Global

Gl b l Tactical
T ti l
A t Allocation
Asset All ti
GTAA
Commodities

First Quarter
January 9th , 2009

Damien Cleusix
d i @ l 6
damien@clue6.com

Clue6 Fourth Quarter 2009

 Quotes 1

Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people
to stand around guarding it.
it It has no utility.
utility Anyone watching from Mars would be scratching their head.
head

W.Buffet, Harvard 1998

“The generally accepted theory is that financial markets tend towards equilibrium, and on the whole, discount the future
correctly. I operate using a different theory, according to which financial markets cannot possibly discount the future correctly
because they do not merely discount the future; they help to shape it. In certain circumstances, financial markets can affect the
so called fundamentals which they are supposed to reflect. When that happens, markets enter into a state of dynamic
di
disequilibrium
ilib i andd behave
b h quite
it differently
diff tl from
f what
h t would
ld be
b considered
id d normall byb the
th theory
th off efficient
ffi i t markets.
k t Such
S h
boom/bust sequences do not arise very often, but when they do, they can be very disruptive, exactly because they affect the
fundamentals of the economy. “

G Soros MIT 2004

G.Soros,

Clue6 Fourth Quarter 2009

 Executive Summary 2

Commodities
Most commodities are now greatly overvalued. As with other assets it does not really matter in the short-term (as long as the
trend
d iis positive)
i i ) but
b it
i is
i paramount for
f longer-term
l projections.
j i

Demand has been artificially boosted by China strategic reserve building and infrastructure intensive fiscal stimulus and, as
the trend persisted, by trend followers and money managers new attraction to the sector (you know it is not correlated... sorry it
WAS not correlated
correlated...).
) This increased elasticity of demand will work both way way... and you would better remember it...
it China
buying spree will abate as the strategic reserve are completed and the fiscal stimulus projects are being built (and we will have
new waves later but this is another story but as you know we are not as bullish as the consensus on 2030 and beyond China,
and all other countries by the way, commodities demand... we are too maybe confident on human ingenuity...). While investors
might
g buyy some dips p initially,
y, they
y could become net sellers if price
p do not rebound as expected...
p And do not forget
g the
demand destruction caused by the current very high prices or potential decrease in subsidies in emerging markets...

Supply has been hit hard, as documented last year, by both prices fall and the credit crunch but this is changing rapidly.
Lots of projects which were put on hold are restarted while closed mines/wells are reopened. This increase supply could hit the
market
k in i full
f ll just
j when
h demand
d d momentum will ill turn down...
d Longer-term,
L not enough
h investments
i have
h been
b planned
l d for
f
toward commodity (especially energy) in the various stimuli package around the world… This could come back to haut us in a
couple of years…

Global growth (China tightening could take the upper hand given investors obsession with the story…)
story ) will be the
referee with regard to the timing as continued robust growth could mask some of those dynamics for some time but
ultimately we will have a correction to be remembered...

And commodities will p

probablyy be one of the cause of the slowdown…Observers have focused too much on what happened
pp to

Clue6 Fourth Quarter 2009

 Executive Summary 3

financial markets to explain the rapid slowdown we witnessed in 2008-early 2009... our contention is that even without it, we
would probably have a "commodity price too high" induced mild recession...
recession

Optimism is excessive on the crude oil market with a big chunk of the 2010 planned increase in demand, floating around the
world… but the trend remains positive for the moment… On a cyclical basis, one should expect a potential low by the end of
February-early
February early March which would coincide with the start of the bullish season for oil… We will see…

Gold investor optimism has decreased somewhat but remains very high. Investments now represents 50% of the total yellow
metal demand while Central Banks in emerging countries have started to be net buyers… Price have corrected to the lower part
of the channel and rebounded… Seasonals are not supportive for the short-term…

Copper seems to have the most “bubblious” behavior… Optimism is extremely high while price refuse to correct despite rising
inventories around the world… Seasonals are supportive in the short-term but we would not chase here and exit all long
positions… Any change in trend should be shorted using put backspread to limit the risk… We would be aggressive…

Grains are behaving surprisingly well given the usually weak seasonals. Money managers direct holding is net short but swaps
dealers are heavily long indicating that many institutional investors (pension funds,…) are long. The curve is too steep at this
juncture to take a long position…

Clue6 Fourth Quarter 2009

 Commodities: Valuations 4
Th are various
There i methods
th d to
t gauge commodities
diti valuation.
l ti

We use models analyzing the long-cycles around production cash cost. The principle is the Industrial Metal and
same as with margin at the whole economy level I.e. when the price is much higher than cash Table 1 Crude Oil Marginal Cost
cost (margins are too fat) supply(competition) will increase and push prices (margins) lower to
a point where supply (competition will be reduced sufficiently for a new cycle to emerge.
emerge To
sum it up, this is true capitalism at work.

It is important to keep in mind that both supply and demand are very inelastic to price in
the short to medium-term for commodities but that demand is more elastic to growth than
supply This is something one can easily forget at the beginning and end of an up cycle.
supply. cycle

Industrial metals tend not to fall below the 75th percentiles of producers cash costs on a Source: Brook Hunt, UBS, Clue6
sustainable basis (Table 1). They only do this briefly at the end of a bear market…

This failed to materialize in 2009 because of China opportunistic stock building which
accelerated in 2009 and investment demand which, after a dip during the autumn 2008 started
to increase again early in 2009… We have tried to document those 2 factors during 2009but
what about now…

We are now in a situation where the entire production curve is profitable for the copper,
copper oil and
Nickel market… and price could loose 50 to 70% to get to end of bear market valuation… (but
for now the cycle remains up… see graph section… but with a lots of risks…see the rest).
Looking at production, one can see that many mines/wells/projects which were suspended at
the end of 2008-beginning of 2009 are back on line/on the board… So we are moving back to
demand destruction and supply increase…
increase

Gold is trading significantly higher than cash costs (2-3 times) but , as you know, even if this is
not something to push completely aside, we think gold’s prospect are more closely linked to the
future of the current monetary system...

As an aside, marginal cost of production have been declining since the 2008 peak… The major
factor for the decline are decreasing energy and equipment prices…

Clue6 Fourth Quarter 2009

 Commodities: Sentiment – Crude Oil 5
Crude Oil and Producers/Merchants vs.
vs Crude Oil and Bloomberg Sentiment
Chart 1 Chart 2
Managed Money Net Future Position Survey Bull Ratio

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Managed money is currently holding a very large net long position while producers and merchants are very short (chart 1). The latter positioning can
be partially explained by the huge contango which make arbitrage (storing and sell further down the curve) profitable but… With regard to managed
money , local
l l peaksk in
i positioning
iti i tend
t d to
t be
b coincident
i id t withith short-term
h tt t
tops while
hil you will
ill tend
t d to
t see a divergence
di att the
th bottoms
b tt andd tops…
t Th
They
will be net long with a local peaks but a lower peak than the preceding one at cyclical tops… usually…

The Bloomberg Crude Oil Survey bull ratio has reached the 60% level where the market has peaked shortly after (Chart 2)…

Mexico Finance Ministry,

Ministry which successfully hedged its oil revenue in 2008 is at it again but this time selling usd 57 puts to hedge its 2010
production…

Clue6 Fourth Quarter 2009

 Commodities: Miscellaneous – Crude Oil 6
Crude Oil and 12 Months Forward Crude Oil and Bloomberg Sentiment
Chart 3 Chart 4
Contract Premium/Discount Survey Bullish Ratio

Source: Bloomberg, Clue6 Source: Gibson Consultancy and Research

Contango remains high (Chart 3) which has historically been bullish but could be distorted by the increase in investment-related demand which is
more active further down the curve…
curve In the past oil topped when the 1/12 months backwardation reached 20%...20% This decreased to less than 10% in
2008 so the cycle might top while still in contango… Furthermore oil has still experience nasty short-term corrections while in contango as in 2006-
2007…

Temporary floating remains high (Chart 4)…

There are estimates circulating that half of the increase in oil demand for 2010, on a crude equivalent basis, are in temporary floating storage…

Clue6 Fourth Quarter 2009

 Commodities: Miscellaneous – Crude Oil 7
Europe and Japan Total Petroleum
Chart 5 Petroleum Products Demand (2008) Chart 6 Products Consumption

Source: BP, Clue6

Source: BP Clue6

We have tried in the past to give a balanced view between the “peak oil hypothesis” and the “Supply won’t be a problem hypothesis”… Given the resurgence of peak oil talks now
that oil have rebounded from last year doldrums, let’s review the no-problems argument… First we repeat that this has no great importance on short-term movements as the short-
term supply/demand curve are extremely steep. The perceived lack of spare capacity contributing to short-term volatility… This is crucial for crude oil price far away in the
curve… The below stats and commentaries are mainly

The main argument is that supply might or might not peak, this does not really matter as demand will decline… We see many graphs comparing the US consumption of energy per
capita to China used to tell us that China consumption will increase by many, many fold… This won’t happen… China demand will rise but not that much and demand in
developed country will decline… On Chart 5 one can see the total demand per products. Light distillates are used for transport, middle distillates is 2/3 used for transport and 1/3
for heating and fuel oil for heating… So transport represent a bit more than 50% of the total consumption… and according to the UN, cities represents nearly 70% of the total oil
consumptions so… Can you imagine all the economy that can be made… with electric cars, more effective building, better public transport… The IEA future demand projection
are too high… by a mile…

And as we said in 2008 price had risen too much for those change not to occur, demand was destroyed, permanently… The decline was so steep that we moved to a supply
destruction theme in early 2009 but now price are high again… human beings need crisis to make bold change and the very high oil price is just what was needed… It did it in the
past…did you know for example that Europe and Japan consume less oil than in 1979 (Chart 6?

Clue6 Fourth Quarter 2009

 Commodities: Sentiment – Gold 8
Gold and Producers/Merchants vs.
vs
Chart 7 Chart 8 Gold and CEF Premium/Discount
Managed Money Net Future Position

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

The Cot data is displaying the same configuration has in the crude oil market (chart 7) except that you can not justify the high net short position of
producers and merchants on a high contango (chart 9 next page)… Managed money decreased its net long position before the recent top…
Worrying…

Especially now that investment demand now represents 50% of total demand (one of our assumption back in 2002)

The Central Fund of Canada ppremium to its NAV spiked

p to the 15% level which have tended to pput a short-term ceilingg on ggold pprice when the
yellow metal reached usd 1200 (chart 8) and has now fallen back to 10%...

Clue6 Fourth Quarter 2009

 Commodities: Miscellaneous – Gold 9
Gold and 12 Months Forward Contract
Chart 9 Chart 10 Gold and Central Bank Gold Reserve
Premium/Discount

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

The curve is currently moving around the 0 level (chart 9)…

Central
C t l Banks
B k have
h b
been nett buyers
b ( h t 10).
(chart 10) G7 Central
C t l Banks
B k have
h approximately
i t l 35% off their
th i reserve in
i Gold
G ld while
hil the
th 13 other
th members
b off
the G20 only have 3.5%... If they were to move to 10% gold, this would imply a purchase of a bit less than 400 mio. Troy ounce or approximately
30% of total Central Bank gold holding or 20% of all the gold mined not in the hand of Central Banks…

The recent rise comes from emerging market official buying as advanced economy Central banks have continued to sell…

Real rate are still negative and this is supportive for precious metal and commodities in general…

Clue6 Fourth Quarter 2009

 Commodities: Sentiment – Copper 10
Copper and Producers/Merchants vs.
vs Copper and Bloomberg Sentiment
Chart 11 Chart 12
Managed Money Net Future Position Survey Bull Ratio

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Managed money net long position is making new historic highs while producers and merchants are SHORT (chart 11) and this can not be justified by
the curve (chart 13)…
13)

The Bloomberg bull ratio is above 50% but while local peaks have tended to have some minor predicting power, it is hard to find a real edge here…

As an aside, as said in September, there are talks of increased speculation in China with notably pig farmers stocking copper…

Clue6 Fourth Quarter 2009

 Commodities: Miscellaneous – Copper 11
Copper and 12 Months Forward
Chart 13 Chart 14 Copper and LME Stocks
Contract Premium/Discount

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

The curve remains in a small contango which is supportive (chart 13) but when you combine this data with copper valuation… things do not look
goodd anymore…

Stocks have been increasing around the world… Stocks in the London Metal exchange have reached the peak level of 2008 (chart 14)… The same is
true in Shanghai and at the Comex… Yet prices have continued to move higher… this is a highly unusual behavior…

Chi strategic
China t t i reserve building
b ildi andd infrastructure-heavy
i f t t h fi l stimulus
fiscal ti l are probably
b bl the
th answer to
t this
thi conundrum…
d

Clue6 Fourth Quarter 2009

 Commodities: Sentiment – Grain 12
Wheat and Producers/Merchants vs.
vs Corn and Bloomberg Sentiment
Chart 15 Chart 16
Managed Money Net Future Position Survey Bull Ratio

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Managed money is net short wheat but merchant and producers have an important net short position (chart 15)…
15) Swap dealers have a very big net
long position…

The corn Bloomberg bull ratio has recently spiked above 60% (Chart 16)… Needs more to be very concerned…

Clue6 Fourth Quarter 2009

 Commodities: Miscellaneous – Grain 13
Wheat and 12 Months Forward
Chart 17 Chart 18 Wheat World Stock to Use Ratio (Weeks)_
Contract Premium/Discount

Source: Bloomberg, Clue6 Source: WASDE, Clue6

The contango remains high which has been supportive in the past, especially when it was not the result of an abrupt front-month price decline (chart
17)
17)…

Wheat stock to use ratio has increased (chart 18) and moved away form levels where huge price peaks occur… but El nino which, according to the
NOAA, will continue into the spring could have some negative impact of world production…

Th structural
The t t l case for
f grains,
i laid
l id outt from
f 2004 remains…
i

Clue6 Fourth Quarter 2009

 Commodities: Seasonality 14
Chart 19 Crude Oil TR Seasonality (since 1987) Chart 20 Gold TR Seasonality (since 1977)

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Crude Oil tends to have its best months in March and April (chart 19).
19) This could be the time
time-frame
frame to play for a rally if we have a meaningful
correction until then…

Gold is entering its weak seasonal spot in February (end of January if you add granularity to the analysis) (chart 20)…

Clue6 Fourth Quarter 2009

 Commodities: Seasonality 15
Chart 21 Copper TR Seasonality (since 1977) Chart 22 Wheat TR Seasonality (since 1969)

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Copper had historically tended to be strong until mid-April when it starts to perform poorly until the end of October (with an intermittent rally in
J l
July…)
) (chart
( h 21)

Wheat and agriculture in general tends to perform best when the uncertainty with regard to the harvest are the highest (well when the harvest size
forecast can change the most I.e. during growth season)… Interpret this as a risk premium… During the early part of the year, wheat tends to
perform poorly (notable because of the shape of the future curve) (chart 22)…

Clue6 Fourth Quarter 2009

 Commodities: China 16
Chart 23 China Import (Volume) Chart 24 China Relative Commodity Demand

Source: CSFB

Source: Bloomberg, Clue6

We have written a lot about Chinese influence on the commodity market in the past… At the start of 2009 we said that China would probably use the decline in price to build strategic
reserve and secure as much access to natural resource around the world as possible… We did not think that it would be sufficient to set in motion a new “mini-bubble”… Well it
did…

According to the IEA, China will soon have accumulated in its reserve the equivalent of 90 days of import of crude oil (300 mio. Barrels) by increasing its stocks by 250’000-300’000
a day… It is buying copper and iron ore as if there were no tomorrow (chart 23) and there are increasing signs of speculative stock building by the private sector (and at the SOEs)…

China represents a high percentage of many commodities total demand (chart 24) but it has been even more important in 2009, representing more than the total increase in net demand
for some commodities as advanced economies demand has continued to decline…

China will remain the main driver with speculators… A China slow down or even a collapse as some are predicting (J. Chanos,…) between the end of 2010 and 2012 would have
DRAMATIC consequences… More on this latter during the year…

Clue6 Fourth Quarter 2009

 Commodities: J.Grantham Deep Thought… 17

Clue6 Fourth Quarter 2009

 Commodities: J.Grantham Deep Thought… 18

Clue6 Fourth Quarter 2009

 Commodities: How Long Will it Last – A Repeat 19

Clue6 Fourth Quarter 2009

 Commodities: Graphs – Crude Oil 20
C d Oil
Crude

Crude oil remains in its second rising channel and has made, on a non total return basis new recovery highs recently…

One can also see the rhythm of the current advance and that the cycle dynamic as moved from right to left translation, indicating a
ppotential tiringg trend…

Clue6 Fourth Quarter 2009

 Commodities: Graphs – Gold 21
G ld
Gold

Shoulder Shoulder
Shoulder

Shoulder

Head

Gold has corrected justifying our November decreased allocation and has rebounded when it reached the lower part of its rising
channel…

The trend is up…

The strategic USD 3000/ounce target we fixed on gold in 2002 remains our minimum target…

Clue6 Fourth Quarter 2009

 Commodities: Graphs – Copper 22
Copper

Copper continues to be strong after the August-September consolidation.

Heading toward very heavy resistance and at the top of the channel… Would not be chasing it here…

Clue6 Fourth Quarter 2009

 Commodities: Graphs – Agriculture 23
S&P GSCI A
Agriculture
i l TR

Trend up… but the contangos are often high…

Clue6 Fourth Quarter 2009

 Commodities: Conclusion 24

Most commodities are now greatly overvalued. As with other assets it does not really matter in the short-term (as long as the trend is positive) but
it is paramount for longer-term projections.

Demand has been artificially boosted by China strategic reserve building and infrastructure intensive fiscal stimulus and, as the trend persisted, by
trend followers and money managers new attraction to the sector (you know it is not correlated... sorry it WAS not correlated...). This increased
elasticity of demand will work both way... and you would better remember it... China buying spree will abate as the strategic reserve are completed
and the fiscal stimulus projects are being built (and we will have new waves later but this is another story but as you know we are not as bullish as
the consensus on 2030 and beyond China, and all other countries by the way, commodities demand... we are too maybe confident on human
ingenuity...). While investors might buy some dips initially, they could become net sellers if price do not rebound as expected... And do not forget the
demand destruction caused by the current very high prices or potential decrease in subsidies in emerging markets...

Supply has been hit hard, as documented last year, by both prices fall and the credit crunch but this is changing rapidly. Lots of projects which
were put on hold are restarted while closed mines/wells are reopened. This increase supply could hit the market in full just when demand momentum
will turn down... Longer-term, not enough investments have been planned for toward commodity (especially energy) in the various stimuli package
around the world… This could come back to haut us in a couple of years…

Global growth (China tightening could take the upper hand given investors obsession with the story…) will be the referee with regard to the
timing as continued robust growth could mask some of those dynamics for some time but ultimately we will have a correction to be remembered...

And commodities will probably be one of the cause of the slowdown…Observers have focused too much on what happened to
financial markets to explain the rapid slowdown we witnessed in 2008-early 2009... our contention is that even without it, we would probably have a
"commodity price too high" induced mild recession...

Optimism
O i i is i excessive
i on the h crude
d oilil market
k with
i h a big
bi chunk
h k off the
h 2010 planned
l d increase
i i demand,
in d d floating
fl i aroundd theh world…
ld but
b the
h trendd
remains positive for the moment… On a cyclical basis, one should expect a potential low by the end of February-early March which would coincide
with the start of the bullish season for oil… We will see…

Clue6 Fourth Quarter 2009

 Commodities: Conclusion 25

Gold investor optimism has decreased somewhat but remains very high. Investments now represents 50% of the total yellow metal demand while
Central Banks in emerging countries have started to be net buyers… Price have corrected to the lower part of the channel and rebounded… Seasonals
are not supportive
pp for the short-term…

Copper seems to have the most “bubblious” behavior… Optimism is extremely high while price refuse to correct despite rising inventories around
the world… Seasonals are supportive in the short-term but we would not chase here and exit all long positions… Any change in trend should be
shorted using put backspread to limit the risk… We would be aggressive…

Grains are behaving surprisingly well given the usually weak seasonals. Money managers direct holding is net short but swaps dealers are heavily
long indicating that many institutional investors (pension funds,…) are long. The curve is too steep at this juncture to take a long position…

Clue6 Fourth Quarter 2009