jpm global commodities strategy 2010-12!01!513530

Global Commodities Strategy Global Commodities Research JPMorgan Chase Bank, NA December 1, 2010 www.morganmarkets.com See back page for analyst certification and important disclosures, including investment banking relationships. 2011 Outlook Summary: The outlook for commodities in 201 1 is positive, spurred by global cyclical recovery and easy hurdles for global consumption to surpass constrained global production. We believe the risks to our central view are skewed toward higher price volatility and higher returns, especially should governments implement price controls and other trade barriers that increas e friction in the movement of scarce invento ries to jurisdictions where they are needed most. For investors looking to initiate long exposures heading into 2011, we prefer Brent crude oil, wheat, corn, and copper. In 2010, involuntary supply losses—mostly the result of severe weather—drove risk across a number of commodity markets, helping spu r significant price surges in wheat, sugar, rice, coffee, cotton, and corn. In 2011, the cyclical reignition of demand growth expectations will likely bec ome a more dominant factor in guiding the performance of physical commodities and their associated futures markets. Recent interest rate hikes in metals-producing and commodity-consuming countries have reinforced our sense that the global recovery, while below trend, is on a sustainable and broadly upward cyclical track. Rising inflation expectations and actual rate hikes in 2011 will tend to steepen upward-sloping commodity forward curves, as rising forward valuations and higher carrying costs are embedded in term structures. Meanwhile, a number of commodity forward curves are already exhibiting backwardation (i.e., downward-sloping shapes), providing concrete evidence of the very low level of inventories that prevails in a number of agricultural markets. Low stock levels will continue to be an important factor in 2011. In assessing risks to our view , we note that recent weeks have brought (1) rising complaints about central banks’ plans for incremental rounds of Large Scale Asset Purchases, and (2) threats of p rice controls to manage food price inflation in emerging markets. In early November , these factors contributed to a correction in the powerful rally in commodity prices that has followed the Fed’s 2010 Jackson Hole conference. However, in our view, these risks have not reversed the central tendency of these markets toward tighter balances and higher prices over the next 12 months. T o the contrary, we still expect the Fed’s spending program to unfold as promised. And if growth conditions were to deteriorate, we would expect even further salutary measures. Moreover, we note that China already has in place systematic price controls in various commodity markets. It would be factually incorrect to suggest China is introducing commodity price controls for t he first time. Many other countries, including the United States, also already impose commodity price controls in the forms of tariffs, trade quotas, subsidies, and rules on the warehousing and transport of commodities. Incremental measures in this policy direction, while typically not optimal for efficient resource allocation, do not necessarily surprise physical market agents or lead to worst outcomes. Commodity markets also have the fresh experience of watching a number of price controls attempted in sugar in 2010 not work at all. Instead, these policy prescriptions contributed significantly and unintentionally to higher realized and implied price volatility and a return to fresh 30-year highs within months of their implementation. A policy mistake is a very real risk, but at present the most likely policies lead to higher commodity prices, not lower. Colin P. Fenton AC (1-212) 834-5648 [email protected] Lawrence E. Eagles (1-212) 834-8107 [email protected] Michael J. Jansen (44-20) 7325-5882 [email protected] Scott C. Speaker (1-212) 834-3878 [email protected] Jeff G. Brown (65) 6882-2215 [email protected] David G. Martin (44-20) 7777-0211 [email protected] Peter K. Nance (1-713) 236-3337 [email protected] Lewis A. Hagedorn (1-212) 834-8046 [email protected] Jonah D. Waxman, CFA (1-212) 834-2203 [email protected] Tobin Gorey (44-20) 7777-3103 [email protected] Sung K. Yoo (1-212) 834-7045 [email protected] Ryan F. Sullivan (1-212) 834-3935 [email protected] Shikha Chaturvedi (1-212) 834-3245 [email protected] Elizabeth M. Vo lynsky (1-212) 834-4021 [email protected]

jpm global commodities strategy 2010-12!01!513530

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