLY BY PROCESS Chloride Pigment Supply 2,602 2,243 Sulfate Pigment (ex-China) 1,438 1,097 China Pigment Supply 900 1,047

2010

2011

2012

2013F

2014F

2015F

2016F

1,223 1,126 463 905 730 747 194 912 6,300 6,300 16.7%

1,205 1,141 437 956 979 610 217 900 6,504 6,504 3.2%

1,298 1,094 1,285 1,382 1,468 1,033 1,018 1,094 1,144 1,139 418 604 1,126 1,367 1,405 1,056 900 1,109 1,109 1,129 1,037 892 1,051 1,110 1,142 694 760 812 873 852 164 153 154 74 74 823 831 839 891 907 6,580 6,312 7,529 8,017 8,217 - - 316 - 376 - 401 - 411 6,580 5,996 7,152 7,617 7,806 1.2% -8.9% 19.3% 6.5% 2.5%

6,355 22.2% -55 339 2.8

6,918 8.9% -414 -75 -0.6

6,429 -7.1% 152 76 0.6

5,824 -9.4% 172 248 2.2

6,774 16.3% 378 626 4.8

7,343 8.4% 274 900 6.4

7,590 3.4% 216 1116 7.6

4,747 685 761 188 635 1,692 860

4,793 681 810 159 614 1,769 940

4,892 730 799 205 585 1,756 1,012

4,922 865 655 205 392 1,560 1,113

5,857 1,302 906 253 447 1,905 1,072

6,275 913 999 285 702 1,945 1,247

6,161 1,110 1,038 290 657 1,985 1,372

2,229 421 1,455 1,494 700 46% 54%

2,318 420 1,460 1,562 744 47% 53%

2,373 444 1,449 1,556 759 48% 52%

2,445 522 1,116 1,362 867 52% 48%

2,867 742 1,426 1,686 808 49% 51%

3,066 550 1,736 1,721 944 50% 50%

2,997 818 1,602 1,755 1,045 49% 51%

2,795 1,332 1,200

2,854 1,306 1,545

2,351 1,129 1,700

2,203 1,087 1,300

2,590 1,220 1,600

2,855 1,285 1,700

2,985 1,305 1,700

kt 2008 2009 2010 2011 2012 2013F 2014F 2015f TiO2 CONSUMPTION BY SECTOR Pigments 5,374 4,732 5,785 6,185 5,620 4,980 5,870 6,335 Titanium sponge 360 260 290 423 479 479 494 548 Other (Welding rods) 177 208 280 310 330 365 410 460 TOTAL TiO2 demand 5,912 5,200 6,355 6,918 6,429 5,824 6,774 7,343 TiO2 for Pigments 91% 91% 91% 89% 87% 86% 87% 86% TiO2 for Titanium sponge 6% 5% 5% 6% 7% 8% 7% 7% Other 3% 4% 4% 4% 5% 6% 6% 6% PIGMENT BALANCE PIGMENT PRODUCTION 4,950 4,370 5,330 5,695 5,180 4,590 5,410 5,840 % Chg y-o-y -3.5% -11.7% 22.0% 6.9% -9.1% -11.4% 17.9% 7.9% PIGMENT CONSUMPTION 4,974 4,340 5,332 5,585 4,690 5,110 5,370 5,560 % Chg y-o-y -3.3% -12.7% 22.9% 4.7% -16.0% 9.0% 5.0% 3.5% PIGMENT BALANCE 24 30 2 110 490 - 520 40 280 TiO2 FEEDSTOCK BALANCES (TiO2 units kt) Chloride ilmenite supply 636 458 421 420 444 522 742 550 Disruption allowance - 21 37 28 Chloride ilmenite demand 761 697 911 924 751 693 826 872 CHLOR. ILMEN. TiO2 BALANCE High grade supply 2,701 2,293 2,950 3,022 3,004 2,478 3,112 3,457 Disruption allowance - 99 - 156 - 173 High grade demand 2,573 2,246 2,965 2,977 2,436 2,241 2,479 2,983 HIGH GRADE TiO2 BALANCE 128 47 -15 45 568 138 478 300 Sulfate slag supply (ex China) 649 428 457 518 571 630 571 685 Disruption allowance - 28 31 36 Sulfate slag demand (ex China) 675 544 628 709 628 618 675 724 SULFATE SLAG BALANCE 26 - 116 - 171 - 192 57 16 - 135 75 Global sulfate ilmenite TiO2 1,888 1,972 2,229 2,318 2,373 2,445 2,867 3,066 Disruption allowance - - 167 - 153 - 165 Global sulfate ilmenite demand 1,917 1,824 2,178 2,537 2,596 2,130 2,548 2,682 SULFATE ILMENITE BALANCE -29 148 51 -219 -223 147 166 219 PRICES(US$/t) Rutile - Bulk Aust FOB Synthetic rutile - Aust FOB Ilmenite (sulfate) Slag (Chloride SA 86%) Slag (Sulphate 80%) Slag (UGS 95%)

509 429 119 449 356 -

537 424 74 426 294 -

550 443 84 431 322 524

1,055 858 209 490 415 996

2,405 1,707 313 1,688 1,500 2,350

1,463 1,313 250 1,163 850 350

1,450 1,350 250 1,200 950 1,400

1,175 1,075 225 925 825 1,125

Source: Credit Suisse

25 June 2013

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Commodities’ Forecast Update: The Return of “Fundamentals”

Exhibit 297: Zircon supply & demand summary kt 2008 MINED ZIRCON PRODUCTION Australia 500 South Africa 398 Other Africa 8 China 50 India 29 Ukraine 24 United States 124 Other 161 Highly Probable Growth Disruption Allowance Total Production 1,294 % change -10.0%

2009

2010

2011

2012

2013F

2014F

2015F

2016F

415 352 27 40 28 27 57 161 1,107 -14.5%

530 381 54 30 35 24 88 145 1,288 16.4%

722 395 72 25 40 24 85 233 1,596 24.0%

478 410 77 40 43 28 74 241 1,392 -12.8%

335 145 80 40 53 25 71 175 -37 888 -36.2%

606 390 164 40 53 25 69 175 -61 1,461 64.5%

645 420 219 40 53 25 39 185 -65 1,561 6.9%

621 440 219 40 53 25 39 185 -65 1,557 -0.2%

ZIRCON CONSUMPTION Nth America % change Europe % change China % change Japan % change Other Asia % change Other World % change Total consumption % change Restocking SURPLUS/(DEFICIT) Estimated Total Stocks weeks Consumption

86 -28.9% 229 -23.7% 398 -5.5% 37 -17.8% 140 -14.1% 97 -12.6% 987 -15% 120 150 7.9

113 31.4% 328 43.2% 578 45.2% 45 21.6% 196 40.0% 111 14.4% 1,371 39% 25 -83 42 1.6

120 6.2% 290 -11.6% 625 8.1% 45 0.0% 195 -0.5% 110 -0.9% 1,385 1% 211 253 9.5

130 8.3% 150 -48.3% 522 -16.5% 40 -11.1% 130 -33.3% 100 -9.1% 1,072 -23% -40 320 613 29.7

140 7.7% 200 33.3% 568 8.8% 50 25.0% 170 30.8% 115 15.0% 1,243 16% -355 258 10.8

150 7.1% 230 15.0% 612 7.9% 50 0.0% 190 11.8% 120 4.3% 1,352 9% 109 366 14.1

155 3.3% 270 17.4% 662 8.0% 50 0.0% 200 5.3% 125 4.2% 1,462 8% 99 466 16.6

160 3.2% 290 7.4% 702 6.1% 50 0.0% 210 5.0% 130 4.0% 1,542 5% 16 481 16.2

Price (US$/t) Bulk from Australia

121 -17.7% 300 -21.3% 421 7.7% 45 -21.1% 163 -13.8% 111 23.3% 1,161 -7% 133 81 3.6

765

858

875

1,875

2,173

1,370

1,700

1,650

1,650

kt 2008 CONSUMPTION SECTOR USE Ceramics 628 Refractories 144 Foundry 133 TV glass 35 Zirconia & chemicals 200 Other 21 Total 1,161 Mkt share Ceramics 54% Refractories 12% Foundry 11% TV glass 3% Zirconia & chemicals 17% Other 2% Total 100%

2009F

2010

2011

2012

2013F

2014F

543 113 109 27 176 19 987

780 160 140 21 245 25 1,371

795 165 145 15 260 20 1,400

600 140 120 10 260 20 1,150

-

-

55% 11% 11% 3% 18% 2% 100%

57% 12% 10% 2% 18% 2% 100%

57% 12% 10% 1% 19% 1% 100%

52% 12% 10% 1% 23% 2% 100%

-

-

2

Zircon Production (bars) v Consumption (kt) & price (line) US$/t RHS 1,800

2,3 2,2

1,600

2,1 2,0

1,400

1,9 1,8

1,200

1,7 1,6

1,000

1,5 1,4

800

1,3 1,2

600

1,1 1,0

400

90 80

200

70 60

0

2008

2009

2010

2011

2013F Japan

50

2014F

Nth America

Europe

Other World

Australia

South Africa

Other Africa

China

Ukraine

United States

Other

Bulk from Aust

India

China

2012

Other Asia

Source: TZMI, Company reports, Credit Suisse 25 June 2013

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25 June 2013

Uranium: Nuclear regulations in Japan a positive step RESEARCH ANALYSTS Equity Research Ralph Profiti [email protected] +1 416 352 4563 Commodities Research Ric Deverell [email protected] +44 20 7883 2523

Uranium price forecasts We are lowering our uranium price forecast 10% to $43/lb in 2013 and 4% to $54/lb in 2014, both to reflect year-to-date performance. Our long-term price forecast of $65/lb remains unchanged. Our forecast reductions are offset by a positive view of the pricing impact of nuclear regulations in Japan, which are coming together towards a partial restart of suspended operations, and expiry of the HEU agreement in 2013. As a result, we forecast a balanced market in the medium-term. Our peak uranium price of $70/lb in 2016 remains unchanged

Exhibit 298: Uranium price forecast Uranium (spot) New (US$/lb) Previous (US$/lb)

2011E 56.75

2012E 48.75

1Q13A 43.00

change (%)

Uranium (LT)

New (US$/lb) Previous (US$/lb)

2Q13A 40.25 45.00

3Q13E 42.50 47.50

4Q13E 45.00 50.00

2013E 42.69 47.50

2014E 53.88 56.00

2015E 65.00 65.00

2016E 70.00 70.00

2017E 65.00 65.00

LT 65.00 65.00

2Q12E 57.00 56.00

3Q12E 58.00 58.00

4Q12E 60.00 60.00

2013E 57.75 58.00

2014E 62.50 62.50

2015E 65.00 65.00

2016E 65.00 65.00

2017E 65.00 65.00

LT 65.00 65.00

-11%

2011E 67.50

2012E 59.25

1Q12E 56.00

change (%)

2%

-11%

0%

-10%

0%

-10%

0%

-4%

0%

0%

0%

0%

0%

0%

0%

0%

0%

Source: Company reports, Credit Suisse Equity Research

The price forecasts mentioned in this section have been provided by the Equity Research analysts above.

In our view, positive uranium price momentum will be driven by stronger evidence of the following key factors over the next 12 months: (i) clarity surrounding the nuclear outlook for Japan; (ii) resumption of approvals for new nuclear reactors in China; (iii) clarity over Russian supplies post expiry of the HEU supply agreement in 2013; (iv) uranium spot prices trading at marginal cost of production and the impact on near-term uranium mine supply; and (v) lower expected uranium production growth rates in Kazakhstan. Supply From 2013-2022 (10-year view), we estimate total uranium supply of 2.359Bln lbs U3O8, including 2.033Bln lbs of primary mine supply and 0.326Bln lbs of secondary sources. Our forecasts include adjustments for lower supply from higher-cost producers resulting from weaker uranium prices, regulatory delays, and slower construction schedules for new mines, offset by increased Russian secondary supply (incl. Russia Suspension Agreement/Amendments). We believe future supply trends will focus on uranium deposits of the highest quality in terms of tonnage, grade, cost, and ability to finance. Demand From 2013-2022, we estimate total uranium demand of 2.424Bln lbs U3O8. Our demand forecasts take into account assumptions for Japanese restarts (20 reactors in operation by the end of 2016) and full decommissioning in Germany. In summary, we forecast a net addition of 81 reactors to the current global fleet of 434 in operation by 2021 (including Japan restarts). In our view, the social and political tolerance for new nuclear build initiatives remains dynamic and because of the unique technological and environmental challenges facing uranium/nuclear, industry sentiment continues to be subject to public opinion risks. We remain constructive on the outlook for new reactor build in China, Russia, and India, where we forecast 47GWe of new nuclear capacity over the next five years (2013-2017) out of total global new capacity of 57GWe, accounting for 83% of our growth forecast.

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Exhibit 299: World Nuclear Association nuclear reactor data

Argentina  Armenia  Bangladesh  Belarus  Belgium  Brazil  Bulgaria  Canada  Chile China  Czech Republic  Egypt  Finland  France  Germany  Hungary  India  Indonesia  Iran  Israel  Italy   Japan  Jordan  Kazakhstan  North Korea Korea RO (South)  Lithuania  Malaysia  Mexico  Netherlands  Pakistan  Poland  Romania  Russia  Slovakia  Slovenia  South Africa  Spain  Sweden  Switzerland  Thailand  Turkey  Ukraine  UAE    United Kingdom  USA  Vietnam  WORLD** 

NUCLEAR ELECTRICITY GENERATION 2012 KWh (Billion) % 5.9 4.7 2.1 26.6 38.5 51.0 15.2 3.1 14.9 31.6 89.1 15.3 92.7 2.0 28.6 35.3 22.1 32.6 407.4 74.8 94.1 16.1 14.8 45.9 29.7 3.6 1.3 0.6 17.2 2.1 143.5 30.4 10.0 76.2 8.4 4.7 3.7 4.4 5.3 5.3 10.6 19.4 166.3 17.8 14.4 53.8 5.2 53.8 12.4 5.1 58.7 20.5 61.5 38.1 24.4 35.9 84.9 46.2 64.0 18.1 770.7 19.0 2,346.0 13.5

REACTORS NOW OPERATING # MWe 2 935 1 376 7 5,943 2 1,901 2 1,906 19 13,553 17 13,842 6 3,766 4 2,741 58 63,130 9 12,003 4 1,880 20 4,385 1 915 50 44,396 23 20,787 2 1,600 1 485 3 725 2 1,310 33 24,164 4 1,816 1 696 2 1,800 7 7,002 10 9,388 5 3,252 15 13,168 16 10,038 102 101,060 434 373,892

REACTORS UNDER REACTORS REACTORS PROPOSED CONSTRUCTION CURRENTLY PLANNED # MWe # MWe # MWe 1 745 1 33 2 1,400 1 1,060 2 2,000 2 2,400 2 2,400 1 1,405 4 4,000 1 950 2 1,500 3 3,800 4 4,400 28 30,550 49 56,020 120 123,000 2 2,400 1 1,200 1 1,000 1 1,000 1 1,700 2 3,000 1 1,720 1 1,720 1 1,100 2 2,200 7 5,300 18 15,100 39 45,000 2 2,000 4 4,000 1 1,000 1 300 1 1,200 10 17,000 3 3,036 9 12,947 3 4,145 1 1,000      2 600 2 600 1 950 4 5,415 6 8,730  1 1,350 2 2,000 2 2,000 1 1,000 2 680 2 2,000 6 6,000 2 1,310 1 655 10 9,160 24 24,180 20 20,000 2 880 1 1,200 1 1,000 6 9,600 3 4,000 5 5,000 4 4,800 4 4,500 2 1,900 11 12,000 2 2,800 2 2,800 4 6,680 9 12,000 3 3,618 9 10,860 15 24,000 4 4,000 6 6,700 67 69,709 159 174,340 318 359,750

URANIUM REQUIRED tonnes U 213 64 995 995 317 1,906 5,999 577 728 9,254 1,934 331 1,261 172 4,425 3,769 279 102 117 177 5,073 305 137 304 1,355 1,469 527 2,356 1,775 18,983 66,512

URANIUM REQUIRED M'lbs U3O8 0.554 0.166 2.587 2.587 0.824 4.956 15.597 1.500 1.893 24.060 5.028 0.861 3.279 0.447 11.505 9.799 0.725 0.265 0.304 0.460 13.190 0.793 0.356 0.790 3.523 3.819 1.370 6.126 4.615 49.356 171.337

Under Construction = first concrete for reactor poured, or major refurbishment under way; Planned = Approvals, funding or major commitment in place, mostly expected in operation within 8-10 years; Proposed = Specific program or site proposals, expected operation mostly within 15 years. Source: World Nuclear Association, Credit Suisse estimates

Market balance Our supply-demand forecasts remain largely unchanged from our last update. In total, from 2013-2022, we estimate the global uranium market will be in a deficit of 65Mln lbs, with deficits occurring in 2014 and 2015, followed by a balanced market until 2020, and then more significant deficits growing thereafter.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Exhibit 300: Uranium price history, forecasts and NYMEX futures curve 300

Demand - Reloads for initial cores (M'lbs, LHS)

300

Demand - Initial cores (M'lbs, LHS) Demand - Existing NPP's (M'lbs, LHS)

250

Primary mine supply (M'lbs, RHS)

250

Total supply (M'lbs, RHS)

200

200

150

150

100

100

50

50

-

-

Source: Company reports, Credit Suisse

Recent price leakage resulting from limited demand interest has caused spot prices to dip below the $40/lb barrier for the first time since March 2006. Medium and long term, we believe the uranium price will stage a steady recovery to a level that reflects the incentive price for production expansion and exploration, averaging between $65-70/lb over the next five years. Supporting of view, we estimate the market will be in a modest structural deficit in 2014/15, although it is unlikely in our view that prices will return to $100+/lb level seen in 2007. It is interesting to note that during the period between June 2010 (post GFC) and January 2011 (pre-Fukushima), the spot uranium price increased from $40/lb to $73 (an average of $4-5/lb per month and the LT price increased from $58//lb to $73/lb (an average of $2-2.50/lb per month).

Exhibit 301: Uranium price history, forecasts and NYMEX futures curve UxC Month-end U3O8 spot price (US$/lb)

Credit Suisse spot forecast (US$/lb)

NYMEX-UxC Futures (US$/lb)

UxC Month-end U3O8 LT price (US$/lb)

140 Historical

Forecast

120 100 80 60 40 20 -

Source: Company reports, Credit Suisse Equity Research

Commodities’ Forecast Update: The Return of “Fundamentals”

165

25 June 2013

Uranium supply: Supply growth fueled by Kazakhstan and Cigar Lake Current low uranium price relative to the marginal cost of production and availability of both inventory and secondary sources of fuel supply translates into a riskier environment for mine supply, in our view. As such, we believe future mine supply trends will focus on uranium deposits of the highest quality in terms of tonnage, grade, cost, and ability to finance. Prior to the events of Fukushima, questions facing the uranium market centered on security of supply, and although we believe this to still be the case, addressing future supply concerns will now have to be made in a period of lower prices and sentiment.

Exhibit 302: Uranium supply forecasts all figures in Mln lbs U3O8, unless noted Uranium mine production North America South America Western Europe Eastern Europe Kazakhstan Russia & Other FSU Africa Asia & Oceana Other (adjustments) Mine production growth rate Secondary supply Total supply growth rate

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

29.8 0.9 0.7 36.5 19.6 19.6 27.7 134.8 16.3% 45.5 180.3 7.6%

29.4 0.4 0.7 46.3 22.2 23.0 25.9 147.8 9.7% 48.2 196.0 8.7%

27.3 0.7 0.6 50.6 22.5 26.6 21.0 149.2 0.9% 47.1 196.3 0.2%

24.8 0.7 0.7 54.3 22.8 33.4 20.3 157.0 5.2% 50.3 207.3 5.6%

25.2 0.7 0.7 55.9 23.1 37.2 22.6 165.3 5.3% 54.2 219.6 5.9%

27.4 0.7 0.7 58.5 23.8 40.7 21.5 173.2 4.8% 27.0 200.2 -8.8%

30.5 0.7 0.7 58.5 24.6 44.9 21.5 181.3 4.7% 29.5 210.8 5.3%

39.3 0.7 0.7 61.1 25.5 56.4 21.0 204.5 12.8% 29.5 234.0 11.0%

44.9 0.7 0.0 59.5 26.5 56.4 20.4 208.4 1.9% 32.0 240.4 2.7%

48.3 0.7 0.0 55.9 26.6 58.3 19.8 209.5 0.5% 32.0 241.4 0.4%

51.1 0.7 0.0 56.4 26.7 60.2 23.1 218.3 4.2% 32.0 250.2 3.6%

54.5 0.0 56.4 26.8 62.8 23.3 223.9 2.6% 32.0 255.9 2.2%

Source: Company reports, Credit Suisse Equity Research

Kazakhstan production increased 7.5% YoY in 2012 to 54.3Mln lbs U3O8. We estimate further growth to ~60Mln lbs by 2016; however, resources could be depleted at a faster rate than anticipated, with some high-grading occurring at the expense of future production, leaving future production more dependent on higher market prices. We estimate production peaking in 2016 at an annual rate of 60Mln lbs/year, with expansion to 60+Mln lbs/yr requiring a price above $80/lb. Cameco has made steady progress towards its mid-2013 startup at Cigar Lake. In addition to the successful sinking of the #2 shaft, Cameco has restored underground mine systems, infrastructure and development areas, secured regulatory approval and started construction of systems to increase discharge capacity for treated water, initiated orebody freezing from surface, and developed and secured regulatory approval for a revised mine plan. Cigar Lake is expected to produce at an annual rate of 18Mln lbs/year U3O8 with first delivery occurring in late 2013. Although secondary sources of nuclear fuel supply are finite and the HEU agreement governing the sale of decommissioned Russian warheads is due to expire in 2013, we believe other fuel sources, such as quantities delivered under the US-Russia Suspension Agreement (enrichment), tails re-enrichment, reprocessing, and US DOE stockpiles, are all likely sources that will greatly mitigate the impact of lower supplies under HEU and when combined with relatively light volumes of uncovered requirements, should results in commercial markets able to access required quantities over the next 3-5 years. Nuclear regulations in Japan a positive step towards plant restarts The only two operating nuclear reactors (Kansai Electric Power's Ohi plants in western Japan) among Japan’s 50 must be for shut for maintenance 13 months after resuming commercial operations, according to Japanese law (mid-September 2013). That said, we see a generally supportive scenario for restarts in Japan over the next three years, and compared to the 50 reactors currently operable, we forecast a total of a total of 6 reactors in operation by end-2014, a total of 12 by end-2015, and a total of 20 by end-2016, which equates to 40% of current operable capacity. We believe the largest hurdle to these forecasts remains general public opposition to nuclear and the final outcome of regulatory

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

reforms under the new Nuclear Regulation Authority (NRA). The NRA is an independent organization established under the National Government Organization Act, Article 3, and its decisions are protected in principle from interference by the government.

Exhibit 303: Nuclear output of Japan and China (TWh)

Source: Nuclear Power Authority, Credit Suisse - Japan Market Strategy (Shinichi Ichikawa; April 2013)

The NRA has stipulated requirements at nuclear reactors in Japan to include markedly higher and tighter enforcement of countermeasures against earthquakes and tsunamis, and design standards to prevent major accidents, as well as countermeasures to deal with major accidents. The timing of implementation is divided into measures that must be in operation when the plants are restarted and backup measures to increase reliability that must be in place within five years of restart. According to Credit Suisse’s Japan Marketing Strategy Team (Shinichi Ichikawa), the new regulations should allow electric power companies to restart their nuclear plants at a relatively early stage, such as the five-year grace period granted for establishing a second control room to deal with severe accidents. Once the new regulations are approved (expected mid-July) the application and approval process should begin at nuclear plants where conditions are already in order. China at 60GWe by 2020 still a realistic goal Nuclear power currently provides about 13.5% of the world's electricity, comprised of roughly 24% share of electricity in OECD countries and a much lower share in developing economies. According to WNA estimates, 218 nuclear reactors were started up during the 1980s (an average of one every 17 days), including 47 in the U.S., 42 in France and 18 in Japan, so there is a strong precedent for rapid building and commissioning phases for nuclear power. Our current 10-year forecast (2012-2021) incorporates a more modest 112 nuclear reactors, or one every 33 days. China’s Nuclear Power Mid/Long Term Development Plan issued in 2007, China planned to have 40GWe of installed nuclear capacity by 2020. The number was subsequently talked up to 80GWe by 2020; however, the Fukushima nuclear event has created waves for the development strategy of nuclear power, in our view, particularly plans for inland nuclear plants where closer scrutiny based on seismic sensitivity has put approximately 20GWe of growth at risk of delay. Our estimate calls for 60Gwe of installed capacity by

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

2020. Domestically, China currently produces about 2-3Mln lbs of uranium annually (vs. 15-20Mln lbs currently required). The remaining requirements have been imported or purchased in the open market, and strategically stockpiled for future use.

Exhibit 304: Uranium supply/demand model all figures in Mln lbs U3O8, unless noted

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Uranium mine production North America South America Western Europe Eastern Europe Kazakhstan Russia & Other FSU Africa Asia & Oceana Other (adjustments) Mine production growth rate Secondary supply Total supply growth rate

29.8 0.9 0.7 36.5 19.6 19.6 27.7 134.8 16.3% 45.5 180.3 7.6%

29.4 0.4 0.7 46.3 22.2 23.0 25.9 147.8 9.7% 48.2 196.0 8.7%

27.3 0.7 0.6 50.6 22.5 26.6 21.0 149.2 0.9% 47.1 196.3 0.2%

24.8 0.7 0.7 54.3 22.8 33.4 20.3 157.0 5.2% 50.3 207.3 5.6%

25.2 0.7 0.7 55.9 23.1 37.2 22.6 165.3 5.3% 54.2 219.6 5.9%

27.4 0.7 0.7 58.5 23.8 40.7 21.5 173.2 4.8% 22.0 195.2 -11.1%

30.5 0.7 0.7 58.5 24.6 44.9 21.5 181.3 4.7% 27.0 208.3 6.7%

39.3 0.7 0.7 61.1 25.5 56.4 21.0 204.5 12.8% 27.0 231.5 11.1%

44.9 0.7 0.0 59.5 26.5 56.4 20.4 208.4 1.9% 29.5 237.9 2.8%

48.3 0.7 0.0 55.9 26.6 58.3 19.8 209.5 0.5% 29.5 238.9 0.4%

51.1 0.7 0.0 56.4 26.7 60.2 23.1 218.3 4.2% 32.0 250.2 4.7%

54.5 0.0 56.4 26.8 62.8 23.3 223.9 2.6% 32.0 255.9 2.2%

Nuclear power plant (NPP) forecasts (units) China India Japan Russia U.S.A. Other Total growth rate

11.0 17.0 53.0 31.0 104.0 225.0 441.0 0.0%

11.0 17.0 53.0 31.0 104.0 225.0 441.0 0.0%

15.0 20.0 32.0 104.0 262.0 433.0 -1.8%

15.0 20.0 2.0 33.0 104.0 262.0 436.0 0.7%

18.0 18.0 6.0 32.0 104.0 270.0 448.0 2.8%

26.0 18.0 12.0 34.0 104.0 269.0 463.0 3.3%

35.0 19.0 18.0 35.0 104.0 264.0 475.0 2.6%

40.0 21.0 18.0 37.0 104.0 264.0 484.0 1.9%

44.0 22.0 18.0 40.0 104.0 265.0 493.0 1.9%

48.0 22.0 18.0 42.0 105.0 265.0 500.0 1.4%

52.0 23.0 18.0 43.0 105.0 265.0 506.0 1.2%

56.0 24.0 18.0 45.0 106.0 266.0 515.0 1.8%

Uranium demand analysis Existing NPP capacity New NPP capacity Strategic inventory build Total demand growth rate

175.4 175.4 0.6%

178.2 178.2 1.6%

175.1 175.1 -1.8%

178.2 178.2 1.8%

177.8 23.9 10.0 211.0 18.4%

180.3 27.5 10.0 217.0 2.9%

183.6 34.3 10.0 226.7 4.5%

187.7 36.4 10.0 232.9 2.8%

188.5 39.9 10.0 237.3 1.8%

189.2 48.4 10.0 246.4 3.9%

190.0 51.7 10.0 250.6 1.7%

190.7 62.8 10.0 262.4 4.7%

Market surplus (deficit) Based on total supply Surplus (deficit) as % of global demand

5 3%

18 10%

21 12%

29 16%

9 4%

(22) -10%

(18) -8%

(1) -1%

1 0%

(7) -3%

(0) 0%

(7) -2%

Excl Russia/supplier inventories Surplus (deficit) as % of global demand

5 3%

18 10%

21 12%

29 16%

9 4%

(22) -10%

(23) -10%

(6) -3%

(7) -3%

(15) -6%

(10) -4%

(17) -6%

Excluding secondary sources Surplus (deficit) as % of global demand

(41) -23%

(30) -17%

(26) -15%

(21) -12%

(46) -22%

(44) -20%

(45) -20%

(28) -12%

(29) -12%

(37) -15%

(32) -13%

(38) -15%

Source: Company reports, Credit Suisse Equity Research

Commodities’ Forecast Update: The Return of “Fundamentals”

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Financial Flows RESEARCH ANALYSTS Commodities Research Stefan Revielle [email protected] +1 212 538 6802

2Q 2013 summary of commodity-linked flows Investments into commodity-linked indices and exchange-traded funds fell in the second quarter of 2013, with commodity-linked index assets under management (AUM) decreasing by 3.4% to average $204.1 billion using data through June 11 (see Exhibit 305). Additionally, we note that average total contracts held by indices increased by 3.6%. Among exchange traded products, physical commodity-linked exchange traded product (ETP) AUM fell by about 12% to average $128.3 billion for 2Q13. Non-physical commodity ETP AUM decreased by 2% to $32.7 billion over the same period. Together, total commodity investment AUM during 2Q averaged an estimated $365.1 billion, approximately 10% lower than total average AUM for 1Q13 ($408.9 billion). Most recent data indicate current total commodity AUM has retreated further to 351.6 billion, below both 2Q12 and 1Q13 averages.

Exhibit 305: Commodity-linked index AUM fell in 2Q 2013 Estimated billions of US$, 2010 onwards 10

Flows (left axis)

Index-linked AUM (right axis)

265

2013 Q2: AUM: -3.4% Contracts: +3.6%

255 245 235

5 225 215 205 0

195 185 175 165

(5) 155 145 135 (10) 17-May-11

20-Sep-11

24-Jan-12

29-May-12

2-Oct-12

125 11-Jun-13

5-Feb-13

Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse

Exhibit 306: Physical ETF AUM in 2Q 2013

Exhibit 307: Non-physical ETF AUM in 2Q 2013

Estimated billions of US$, 2012 onwards, 99.98% in precious metals

Estimated billions of US$, 2012 onwards, tracks indexes and futures 190

1.20

180

1.00

170

0.80

2.00

160

0.60

1.00

150

0.40

0.00

140

0.20

(1.00)

130

0.00

(2.00)

120

(0.20)

(3.00)

110

(0.40)

100

(0.60) 6-Jan-12

5.00

Flow (lhs)

Physical ETP AUM (rhs)

4.00

2013 Q2: AUM: -12%

3.00

(4.00) 6-Jan-12

22-Jun-12

7-Dec-12

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

24-May-13

Flow (lhs)

Non-physical ETP AUM (rhs) 39

2013 Q2: AUM: -2%

37

35

33

31

29 22-Jun-12

7-Dec-12

24-May-13

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

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25 June 2013

Index investments While the average value of commodity-linked index investments fell by 12% in 2Q13, indices ended the quarter nearly flat. In contrast to 2012, the sum of all index flows so far in 2013 continues to be near zero (see Exhibit 308), while total contracts held has increased by 3.6% so far in the quarter. We further note that the majority of outflows were focused around energy and precious metal commodities. Exhibits 309 and 310 summarize key changes in commodity AUM and contracts. In 2Q13 we note: • Energy commodities saw net outflows, with AUM falling by 6.7% and contracts held increasing by 1.0% qoq. • Base metals saw net inflows with AUM increasing 83% and contracts held rising 3.2% qoq. • Precious metals saw net outflows with total contracts held increasing by 10.8% and AUM falling by 7.4%. • Agriculture saw net outflows as total contracts held increased by 4.5% while AUM fell by 1.0%.

Exhibit 308: Cumulative index flows per year: 2010-2013 US$ billions 30

2013

2012

2011

2010

20 10 (10) (20) (30) (40) Jan

Apr

Jul

Oct

Source: Credit Suisse

• Livestock saw a net inflows, with total contracts held falling by 2.4% and AUM falling by 5.7% qoq.

Exhibit 309: Commodity index investments AUM

Exhibit 310: Commodity index investment contracts

US$ billion (end of quarters), 1Q 2013 as of June 11, 2013

Thousands of contract (end of quarters), 2Q 2013 as of June 11, 2013

Q2-2013 Q1-2013 Crude Oil (WTI) 30.2 31.8 Crude Oil (Bren 21.7 24.7 Heating Oil 8.8 9.4 Gasoil 5.2 6.5 Gasoline 9.0 10.0 Natural Gas 19.2 18.4 Energy 94.0 100.7 Copper (LME) 1.9 2.5 Copper (Comex 9.3 8.7 Zinc 3.7 3.4 Aluminum 7.9 7.3 Nickel 3.1 3.2 Lead 0.3 0.3 Base Metals 26.2 14.3 Gold 14.9 15.7 Silver 4.4 5.1 Precious Me 19.3 20.8 Wheat (Chicago 6.9 6.9 Wheat (Kansas 2.2 2.2 Corn 12.2 13.7 Soybeans 10.0 9.5 Cotton 3.7 3.5 Cocoa 0.2 0.2 Sugar 5.9 5.8 Coffee 3.4 3.3 Soybean Oil 3.8 3.6 Agriculture 48.2 48.7 Lean Hogs 4.3 3.9 Live Cattle 6.0 5.9 Feeder Cattle 0.3 0.4 Livestock 10.7 10.1 TOTAL 198.4 194.7

Q4-2012 42.3 26.6 8.9 10.2 8.4 11.8 108.2 4.3 5.5 3.3 7.2 2.5 0.6 23.4 11.6 3.0 14.6 9.4 1.4 12.2 10.0 2.4 0.3 4.3 2.1 2.4 44.5 3.5 6.7 0.6 10.8 201.5

Q3-2012 49.9 30.7 10.0 12.8 9.4 8.8 121.6 5.2 4.0 2.7 6.3 2.2 0.7 21.1 10.5 2.5 13.0 9.5 1.7 12.1 9.7 2.2 0.4 4.3 2.2 1.8 43.8 3.0 6.2 0.7 9.9 209.3

Q2-2012 36.9 22.1 7.5 8.5 7.7 9.7 92.4 3.7 5.1 2.8 6.2 2.3 0.4 20.6 10.7 2.5 13.2 8.4 1.1 10.2 9.6 2.1 0.3 4.5 2.3 2.6 41.0 3.6 5.7 0.6 9.9 177.0

YoY -18.3% -1.9% 17.1% -39.1% 17.3% 96.8% 1.7% -47.2% 81.3% 31.6% 26.5% 33.0% -32.8% 27.3% 39.9% 74.8% 46.5% -18.4% 103.6% 19.8% 4.3% 72.3% -40.6% 31.2% 49.5% 49.0% 17.7% 21.4% 5.5% -42.8% 8.3% 12.1%

Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

QoQ -5.1% -12.2% -5.7% -20.3% -10.2% 4.1% -6.7% -22.2% 6.8% 8.4% 7.0% -4.1% -16.3% 83.0% -4.9% -14.9% -7.4% -1.2% 2.2% -11.3% 5.0% 5.0% -8.8% 1.1% 3.6% 7.2% -1.0% 12.0% 2.8% -13.6% 5.7% 1.9%

Crude Oil (WTI) Crude Oil (Brent) Heating Oil Gasoil Gasoline Natural Gas Energy Copper (LME) Copper (Comex) Zinc Aluminum Nickel Lead Base Metals Gold Silver Precious Metals Wheat (Chicago) Wheat (Kansas) Corn Soybeans Cotton Cocoa Sugar Coffee Soybean Oil Agriculture Lean Hogs Live Cattle Feeder Cattle Livestock TOTAL

Q2-2013 Q1-2013 316.2 329.8 210.7 226.0 73.5 77.3 45.0 50.4 75.8 76.6 514.6 463.2 1235.8 1223.3 11.0 13.1 116.7 101.7 81.5 81.5 169.8 169.8 35.7 35.7 5.2 5.2 419.9 407.0 108.5 98.5 40.3 35.7 148.8 134.2 196.9 189.9 60.6 56.3 369.3 375.8 129.9 131.6 83.2 79.2 6.4 7.8 322.3 292.1 71.5 64.1 132.9 117.2 1373.1 1314.0 107.8 121.4 125.5 116.6 4.6 5.8 237.9 243.8 3415.4 3322.3

Q4-2012 493.5 246.6 72.7 88.0 76.3 345.8 1,322.9 21.4 60.2 63.3 135.7 23.8 10.0 314.4 68.1 18.3 86.3 233.7 31.7 337.3 136.4 63.8 12.4 201.1 39.1 81.2 1,136.7 105.1 132.5 8.5 246.0 3,106.3

Q3-2012 546.4 277.5 76.3 110.7 75.5 302.4 1,388.7 25.2 42.1 51.3 121.7 20.1 11.5 271.8 59.3 14.8 74.1 215.2 36.8 324.1 119.9 61.7 15.0 195.0 33.0 56.9 1,057.5 97.2 126.5 10.2 233.9 3,026.0

Q2-2012 465.2 237.8 69.6 67.3 69.0 351.8 1,260.7 19.9 62.1 63.4 136.7 23.8 9.2 315.2 67.8 18.4 86.3 230.7 29.5 314.6 130.5 62.2 11.9 194.9 36.9 84.2 1,095.5 95.1 124.2 7.9 227.3 2,984.8

YoY -32.0% -11.4% 5.6% -33.2% 9.9% 46.3% -2.0% -44.6% 88.0% 28.6% 24.2% 49.6% -44.0% 33.2% 60.0% 118.4% 72.4% -14.7% 105.2% 17.4% -0.4% 33.6% -45.8% 65.3% 93.7% 57.8% 25.3% 13.3% 1.0% -41.6% 4.7% 14.4%

QoQ -4.1% -6.8% -5.0% -10.7% -1.1% 11.1% 1.0% -15.9% 14.7% 0.0% 0.0% 0.0% 0.0% 3.2% 10.2% 12.7% 10.8% 3.7% 7.6% -1.7% -1.3% 5.0% -16.9% 10.4% 11.6% 13.4% 4.5% -11.2% 7.6% -19.5% -2.4% 2.8%

Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse

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Exchange Traded Products As of June 14, we estimate total commodity ETP AUM fell by 21.5% qoq to $149.2 billion from $190.1 billion last quarter. The ratio AUM held in non-physical ETPs to physical ETPs saw a large increase as outflows in physical were far more severe than those in nonphysically linked ETPs. We believe this is largely attributable further liquidation in precious metal ETPs, which saw outflows of nearly 25% qoq. Examining cumulative ETP flows for 2013 YTD, we note that we are significantly lower than the same period over the previous three years (see Exhibit 312). AUM fell within all commodity sectors qoq, with the most significant declines seen in Precious metals followed by base metals and livestock. Exhibit 313 summarizes recent changes to ETP AUM.

Exhibit 311: Commodity ETP AUM and ratio – physical and non-physical

Exhibit 312: Cumulative ETP flows per year – 2010, 2011, and 2012

US$ billion (end of quarters), 2Q 2013 based on June 14, 2013 data

US$ billions, 2Q 2013 based on June 14, 2013 data

300.0

0.28 Physical Non-physical

250.0

36.4 37.4

2013

2012

2011

2010

20

Ratio of non-physical to physical 200.0

30

0.27 0.26 10

35.7

0.25 34.8

32.8

150.0

0.24

0

32.1 100.0 159.2

178.7 150.7

170.6

155.4

0.23

-10

0.22

-20

117.1

50.0

0.21

0.0

-30

0.20 -40

Q1-2012 Q2-2012 Q3-2012 Q4-2012 Q1-2013 Q2-2013

Jan

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Mar

May

Jul

Sep

Nov

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Exhibit 313: Commodity ETP AUM summary US$ billion (end of quarters), 2Q 2013 based on June 14, 2013 data

Q4-2011 Q1-2012 Q2-2012 Q3-2012 Q4-2012 Q1-2013 YoY change QoQ change

Total

Physical

Index

Futures

Nonphysical

Broad

Energy

Precious Metals

Base Metals

Agriculture

Livestock

178.6 196.6 183.5 215.1 211.2 191.5 -2.6% -9.3%

144.3 159.2 150.7 178.7 175.3 156.6 -1.6% -10.6%

30.9 33.7 29.2 32.9 32.1 31.6 -6.2% -1.5%

3.3 3.7 3.6 3.5 3.7 3.2 -11.8% -13.2%

34.2 37.4 32.8 36.4 35.86 34.9 -6.8% -2.7%

16.4 18.0 15.3 17.9 17.4 17.7 -1.3% 1.8%

7.7 8.8 8.0 8.1 8.4 7.5 -14.5% -10.4%

147.0 162.0 153.2 181.7 178.3 159.1 -1.8% -10.8%

1.8 2.4 2.1 2.3 2.5 2.7 13.0% 6.0%

5.3 5.2 4.7 4.8 4.3 4.3 -16.9% 0.1%

0.3 0.3 0.3 0.3 0.3 0.3 -10.5% -14.0%

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Technical Analysis RESEARCH ANALYSTS Fixed Income Research David Sneddon +44 20 7888 7173 [email protected]

Gold (Spot) – Weekly

Christopher Hine 212 538 5727 [email protected] David Robertson +44 20 7888 7172 [email protected]

Source: Updata, the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

We have held core bearish outlooks for Gold and Silver since the completion of mediumterm tops in early April (c.f. Technical Analysis – Precious Metal Update and Trade Idea: Sell Gold and Silver). The recent price collapse has now achieved and exceeded key support levels, reinforcing out bearish stance and warning of further significant weakness. Gold has broken below our first target at $1310/00 – the 50% retracement of the 2008 to 2011 rally – as well as the subsequent major support level at $1284 – the 38.2% retracement of the whole 1999 to 2011 bull market. We allow for a knee-jerk bounce at first, but remain bearish for a deeper setback through $1210/00 towards $1157/54 – a further key retracement level and the July 2010 low. With the measured target from the top not far below at $1122, we would look for buying interest to emerge from here. Surrender of the later level would allow an overshoot to $1085. Above $1322/39 allows a better recovery to $1424. While below $1488/$1503 then the near-term bearish pressure can remain. Silver has also plunged lower, removing the May low at $20.70 for a test of $19.83/46 chart support. We remain bearish for a deeper setback to our $17.30/00 target – the 78.6% retracement of the 2008 to 2011 advance. Bigger picture, we would not rule out an eventual move to the 2010 low at $14.64. Above $22.57 eases the immediate downward pressure, with scope for the $24.87 recent high. While below pivotal resistance at $25.99/$26.16 the large top is maintained. Meanwhile, Platinum has capitulated below the key range lows at $1379/73 to complete a much larger top to the market. Buying interest has been found at the next key level of support at $1331/30 – the 50% retracement of the whole 2008 to 2011 bull run – but we view this as an opportunity to sell strength. Our bias is for a break below $1331/30 in due course to allow a still deeper setback to $1203/1192 – chart support and the 61.8% retracement. Bigger picture, we would not rule out an eventual look at the $1000 level. Above $1375/79 can see a recovery to $1431 next. However, while $1540/55 caps then the risks can remain skewed to the downside.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Copper (LME 3-month) – Weekly

Source: CQG, Credit Suisse

We have been long-time bears on Copper (c.f. our earlier reports Copper maintains a large top and Base & Precious metals look close to major tops) and the latest downtrend since the beginning of the month has reinforced this view. Indeed, the recent fall managed to push briefly below the key April lows and trendline support at $6776/62. This bearish excursion warns of further weakness in due course to pivotal support at $6635/6500 – the 2011 major low and the 50% retracement of the 2008 to 2013 rally. We would look for a fresh consolidation from here. However, our broader bias is for an eventual break below $6505 to target $6038, and then the 61.8% retracement level at $5635. Above $7221/23 can see a fresh look at the $7534/54 recent highs, which we look to hold to keep the downtrend intact. We flagged that Aluminium (LME 3-month) was forming a major top back in the beginning of May (c.f. Trade idea: Aluminium looks close to confirming a top). The recent collapse below $1821/09 has finally confirmed the top, warning of further significant declines. The initial focus is on the October 2009 lows at $1777/76, and then $1701/00 chart support. Bigger picture, we look for a deeper setback to $1605/00 with to $1545. Back above $1867/69 can see a better recovery to the $1981 high, which we look to hold to maintain the bearish pressure. Nickel stays biased lower to the 78.6% retracement level at $13253 next beneath which would aim at $10750 then major support at $9250/8850. Lead stays on course to $1938 beneath which would see a bigger top for $1877 then $1841/18. Zinc targets $1812 through which would expose $1779 then 2012 low at $1745.

Commodities’ Forecast Update: The Return of “Fundamentals”

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25 June 2013

Brent Crude Oil – Daily

Source: Updata, the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Brent Crude Oil has settled into a range since the beginning of April, capped by chart resistance at $106.63/64. We expect this level to continue to hold to keep prices rangebound. However, should a break above be realised then this would allow meaningful strength through $107.96 towards $110.61/$111.79 at first – the April high and 61.8% retracement of the February/April retreat. A push above $114.37/$11587 would then be needed to expose the $119.17 peak. The bottom of the range is placed at $96.75/73, which we look provide a floor. A capitulation below allows significant weakness through $95.30/06 to target $90.88/70, with overshoot risk for the 2012 low at $88.49. WTI Crude Oil has failed at the top end of the converging range now at $98.16. The sharp reversal lower from here leaves the spotlight on $91.26/$90.73. Beneath here would see a roll down to $88.78 then $88.48 with range support at $86.32/$85.52. Above $98.16/65 is needed to turn the focus higher again on $99.18 then $103.20. Gasoline stays under pressure to the year’s low at 268.79 through which would look to the multi-year converging range lows at 262.47. We would expect a basing effort here and only below would see a deeper setback to 258.93 then 255.24. Heating Oil stays bearish in the range for 276.40 though which would expose the year’s low’s at 272.55. Only surrender here sees a more bearish turn for 270.32 then 267.20. We flagged the formation of a top for API 4 Coal (1st Month) at the end of April (c.f. Trade idea: Sell API 1st Month Coal) confirmed on the collapse below $79.60/00. This now targets $69.73, the measured target from the base at $69.90/80 and the $67.50 low. Similarly, API 2 Coal (1st Month) has seen a steep decline, and is fast approaching the measured objective from the base $73.00/$72.80. Through here exposes significant support at $70.82/50 – the 78.6% retracement of the 2009/11 rally and chart props.

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Contributors Commodities Research Ric Deverell Marcus Garvey Tom Kendall Stefan Revielle Andrew Shaw Jan Stuart Johannes Van Der Tuin

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Equity Research – Metals and Mining Paul McTaggart James Redfern Matt Hope Martin Kronborg Sam Webb Trina Chen Owen Liang Frankie Zhu Shinya Yamada Paworamon (Poom) Suvarnatemee Ami Tantri Fonny Surya Minseok Sinn Hayoung Chung Neelkanth Mishra Anubhav Aggarwal Digvijay Singh Michael Shillaker James Gurry Semyon Mironov Mikhail Priklonsky Richard Garchitorena Nathan Littlewood Ivano Westin Viccenzo Paternostro Marina Melemendjian Vanessa Quiroga Santiago Perez Teuffer

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Equity Research – Agriculture Christopher Parkinson Lars Kjellberg Robert Moskow

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Global Energy

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Commodities’ Forecast Update: The Return of “Fundamentals”

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Equity Research – Energy (Continued) Brad Handler Eduardo Royes Jonathan Sisto Yves Siegel Brett Reilly Pooja Shakya Dan Eggers Kevin Cole Matt Davis Katie Chapman Satya Kumar Patrick Jobin Charlie Balancia Brian Dutton Andrew Kuske Courtney Morris Paul Tan Jason Frew Terence Chung David Phung Mark Henderson Andrey Ovchinnikov Piotr Dzieciolowski Onur Muminoglu Kim Fustier Thomas Adolff Charlotte Elliott Ritesh Gaggar Arpit Harbhajanka Thomas Adolff Ritesh Gaggar Vincent Gilles Mark Freshney Michel Debs Zoltan Fekete Emerson Leite Andre Sobreira Vinicius Canheu Adelia Souza Luiz Campos Viccenzo Paternostro Paul McTaggart James Redfern

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[email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected]

Commodities’ Forecast Update: The Return of “Fundamentals”

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GLOBAL COMMODITIES RESEARCH

Ric Deverell, Managing Director Global Head of Commodities, GFX and Asia Strategy +44 20 7883 2523 [email protected]

Eric Miller, Managing Director Global Head of Fixed Income and Economic Research +1 212 538 6480 [email protected]

LONDON

One Cabot Square, London E14 4QJ, United Kingdom

Tom Kendall, Director

Marcus Garvey, Analyst

Head of Precious Metals Research +44 20 7883 2432 [email protected]

+44 20 7883 4787 [email protected]

NEW YORK

11 Madison Avenue, New York, NY 10010

Jan Stuart, Managing Director

Stefan Revielle, Associate

Johannes Van Der Tuin

Head of Energy Research +1 212 325 1013 [email protected]

+1 212 538 6802 [email protected]

+1 212 325 4556 [email protected]

SINGAPORE Andrew Shaw, Director Head of Base Metals & Bulks Research +65 6212 4244 [email protected]

One Raffles Link, Singapore 039393

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