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Commodities overview

Commodities – Key points
• Broadly diversified commodity indices, which declined by about 10% in May, found some support in June. The sideways move was visible across all commodity sectors, with gold (precious metals) delivering a temporary price uptick after the May US nonfarm payroll release.
• Despite signs of price stabilization, diversified commodity indices are likely to decline in the coming weeks. Sluggish economic activity should put upward pressure on most commodity inventories. To mitigate inventory buildups, lower prices are required, in our view. Production cuts for cyclical commodities need to be incentivized, while demand needs a push.
• The starting point for gold (precious metals) remains challenging, with supply likely to outpace demand this year. However, the chance of further monetary easing (QE3) by the Fed - which is not our base case - is an upside risk to the gold price. Given the weak fundamental situation combined with the substantial QE3 risk we maintain our neutral position.
• Easing geopolitical tensions related to Iran and further inventory builds in crude oil shifted the market's attention to sluggish demand growth. With muted incremental crude oil consumption, crude oil prices are likely to remain under pressure. But as production cuts are likely to kick in, downward price momentum should slow meaningfully. OPEC production cuts of up to 0.5 mbpd are needed in the coming months, and should allow the Brent price to stabilize in the USD 80.5 - 90/bbl range (WTI with a USD 12/bbl discount). But a sideways move in crude oil is not good enough to be long the commodity. The Brent forward curve has joined WTI and moved into contango as well. Hence, we keep our underweight position.
• With regards to base metals, prices have room to soften in the very short run (4-6 weeks). Copper prices are likely to decline to USD 6,600/mt in order to weigh on scrap supply and compensate for deteriorating Chinese import volumes. But the price decline in copper and other base metals should be short lived. Fiscal and monetary easing in China provide the basis for an acceleration in base metal demand and should keep prices largely flat on a 6-month horizon. Moreover, metals like aluminum and nickel are already trading deeply into the production cost curve, which we regard as unsustainable over the long run. We keep a neutral position on base metals until we see further confirmation of a pickup in Chinese economic activity.
• The outlook for ample supply in agricultural commodities, especially for corn, should still weigh on the grain complex towards the end of the year. Some short-term price support from dry US Midwest weather conditions in recent weeks is not altering our negative stance. Soft commodities are also battling with higher inventories, which will not bode well for prices in 3Q 2012.

Preferences (6 months)
[Chart showing underweight, neutral, overweight positions for Commodities total, Precious Metals, Energy, Base Metals, Agricultural]
Legend: new, old
Source: UBS CIO, as of 22 June 2012
Note: Past performance is not an indication of future returns.

UBS
For further information please contact CIO's asset class specialists Dominic Schnider, dominic.schnider@ubs.com or Giovanni Staunovo, giovanni.staunovo@ubs.com
Please see important disclaimer and disclosures at the end of the document.
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