Commodity Revival at Risk You Cannot Create Experience

Commodity Revival At Risk You cannot create experience. You must undergo it. Albert Camus, Notebooks, 1935 - 1942

March 2018

Robert P. Ryan Senior Vice President Commodity & Energy Strategy BCA Research’s Commodity & Energy Research

BCA Lifts Oil Price Forecasts USD/ USD/ FFBottom-up Fundamental analysis bbl BRENT PRICES bbl BCA BRENT PRICES MODEL*: SCENARIO 1** FFSupply SCENARIO 2*** 120 WEIGHTED AVERAGE OF BOTH SCENARIOS**** 120 FFDemand 100 100 FFInventories 80 80 FFTop-down Global-Macro analysis 60 60 FFFinancial variables (Money supply, interest rates, FX) 40 40 FFGlobal trade volumes, particularly EM

USD/ USD/ FFInflation in key economies (U.S., EU, China) bbl WTI PRICES bbl BCA WTI PRICES MODEL*: SCENARIO 1** FFTrading-market analysis SCENARIO 2*** 120 WEIGHTED AVERAGE OF BOTH SCENARIOS**** 120 FFForward curves 100 100 FFVolatility 80 80 FFCES Leadership 60 60 FFBob Ryan has more than 30 years in commodities 40 40

FFNYMEX Senior Economist, Dir. of Options Research © BCA Research 2018

2014 2016 2018 FF~20 years in sales/trading at BT, GS, DB NOTE: SHADED AREA DENOTES PROJECTIONS. *PRICES ARE MODELED AS A FUNCTION OF FUNDAMENTAL VARIABLES. **OPEC 2.0 INCREASES PRODUCTION STARTING IN JUN/18. FU.S. EIA Economist, joined BCA as an ME in 2014 ***OPEC 2.0 INCREASES PRODUCTION STARTING IN DEC/18. F ****WE ASSIGN A 20% PROBABILITY TO SCENARIO 1 AND A 80% PROBABILITY TO SCENARIO 2. FF2016 calls up 95%; 2017 up 111%

2 BCA RESEARCH BCA Research Energy Markets

3 BCA RESEARCH OPEC 2.0 Production Discipline Holds

FFOPEC 2.0 – the producer coalition led by the U.S. Shales Dominate Non-OPEC Supply Growth Kingdom of Saudi Arabia (KSA) and Russia MMb/d MMb/d – will maintain its production discipline 64 64 63 63 throughout 2018. NON-OPEC OIL & LIQUIDS PRODUCTION 62 62 FFWe expect global crude and liquids supply to 61 61 average 99.64mm b/d in 2018 (+1.98mm b/d). 60 60 U.S. shale-oil production rises 1.15mm b/d, 59 59 leading global growth. 58 58 57 57

56 FOR ALL PANELS: 56 FFIn 2019, global crude and liquids supply will BCA EIA average 102.22mm b/d (+2.58mm b/d), led MMb/d MMb/d again by surging U.S. shale-oil production OPEC CRUDE OIL PRODUCTION (+1.39mm b/d). 33 33 FFOPEC production in February 2018 was 270k b/d below the group’s OPEC 2.0 quota of 32 32 32.73mm b/d, according to Platts.

31 31 FFBeyond 2018, we believe OPEC 2.0 will endure as a coalition. It will manage production and 30 30 provide forward guidance consistent with a © BCA Research 2018 2014 2015 2016 2017 2018 2019 strategy to keep WTI and Brent forward curves SOURCE: U.S. EIA; BCA RESEARCH. backwardated. NOTE: SHADED AREA DENOTES PROJECTIONS.

4 BCA RESEARCH BCA’s Bullish Demand Estimates

FFDriven by the synchronized global recovery and Non-OECD Demand Growth Continues lower oil prices, BCA expects EM oil demand to MMb/d MMb/d have grown in 2017 by ~160k b/d more than the OECD 49 49 EIA.

48 48 FFWith GDP growth accelerating in ~ 75% of countries monitored by the IMF, we expect commodity 47 47 demand - particularly for crude oil and refined 46 46 products - to remain strong in 2018 and 2019.

45 45 FFThe EIA has historically underestimated demand and retroactively revised its net demand estimates FOR ALL PANELS: MMb/d OIL & LIQUIDS CONSUMPTION: MMb/d BCA by an average 470k b/d per year since 2010. For EIA

4Q17, EIA revised global demand up 450k b/d. 54 54 FFChina and India continue to dominate EM demand NON-OECD growth. Most of the slowdown in consumption since 52 52 2014 came from the economic contraction in petro 50 50 states (Middle East, Russia and Brazil). FFIn 2018, global demand crosses 100mm b/d; in 48 48 2019 it grows to close to 102mm b/d. © BCA Research 2018

2014 2015 2016 2017 2018 2019 SOURCE: U.S. EIA; BCA RESEARCH. NOTE: SHADED AREA DENOTES PROJECTIONS

5 BCA RESEARCH Global Oil Market Tightening

FFOur monthly World Supply-Demand balances Fundamental Balances Remain In Deficit Longer MMb/d MMb/d points toward a tightening of the global oil BCA CRUDE OIL BALANCE (LS) BCA WORLD SUPPLY (RS) 102 market in 2018. This will increase the impact of BCA WORLD DEMAND (RS) 100 2.5 supply-demand shocks, particularly the impact of END-2018 EXTENSION 98 2.0 96 unplanned supply disruptions. 1.5 94 1.0 92 FFThe past two years have been remarkably benign .5 90 (i.e. bearish for oil prices) regarding unplanned 0 88 production outages, with Iran, Libya, and Nigeria -.5 all returning production to near full potential, -1.0 -1.5 adding over 1.5 MMb/d of constrained supply back

MMb/d MMb/d to the world market. BCA CRUDE OIL BALANCE (LS) BCA WORLD SUPPLY (RS) 102 BCA WORLD DEMAND (RS) 100 FFWe believe the risk of future unplanned outages 2.5 PREVIOUS ESTIMATES* 98 within OPEC are elevated – particularly in 2.0 96 1.5 Venezuela. 94 1.0 92 .5 FFThe odds OPEC 2.0’s production cuts are extended 90 0 to end-2018 are 80% in our modeling. This will 88 -.5

lift average Brent and WTI crude oil prices to $74 -1.0 and $70/bbl, respectively. The remaining 20% -1.5 © BCA Research 2018 reflects our previous expectation that cuts would 2013 2014 2015 2016 2017 2018 2019 SOURCE: U.S. EIA & BCA CALCULATION. cease at end-June. Resolving this in favor of the *OPEC 2.0 STARTS INCREASING PRODUCTION IN JUNE 2018. former expectation would lift our expectations to NOTE: SHADED AREA DENOTES PROJECTONS. $76 and $73/bbl for Brent and WTI this year, and $70 and $68/bbl next year.

6 BCA RESEARCH BCA’s Bullish Demand Estimates

FFSupported by OPEC 2.0’s strong compliance level Maintaining Production Cuts Depletes Inventories Even More to the agreement, we estimated OECD commercial MMb MMb FOR BOTH PANELS: OECD INVENTORIES: inventories fell by 183mm bbls since January BCA ESTIMATE 5-YEAR AVERAGE 2017. 2010-2014 AVERAGE 3000 3000 FFExtending OPEC 2.0’s production cuts to end- END-2018 EXTENSION 2018 would result in an additional 130mm bbls reduction to OECD inventories versus our prior 2800 2800 modeling. This means Brent and WTI forward

curves will be more backwardated than they would 2600 2600 have been had the barrels taken off the market at the beginning of 2017 been slowly restored MMb MMb starting in July of this year, as we earlier expected.

PREVIOUS ESTIMATES* FFOnce OECD inventories are finally drained to below 3000 3000 their five-year average level, the real work for OPEC 2.0 begins. 2800 2800 FFWe expect U.S. shale production increases by 1.15mm b/d from December 2017 to December 2018, and another 1.3-1.4mm b/d during calendar 2600 2600 2019. This dominates non-OPEC production © BCA Research 2018 2010 2012 2014 2016 2018 growth this year and next. Due to the supply SOURCE: U.S. EIA; BCA RESEARCH. *OPEC 2.0 STARTS INCREASING PRODUCTION IN JUNE 2018. response of the shales to higher prices in 2018, global production levels would see a net increase from March 2019 and beyond.

7 BCA RESEARCH Balances Tighten BCA Global Oil Supply - Demand Balances (mm b/d) 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19 OPEC PRODUCTION OF CRUDE OIL AND LIQUIDS OPEC CRUDE OIL PRODUCTION 32.32 32.28 32.27 32.29 32.51 32.80 32.71 32.50 FFOil ministers from the Kingdom OF WHICH ALGERIA 1.04 1.02 1.01 0.99 0.98 0.96 0.95 0.93 of Saudi Arabia (KSA) and Russia ANGOLA 1.61 1.59 1.58 1.56 1.55 1.53 1.52 1.50 - OPEC 2.0’s putative leaders - ECUADOR 0.54 0.54 0.54 0.54 0.54 0.54 0.54 0.54 EQUATORIAL GUINEA 0.14 0.14 0.14 0.14 0.14 0.14 0.14 0.14 separately indicated increased GABON 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 IRAN 3.85 3.86 3.88 3.89 3.91 3.92 3.94 3.95 comfort with higher prices over the IRAQ 4.47 4.50 4.55 4.63 4.65 4.65 4.65 4.65 KUWAIT 2.71 2.71 2.71 2.71 2.77 2.83 2.80 2.80 next year or so. LIBYA 0.92 0.90 0.90 0.90 0.90 0.90 0.90 0.90 NIGERIA 1.75 1.74 1.72 1.71 1.69 1.68 1.66 1.65 QATAR 0.61 0.61 0.61 0.61 0.64 0.67 0.68 0.68 FFThis suggests they are converging SAUDI ARABIA 10.00 10.00 10.00 10.00 10.13 10.33 10.29 10.13 on a strategy that accommodates UAE 2.91 2.91 2.91 2.91 2.95 3.01 3.05 3.05 VENEZUELA 1.59 1.56 1.53 1.50 1.47 1.44 1.41 1.38 KSA’s need for higher prices over OPEC NON-CRUDE LIQUIDS 6.90 6.94 6.98 7.02 7.05 7.12 7.19 7.27 TOTAL OPEC PETROLEUM SUPPLY 39.22 39.22 39.25 39.31 39.56 39.92 39.90 39.77 the short term to support the IPO of NON-OPEC PRODUCTION OF CRUDE OIL AND LIQUIDS N. AMERICA 23.48 24.15 24.62 25.25 25.55 26.18 26.48 26.86 Saudi Aramco, and Russia’s longer- OF WHICH U.S. ONSHORE 7.82 8.04 8.33 8.69 9.08 9.46 9.80 10.08 term desire to avoid price levels that CENTRAL AND S. AMERICA 5.01 5.50 5.83 5.50 5.12 5.63 5.96 5.63 overly incentivize growth in the U.S. EUROPEAN 4.35 4.28 4.09 4.31 4.30 4.22 4.10 4.29 FSU AND EASTERN EUROPE 14.46 14.44 14.37 14.41 14.48 14.43 14.49 14.49 shales. OF WHICH RUSSIA 11.18 11.16 11.10 11.10 11.17 11.33 11.22 11.43 MIDDLE EAST (EX OPEC) 1.11 1.09 1.07 1.05 1.05 1.03 1.02 1.00 FFWe believe OPEC 2.0’s production AFRICA 1.78 1.78 1.78 1.78 1.80 1.80 1.80 1.80 ASIA AND OCEANIA 9.25 9.27 9.29 9.33 9.30 9.30 9.29 9.30 cuts will be extended to year-end. TOTAL NON-OPEC PETROLEUM SUPPLY 59.22 60.28 60.82 61.23 61.30 62.47 62.81 63.15 TOTAL WORLD SUPPLY 98.45 99.50 100.07 100.53 100.87 102.39 102.71 102.92 GLOBAL LIQUID FUELS CONSUMPTION FFThis drives our expectation Brent and TOTAL NON-OECD 52.15 52.84 52.89 53.12 53.23 54.03 54.14 54.44 WTI crude oil prices will average $74 TOTAL OECD 47.43 46.77 47.96 48.00 47.81 47.17 48.27 48.35 OF WHICH and $70/bbl this year, respectively. N. AMERICA 22.29 22.48 23.09 22.85 22.60 22.89 23.38 23.13 CNTL. AND S. AMERICA 8.83 9.00 9.10 9.14 8.95 9.14 9.24 9.28 EUROPE 14.91 14.96 15.40 15.13 14.96 14.94 15.41 15.22 FFFor next year, the extended cuts lift EURASIA 4.81 4.85 5.12 5.00 4.86 4.90 5.17 5.05 MIDDLE EAST 8.35 8.90 9.32 8.73 8.48 9.06 9.48 8.89 Brent and WTI to $67 and $64/bbl. AFRICA 4.47 4.46 4.37 4.48 4.61 4.59 4.51 4.62 ASIA AND OCEANIA 35.94 34.96 34.46 35.81 36.59 35.69 35.21 36.61 TOTAL WORLD DEMAND 99.59 99.61 100.86 101.14 101.05 101.21 102.41 102.80 SOURCE: BCA RESEARCH; U.S. EIA.

8 BCA RESEARCH Elevated FX Risks In 2H18

FFFrom our modelling, we find the USD to be an U.S. Monetary Conditions Drive Oil Prices

important explanatory variable for oil prices. USD/ bbl BRENT PRICE (LS) U.S. BROAD TRADE-WEIGHTED 90 FFIn line with our House view, we are expecting some 140 DOLLAR* (Inverted, RS) USD strengthening on the back of as many as four 100 100 interest-rate hikes by the Federal Reserve in the 110 U.S. As we’ve noted in the past, we expect these 60 120 130 effects to be felt more in 2H18. 20 WTI PRICE (LS) USD/ U.S. BROAD TRADE-WEIGHTED FFA steeper backwardation in oil forward curves - bbl DOLLAR* (Inverted, RS) i.e., the front of the curve trades premium to the 140 100

110 deferred contracts - reduces the USD’s effect on 100

oil prices, all else equal. 120 60 FFIn other words, supply-demand fundamentals 130 20 dominate the evolution of oil prices when forward DUBAI FATEH OIL PRICE (LS) USD/ U.S. BROAD TRADE-WEIGHTED curves are more backwardated, and the influence bbl DOLLAR* (Inverted, RS) of financial variables -the USD in particular - is 140 100

110 muted. 100

120 60

130 20 © BCA Research 2018

2010 2012 2014 2016 2018 * SOURCE: J.P.MORGAN CHASE & CO.

9 BCA RESEARCH BCA Research Bulks + Base Metals Markets

10 BCA RESEARCH China’s Environmental Reforms Drive Steel & Iron Ore

Steel, Iron Ore Prices Diverge

RMB/ FFChina’s environmental policy actions reduced world MT steel-making capacity by ~115mm MT between 1300 STEEL PRICE INDEX* (LS) 1H16 and 1H18. IRON ORE PRICE** (RS) FFThe total gain in steel prices since the start 1200 160

of Beijing’s focus on steel-market reforms is a 1100 resounding 108%.

1000 FFIron ore prices posted similar gains to steel in 2016 140

but diverged sharply in 2017 900 FPrices slumped more than 40% between mid- F 120 800 March and mid-June FFIron ore prices ended last year 15% lower yoy, 700 100 and have since rebounded by 3.5%. 600

500 80

400

2011 2012 2013 2014 2015 2016 2017 2018 *MYSPIC STEEL COMPOSITE PRICE INDEX FROM MYSTEEL.COM.; 2005=100. **SOURCE: CHINA IRON & STEEL ASSOCIATION, AVERAGE CHINA IMPORT PRICE 62% GRADE.

11 BCA RESEARCH China’s Steel Paradox: Record Crude Output Amid Falling Products Output

Shutting Induction Mills Ann% Ann% FFIn addition to eliminating 100-150mm MT of Chg Chg outdated steel capacity over the 2016-2020 CRUDE STEEL* period, Beijing pledged to eliminate smaller 20 20 induction furnaces in China by 2H17. FFThese induction furnaces account for ~ 80-120mm 10 10 MT worth of annual capacity. Actual output was ~ 30-50mm MT in 2016. FFThe production cuts from induction mills are 0 0

not evident in official data – China’s crude steel Ann% Ann% Chg Chg production figures have continued to rise amid STEEL PRODUCTS*

these cuts. 30 FOR BOTH PANELS: 30 CHINA PRODUCTION FFThis production paradox is because Chinese induction furnaces are illegal. As a result, their 20 20 output is not accounted for in official production data. 10 10

0 0 © BCA Research 2018

2008 2010 2012 2014 2016 2018 *BASED ON 12-MONTH MOVING TOTALS. SOURCE: CHINA STAT. INFO & SERVICE CENTRE, BCA RESEARCH.

12 BCA RESEARCH Evidence Of A Tight Steel Market In China

FFDespite record crude steel production in China, China Steel Market Looks Tight Mn Mn the following observations point to a strained steel MT MT

market: 5 CHINA STEEL INVENTORY: 5 LARGE & MEDIUM ENTERPRISE: STEEL BILLET 1. Output of steel products have been falling: 4 4 they came in 3.46% lower yoy for the March to November period – the first yoy 3 3

decline for that period since 1995. 2 2

2. China’s steel exports have been on a 1 1 downtrend.

Mn Mn MT MT 3. China’s scrap steel imports – the main LARGE & MEDIUM ENTERPRISE: input to illegal induction furnaces – fell in STEEL PRODUCT 2H17. 16 16

12 12

8 8

4 4 © BCA Research 2018

2002 2004 2006 2008 2010 2012 2014 2016 2018 SOURCE: CHINA IRON & STEEL ASSOCIATION.

13 BCA RESEARCH Wider Iron Ore Spreads

FFA consequence of the steel winter capacity cuts Reform Widens IO Spreads USD/ USD/ CHINA SPOT PRICE IRON ORE IMPORTS: in China is stronger demand for higher grade raw MT MT 58% FINES 200 62% FINES 200 materials. 65% PELLETS 160 160 66% FINES 120 62% LUMPS 120 FFHigher-grade ores are more efficient for blast 80 80 40 40 furnaces, allowing them to produce more steel USD/ FOR BOTTOM FOUR PANELS: USD/ MT CHINA IMPORTED IRON ORE PRICE SPREADS MT from each tonne of iron ore. 80 80 60 65% PELLETS - 62% FINES 60 FFGiven steelmakers’ healthy profit margins, they are 40 40 able to afford the higher grades and are favoring 20 20 USD/ USD/ productive efficiency. MT 62% FINES - 58% FINES MT 20 20 15 15 FFThis widened the discount for lower grade iron ore 10 10 fines – 58% iron content – as well as the premium 5 5

USD/ 66% FINES - 62% FINES USD/ for higher grade 65% iron content. MT MT 20 20 16 16 FFPremiums for iron ore pellets and lumps – which 12 12 8 8 do not require the highly polluting sintering phase 4 4

– have also widened. USD/ USD/ MT 62% LUMPS - 62% FINES MT 30 30

20 20

10 10 © BCA Research 2018 0 0

2013 2014 2015 2016 2017 2018 SOURCE: BEIJING CUSTEEL E-COMMERCE CO.

14 BCA RESEARCH Demand For High-Grade Iron Ore Will Persist

FFHigher metallurgical coke prices are also driving High-Quality IO Favored In China Mn Mn up spreads. Higher-grade iron ore requires less met Tons Tons FOR BOTH PANELS: coke to purify the ores. CHINA IRON ORE IMPORTS: 600 1000 TOTAL (LS) AUSTRALIA (RS) FFChina’s imports show a decline in iron ore from BRAZIL (RS) 500 800 India – which is of the lower grades. 400 LEVEL

300 FFOn the other hand, high-grade ore imports from 600

Brazil and Australia are expected to remain strong. 200

400 FFKeeping production going on the back of higher- 100 grade ores will dampen the impact of the winter Ann% Ann% production cuts. Chg Chg GROWTH RATE* FFChina’s environmental focus is long-term, and, as 80 80 a result, we expect these spreads to remain wider 60 60

than their historical average. 40 40

20 20

0 0

-20 -20

2006 2008 2010 2012 2014 2016 2018 *SERIES SHOWN AS 3-MONTH MOVING AVERAGES. SOURCE: CHINA CUSTOMS GENERAL ADMINISTRATION.

15 BCA RESEARCH China Growth Slows After 1H18

FFWhile we expect more upside to metal prices in China Growth To Slow In 2H18 Ann% Ann% 1H18, slowing growth in China and a stronger USD Chg LMEX BASE METAL INDEX: Chg 50 ACTUAL 50 will prevent a repeat of 2017’s stellar performance. MODEL* 25 25 FFXi’s reforms will turn into a headwind for metal 0 0 prices as they begin to impact the real economy -25 -25 later this year. 2010 2011 2012 2013 2014 2015 2016 2017 2018 640 CRB RAW INDUSTRIALS INDEX (LS) 58 600 GLOBAL MANUFACTURING PMI** (RS) 56 FThe Li Keqiang index and PMIs are weaker. 560 F 54 520 52 480 FReal estate sector, a huge consumer of steel, 50 F 440 48 also will weaken in big cities. 400

CHINA: 55 OFFICIAL MANUFACTURING PMI*** (LS) FAnother bearish risk comes from a stronger USD. LI KEQIANG INDEX**** (RS) 20 F 54 53 16 We see the Fed as more committed to interest-rate 52 12 51 normalization than markets expect, particularly in 50 8 49 4 2H18. 48 MANUFACTURING PMI: U.S.***** EURO AREA** 65 65 EMERGING MARKETS** 60 60

55 55

50 50

45 © BCA Research 2018 45

2010 2012 2014 2016 *AS A FUNCTION OF CHINESE PMI, EM IMPORTS VOLUME AND EM CURRENCIES VS. USD. **SOURCE: MARKIT. ***SOURCE: NATIONAL BUREAU OF STATISTICS OF CHINA. ****WEIGHTED AVERAGE OF ANNUAL GROWTH RATES OF RAILWAY FREIGHT, POWER CONSUMPTION AND BANK LENDING. *****SOURCE: INSTITUTE FOR SUPPLY MANAGEMENT.

16 BCA RESEARCH Copper Prices Remain Supported

FFIn our modelling of copper, we find that China’s Copper Will Remain Bid In 2018 Ann% Ann% steel consumption leads copper prices 6 months Chg Chg

COMEX COPPER PRICES: into the future. GROWTH RATE 75 BCA MODEL* 75 FFThis is because the construction sector is a huge 50 50 end user of both materials at different stages in 25 25 0 0

the construction process. -25 -25

-50 -50 WORLD REFINED COPPER PRODUCTION**: FFWe do not expect a demand-induced plunge in Mn LEVEL (LS) Ann% MT GROWTH RATE (RS) Chg copper prices over the next 6 months. 2.1

2.0 8 1.9 4 1.8

1.7 0 1.6 -4 1.5 WORLD REFINED COPPER CONSUMPTION**: LEVEL (LS) Mn Ann% GROWTH RATE (RS) MT Chg 20

2.0 15

10 1.8 5

1.6 0

-5 1.4 © BCA Research 2018

2010 2012 2014 2016 2018 *AS A FUNCTION OF CHINA APPARENT STEEL CONSUMPTION, U.S. TWIB, CHINA PMI AND COPPER NET SPECULATIVE POSITIONS. **SOURCE: WORLD BUREAU OF METAL STATISTICS.

17 BCA RESEARCH China Fears Weighing On Copper Prices

FFWhile bullish sentiment for copper remains high, Worrying Decline In The Li Keqiang Index Ann% Ann% concerns that policymakers’ attempts at a managed Chg Chg COMEX COPPER PRICES: slowdown in China this year goes too far will weigh 75 GROWTH RATE 75 BCA MODEL* 50 50 on the market. 25 25 0 0 FFFundamentally, support for copper prices from -25 -25 -50 FOR BOTTOM THREE PANELS: -50 potential supply shortfalls at both the mining and Ann% COPPER PRICES (RS) Ann% Chg Chg U.S. BROAD TRADE-WEIGHTED refining levels will be offset by a stronger USD and DOLLAR (Inverted, LS) 100 5 80 slower growth in China this year. 0 60 -5 40 20 -10 0 -15 -20

Ann% Ann% Chg WORLD PMI (LS) Chg 57.5 100 80 55.0 60 40 52.5 20 50.0 0 -20

2010 2012 2014 2016 2018 *AS A FUNCTION OF WORLD PMI, U.S. TWIB, COPPER NET SPECULATIVE POSITIONS AND LI KEQIANG INDEX. SOURCE: J.P.MORGAN CHASE & CO., BLOOMBERG FINANCE L.P. & MARKIT ECONOMICS. NOTE: THE U.S. TWIB IS SHOWN INVERTED. THEREFORE, A NEGATIVE YOY CHANGE REFLECTS AN APPRECIATION OF THE U.S. TWIB.

18 BCA RESEARCH BCA Research Precious Metals Markets

19 BCA RESEARCH Inflation, U.S. Financial Variables Drive Gold

FFLooking into 2018, the major risk factors driving Gold Behaves Like A Currency USD/ USD/ gold will, on balance, continue to incline us to Oz Oz favor gold as a strategic portfolio hedge. FFInflation and inflation expectations; GOLD PRICES: 1800 ACTUAL 1800 FFFiscal and monetary policy; and BCA MODEL* FFGeopolitical risks argue in favor of gold.

FFHowever, this will be partially mitigated by Fed 1600 1600 rate hikes FFWe expect four hikes this year. FFBut if inflation fails to show up again, monetary 1400 1400 policy in the U.S. could remain accommodative, which will favor gold.

1200 1200

2010 2012 2014 2016 2018 *AS A FUNCTION OF U.S. MONETARY VARIABLES, GLOBAL POLICY UNCERTAINTY INDEX AND U.S. CPI.

20 BCA RESEARCH Monetary Accommodation Fails To Spur Inflation

FFInflation failed to emerge in 2017, even as Solving The Inflation Riddle … % % systematically important central banks remained 7.0 U.S. NAIRU BASED ON ESTIMATES FROM: 7.0 massively accommodative, and most of the OECD FEDERAL RESERVE 6.5 CBO* 6.5 economies reported jobless rates below the natural 6.0 6.0 rate of unemployment. 5.5 5.5

FFThese fundamentals should be inflationary and 5.0 5.0 supportive of gold. To date, they haven’t been. Ann% 1960 1970 1980 1990 2000 2010 Ann% Chg Chg FFShould the Fed proceed with rate hikes while 4 CORE** PCE 4 inflation remains quiescent, real interest rates will HEADLINE PCE*** 3 3 increase. 2 2

FFThis would depress gold prices. 1 1 FFIf, on the other hand, the Fed deliberately stays % 1995 2000 2005 2010 2015 %

“behind the curve,” it risks being forced to 90 % OF COUNTRIES WITH 90 UNEMPLOYMENT BELOW NAIRU implement steeper rate hikes later in the cycle. 80 80 70 70 60 60 50 50 40 40 30 30 20 20 © BCA Research 2018

2004 2006 2008 2010 2012 2014 2016 2018 *CONGRESSIONAL BUDGET OFFICE. **EXCLUDES FOOD AND ENERGY. DASHED HORIZONTAL LINE DENOTES FED'S TARGET ***DATA FLOORED AT 0 FOR PRESENTATION PURPOSES SOURCE: BUREAU OF LABOR STATISTICS, FEDERAL RESERVE, CONGRESSIONAL BUDGET OFFICE AND OECD.

21 BCA RESEARCH In Recession & Crises Gold Outperforms

FFIf – as we expect – the economy goes into recession Gold Is A Global Portfolio Hedge % in 2H19, equities could peak as early as the end TOTAL RETURN DURING GEOPOLITICAL CRISES of this year. 4 2

FFGiven gold’s role as a global portfolio hedge during 0

bear markets, the metal could enter a bull market -2 GOLD as soon as end-2018 when equity markets start 500 S&P -4

pricing in a recession. SWISS FRANC -6 U.S. DOLLAR (DXY) -8

FFGold provides the best average returns amongst U.S. 10-YEAR TREASURY different “safe-haven” assets following a major -10

geopolitical event. % TOTAL RETURN DURING RECESSIONS

FFThus elevated political risks in 2018 will further 15 support the gold market. Most notable on our geopolitical strategists’ minds are continued U.S.- 10 China tensions (mostly over N. Korea), Trump’s 5

protectionist policies, and potential conflicts in U.S. DOLLAR (DXY) U.S. 10-YEAR TREASURY SWISS FRANC S&P 500 S&P GOLD the Middle East. 0

-5

NOTE: ECONOMIC EVENTS ARE DEFINED AS NBER DESIGNATED RECESSIONS. THIS TIME FRAME DETERMINES THAT THE MARKET DRAWDOWN IS LESS THAN WHAT IS GENERALLY EXPERIENCED. GEOPOLITICAL EVENTS ARE BASED ON OUR SURVEY OF THE MOST RELEVANT CRISES. FINANCIAL EVENTS ARE LIMITED TO LIQUIDITY, DEBT OR CURRENCY CRISES. SOME EVENTS CAN BE DESIGNATED AS MORE THAN ONE TYPE, BUT THE MOST RELEVANT CATEGORIZATION WAS CHOSEN TO PREVENT OVERLAP IN EVENT TYPES.

22 BCA RESEARCH BCA Research Ags & Softs Markets

23 BCA RESEARCH Latest USDA Global Balances Were Bearish

FFGlobal grains stockpiles are already at record highs Bearish Grain Fundamentals Mn Mn and were revised up further in the January USDA MT MT 100 100 GRAINS* SUPPLY SURPLUS WASDE. 80 80 60 60 FFCorn stocks were revised up, largely on back 40 40 of an upward revision to U.S. ending stocks. 20 20 0 0 FFU.S. wheat ending stocks were revised up; -20 -20 global inventories were revised down negligibly -40 -40 % % due to revisions to Australian stocks. China cut its 2018 minimum purchase price for wheat 40 40 to bring down massive state stockpiles. 35 GRAINS* STOCKS-TO-USE RATIO 35

30 30 FFRice ending stocks revised up slightly due to revisions to Philippine, Pakistan, and Nigeria 25 25 ending stocks. 20 © BCA Research 2018 20 2000 2002 2004 2006 2008 2010 2012 2014 2016 FFDespite a marginal upward revision to soybean 100%% 90%90 SHARE OF U.S. EXPORTS season-end inventories, markets reacted positively 80%80 MEXICO CANADA OTHER to smaller expected U.S. soybean yields, and a 70%70 60%60 smaller upward revision to ending stocks. 50%50 40%40 FFIn addition, the risk that NAFTA is abrogated by the 30%30 20%20 10%10 U.S. would weigh on Ag markets, as Canada and © BCA Research 2018 0% Mexico are among the U.S.’s top three ag export SOYBEANSSOYBEANS CORNCORN WHEATWHEAT COTTONCOTTON RICERICE

*INCLUDES CORN, SOYBEANS, RICE AND WHEAT. destinations. SOURCE: USDA & BCA RESEARCH.

24 BCA RESEARCH Fed Policy Drives Ag Markets

FFU.S. financial factors are important determinants USD Will Be Important

of agriculture commodity price developments. CCI* GRAIN INDEX: ACTUAL Monetary policy impacts agriculture markets 500 BCA MODEL** 500

through the following channels: 400 400 1. Higher real rates will, all else equal, 300 300 WHEAT FOR BOTTOM 3 PANELS: increase borrowing costs for farmers, and USD/ 1ST FUTURES PRICE (LS) Bu U.S. BROAD TRADE-WEIGHTED DOLLAR*** (Inverted, RS) discourage investments in general. 8 100

7 110 2. Tighter credit also leads to a slowdown 6 in growth – ceteris paribus, depressing 5 120

CORN consumption and demand. USD/ Bu 3. Higher U.S. rates entail a strengthening of 7 100 6 the U.S. dollar making U.S. exports less 110 5 competitive. Additionally, the weakening of 120 4 the domestic currency vis-à-vis the dollar USD/ SOYBEANS increases profitability for farmers selling in Bu 16 international markets, incentivizing them 100 14 110 to plant more, despite depressed global ag 12 120 prices, which increases supply. 10 © BCA Research 2018

2010 2012 2014 2016 2018 *TOTAL RETURN EQUAL WEIGHT CONTINUOUS COMMODITY INDEX (CCI). **AS A FUNCTION OF U.S. FINANCIAL VARIABLES. ***SOURCE: J.P. MORGAN & CO.

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