Persian (Gulf)

Highlights Tighter global oil markets resulting from the production cut we expect to be announced November 30 at OPEC's Vienna meeting, along with fiscal stimulus from the incoming Trump administration in the U.S., will continue to stoke inflation expectations. We believe gold is well suited for hedging investors' medium-term inflation exposure, given its sensitivity to 5-year/5-year CPI swaps in the U.S. and eurozone. If the Fed decides to get out ahead of this expected pick-up in inflation and inflation expectations by raising rates aggressively next year, we would expect any increase in gold prices - and oil prices, for that matter - to be challenged. For OPEC and non-OPEC producers, a larger production cut may be required to offset a stronger USD next year. Near term, we still like upside oil exposure, given our expectation that production will be cut. Energy: Overweight. We remain long Brent call spreads expiring at year-end, and long WTI front-to-back spreads in 2017H2, in anticipation of an oil-production cut. Base Metals: Neutral. We expect nickel to outperform zinc in 2017. Precious Metals: Neutral. We are long gold at $1,227/oz after our buy-stop was elected on November 11. We are including a 5% stop-loss for this position. Ags/Softs: Underweight. Our long Mar/17 wheat vs. beans order was filled on November 14. We still look to go long corn vs. sugar. Feature Chart of the WeekBrent, WTI Curves Will Flatten, ##br##Then Backwardate Following Oil-Production Cut bca.ces_wr_2016_11_17_c1 bca.ces_wr_2016_11_17_c1 Continuing production increases from sundry sources outside OPEC, which the International Energy Agency estimates will lift output almost 500k b/d in 2017, are turning the heat up on the Kingdom of Saudi Arabia (KSA) and Russia to agree a production cut at the Cartel's meeting in Vienna later this month. It's either that or risk another downdraft that takes prices closer to the bottom of our long-standing $40-to-$65/bbl price range that defines U.S. shale-oil economics. The unexpected strength in production growth outside OPEC likely will require KSA and Russia to come up with a production cut that exceeds the 1mm b/d we projected earlier this month would be required to lift prices into the mid-$50s/bbl range. On the back of the expected cuts, we recommended getting long a February 2017 Brent call spread - long the $50/bbl strike vs. short the $55/bbl strike at $1.21/bbl. As of Tuesday's close, when we mark our positions to market every week, the position was up 9.09%. Reduced output from KSA and Russia - and, most likely, Gulf allies of KSA - will force refiners globally to draw down crude in storage, and for refined product inventories to draw as well. This will lift the forward curves for Brent and WTI futures (Chart of the Week). We expect oil prices will increase by approximately $10/bbl, following the joint cuts of 500k b/d each we expect KSA and Russia, which will be announced November 30. This also will lift 3-year forward WTI futures prices, which, as we showed in previous research, share a common trend with 5y5y CPI swaps. As stocks continue to draw next year, we expect the forward Brent and WTI curves to flatten, and, in 2017H2, to backwardate - that is to say, prompt-delivery prices will trade above the price of oil delivered in the future. For this reason, we are long August 2017 WTI futures vs. short November 2017 WTI futures, expecting the price difference between the two, which favors the deferred contract at present (i.e., a contango curve), to flip in favor of the Aug/17 contract. Chart 2Longer-dated WTI Futures, ##br##Inflation Expectations Rising bca.ces_wr_2016_11_17_c2 bca.ces_wr_2016_11_17_c2 Fiscal Stimulus Expected in the U.S. The election of Donald J. Trump as the 45th president of the U.S. likely will usher in significant fiscal stimulus beginning next year, particularly as Republicans now control the Presidency and Congress for the first time since 2005 - 06, when George W. Bush was president. Trump campaigned on a promise of significant fiscal stimulus, which likely will, among other things, stoke inflation expectations as money starts to flow to infrastructure projects and tax cuts toward the end of next year. Even before Trump's election 5-year/5-year (5y5y) CPI swaps were ticking higher, as oil markets rebalanced and started to discount the drawdown in global inventories this year and next (Chart 2). As the outlines of the Trump administration's fiscal policy take shape and money starts to flow to infrastructure projects, we expect inflation expectations to continue to rise. In previous research, we showed 5y5y CPI swaps and 3-year forward WTI futures are cointegrated, meaning they follow the same long-term trend. Indeed, we can specify 5y5y CPI swaps in the U.S. and eurozone directly as a function of 3-year forward WTI futures.1 Gold Will Lift With Rising Inflation Expectations... In the post-Global Financial Crisis (GFC) markets, gold prices have shared a common trend with U.S. CPI 5y5y swaps and real interest rates, which we show in a new model (Chart 3A, top panel).2 Using this specification, we find a 1% increase in the U.S. 5y5y CPI swaps increases gold prices by slightly more than 9%. Similarly, we find a 1% increase in EMU 5y5y CPI swaps increases gold prices by slightly more than 10% (Chart 3B, top panel).3 Of course, investors always can go straight to Treasury Inflation Protected Securities (TIPS) for inflation protection, given the evolution of the respective CPIs in the U.S. and eurozone drives returns for these securities (Chart 4). However, we believe gold gives investors higher leverage to actual inflation and expected inflation. Chart 3AGold Prices Ticking Higher With ##br##U.S. CPI Inflation Expectations Gold Prices Ticking Higher With U.S. CPI Inflation Expectations Gold Prices Ticking Higher With U.S. CPI Inflation Expectations Chart 3BEMU Inflation Expectations ##br##Vs. 3-year Forward WTI bca.ces_wr_2016_11_17_c3b bca.ces_wr_2016_11_17_c3b Chart 4Inflation Expectations And TIPS ##br##Are Highly Correlated, As Well Inflation Expectations And TIPS Are Highly Correlated, As Well Inflation Expectations And TIPS Are Highly Correlated, As Well ...But The USD's Evolution Matters, Too The combination of tighter oil markets and fiscal stimulus in the U.S. will continue to push inflation and inflation expectations higher. The Fed will not sit idly by and just watch inflation expectations move higher next year. Indeed, prior to the election, we expected two rate hikes next year, following a likely rate increase at the FOMC's meeting next month. With expectations of a tightening oil market, and a fresh round of fiscal stimulus from the incoming Trump administration, the odds of an even stronger USD increase. We had been expecting the USD will appreciate 10% over the next year or so, as a result of the upcoming December rate hike and two additional hikes next year. This could change, since, as, our Foreign Exchange Strategy service noted, "Trump's electoral victory only re-enforces our bullish stance on the dollar."4 A stronger USD, all else equal, is bearish for commodities generally, since it raises the cost of dollar-denominated commodities ex-U.S., and lowers the costs of commodity producers in local-currency terms. The former effect depresses demand at the margin, while the latter raises supply at the margin. Both effects would combine to reduce oil prices at the margin (Chart 5). This would, in turn, lower inflation expectations, which would feed into lower gold prices (Chart 6). Chart 5A Stronger USD Would Be Bearish For Oil bca.ces_wr_2016_11_17_c5 bca.ces_wr_2016_11_17_c5 Chart 6And Gold Prices As It Would Lower Inflation Expectations bca.ces_wr_2016_11_17_c6 bca.ces_wr_2016_11_17_c6 Our FX view, is complicated by the possibility the Fed might want to run a "high-pressure economy" next year, and the potential for additional Chinese fiscal stimulus going into the 19th Communist Party Congress next fall. If both the U.S. and China deploy significant fiscal stimulus next year, the growth in these economies could overwhelm the negative effects of a stronger USD, and industrial commodities - chiefly base metals, iron ore and steel - could rally as demand picks up. Oil demand also would be expected to pick up as a result of the combined fiscal stimulus coming out of the U.S. and China, both from infrastructure build-outs and income growth. KSA - Russia Oil-Production Cut Gets Complicated These considerations will complicate the calculus of KSA and Russia and their respective oil-producing allies as the November 30 OPEC meeting in Vienna draws near. If the Fed moves to get out ahead of increasing inflation expectations by adding another rate hike or two next year, oil prices will encounter a significant headwind. OPEC and non-OPEC producers could very well find themselves back at the bargaining table negotiating additional cuts, as prices come under pressure next year from higher U.S. interest rates. It is too early to act on any speculation regarding fiscal policy in the U.S. or China next year. However, given our expectation for an oil-production cut announcement later this month at OPEC's Vienna meeting, we are confident staying long the Brent $50/$55 call spread, and the long Jul/17 vs. short Nov/17 WTI spread position we recommended earlier this month. As greater clarity emerges on U.S. and Chinese fiscal policy going into next year, we will update our assessments. Bottom Line: We expect global oil markets to tighten as KSA and Russia engineer a production cut, which will be announced at OPEC's Vienna meeting later this month. Fiscal stimulus from the incoming Trump administration in the U.S., and possible fiscal stimulus in China next year could put a bid under commodities. However, if the Fed gets out ahead of the expected pick-up in inflation and inflation expectations by raising rates aggressively next year, any increase in commodity prices - oil and gold, in particular - will be challenged. KSA and Russia could find themselves back at the bargaining table, negotiating yet another production cut to offset a stronger USD. That said, we are retaining our upside oil exposure via a Brent $50/$55 call spread expiring at the end of this year, and our long Jul/17 WTI vs. short Nov/17 WTI futures, which will go into the money as the forward curve flattens and then goes into a backwardation. Robert P. Ryan, Senior Vice President Commodity & Energy Strategy rryan@bcaresearch.com BASE METALS China Commodity Focus: Base Metals Nickel: A Good Buy, Especially Versus Zinc Chart 7Nickel: More Upside Ahead Nickel: More Upside Ahead Nickel: More Upside Ahead We are bullish on nickel prices, both tactically and strategically. Its supply deficit is likely to widen on rising stainless steel demand and falling nickel ore supply in 2017. China will continue to increase its refined nickel imports to meet strong domestic stainless steel production growth. We remain strategically bearish zinc even though our short Dec/17 LME zinc position got stopped out at $2500/MT with a 4% loss. We expect nickel to outperform zinc considerably in 2017. We recommend buying Dec/17 LME nickel contract versus Dec/17 LME zinc contract at 4.3 (current level: 4.38). If the order gets filled, we suggest putting a stop-loss level for the ratio at 4.15. Nickel prices have gone up over 50% since bottoming in February (Chart 7, panel 1). The global nickel supply deficit reached a record high of 75 thousand metric tons (kt) for the first eight months of this year, based on the World Bureau of Metal Statistics (WBMS) data (Chart 7, panel 2). More upside for nickel in 2017 On the supply side, the outlook is not promising in 2017. Global nickel ore and refined nickel production fell 5.2% and 1.1% yoy for the first eight months of this year, respectively, according to the WBMS data (Chart 7, panel 3). The newly elected Philippine government is clearly aiming for "responsible mining," and has been highly restrictive on domestic nickel mining activities, actions that likely will reduce the country's nickel ore production in 2017. The Philippines became the world's biggest nickel ore producer and exporter after Indonesia banned nickel ore exports in January 2014. The Philippines has implemented a national audit on domestic mines from July to September and has halted 10 mines for their environmental violations since July. Eight of them are nickel producers, which account for about 10% of the country's total nickel output. In late September, the government further declared that 12 more mines (mostly nickel) were recommended for suspension, and 18 firms are also subject to a further review. Stringent policy oversight will be the on-going theme for Philippine mines. We expect more suspensions in the country next year. There is no sign the export ban will be removed by the Indonesian government. Since Indonesia banned nickel ore exports in January 2014, the country's nickel ore output has declined 84% from 2013 to 2015. This occurred even though smelters were built locally, which will allow more nickel ore output in Indonesia. However, the incremental Indonesian output is unlikely to make up for the global nickel ore shortage next year. Global nickel demand is on the rise again (Chart 7, panel 4). According to the International Stainless Steel Forum (ISSF), global stainless steel production grew by 11.5% in 2016Q2 from only 3.7% yoy in 2016Q1. Comparatively, in 2015, the growth was a negative 0.3%. Due to fiscal and monetary stimulus in China this year, we expect continued growth in global stainless steel production in 2017. Why China Is Important To Global Nickel Markets China is the world's biggest nickel producer, consumer and importer. Its primary effect on nickel prices is through refined nickel imports. It also influences global stainless steel prices through stainless steel exports. In comparison to the global supply deficit of 75 kt, the deficit in China widened to 346 kt for the first eight months of this year - the highest physical shortage ever (Chart 8, panel 1). China has driven the global growth of both refined nickel production and nickel consumption since 2010 (Chart 8, panels 2 and 3). During the first eight months of this year, Chinese nickel production dropped sharply to 40.5 kt, nearly three times the global nickel output loss of 13.6 kt. For the same period, China's nickel demand growth accounted for 67% of global growth. In addition, the country produces about 53% of global stainless steel and exports about 10% of domestic-made stainless steel products to the rest of world (Chart 8, panel 4). Clearly, China is extremely important to both the global stainless steel and nickel markets. China Needs To Import More Nickel in 2017 Looking forward, China is likely to continue increasing its nickel imports to meet a growing domestic supply deficit (Chart 9, panel 1). The country's ore imports have been declining because of Indonesia's ban since 2014, and further dropped this year on the Philippine's suspensions (Chart 9, panel 2). Scarcer ore supply drove down Chinese refined nickel and nickel pig iron (NPI) output every year for the past three consecutive years (including this year). Chart 8China: A Key Factor For Nickel Market China: A Key Factor For Nickel Market China: A Key Factor For Nickel Market Chart 9Chinese Nickel Imports Are Set To Rise bca.ces_wr_2016_11_17_c9 bca.ces_wr_2016_11_17_c9 Prior to 2014, China imported nickel ores from Indonesia to produce NPI, which is used in its domestic stainless steel production. In 2013, only 20% of domestic nickel demand was met by unwrought nickel imports. After 2014, China's higher nickel ore imports from the Philippines were not able to make up the import losses from Indonesia (Chart 9, panel 3). As a result, in 2015, the percentage of domestic nickel demand met by unwrought nickel imports jumped to 47%. Furthermore, for the first eight months of this year, imports accounted for 57% of Chinese demand. Before the Indonesian ban in 2014, Chinese stainless steel producers and NPI producers built up mammoth nickel ore inventories for their stainless steel ore NPI production (Chart 9, panel 4). Now, Chinese laterite ore inventories are much lower than three years ago. Plus, most of the inventories likely are low nickel-content Philippines ore. Besides the tight ore inventory, China's stainless-steel output is accelerating. According to Beijing Antaike Information Development Co., a state-backed research firm, for the first nine months of 2016, Chinese nickel-based stainless steel output grew 11.3% yoy, a much stronger growth rate than the 4% seen during the same period last year. Given falling domestic nickel output and increasing nickel demand from the stainless steel sector, China seems to have no other choice but to import more refined nickel or NPI from overseas. Downside Risks Nickel prices could fall sharply in the near term if massive LME inventories are released to the global market. After all, global nickel inventories currently are at a high level of more than 350 kt, which is more than enough to meet the supply deficit of 75 kt (Chart 10, panel 1). However, as prices are still at the very low end of the range over the past 13 years, we believe that the odds of a massive, sudden inventory release is small. Inventory holders will be hesitant to sell their precious inventory too quickly, therefore the inventory release will likely be gradual, especially given the continuing export ban in Indonesia and a likely increase in the suspension of mines in the Philippines. In the longer term, if Indonesian refined nickel output continues growing at the pace registered in the past two years, the global nickel supply deficit may be much less than the market expects (Chart 10, panel 2). In that scenario, nickel prices will also fall. Due to power supply shortages, poor infrastructure and funding problems, many of the smelters and stainless steel plants' development have got delayed, so we believe these problems will continue to be headwinds for Indonesian nickel output growth. A five-million capacity stainless steel project, funded by three Chinese companies, potentially making Indonesia the world's second biggest stainless steel producer, will only be in production by 2018. Therefore, we believe next year is still a good window for a further rally in nickel prices. In addition, global stainless steel output may weaken again after this year's stimulus from China runs out of steam, which will also weigh on nickel prices (Chart 10, panel 3). We will monitor these risks closely. Investment strategy We expect nickel to outperform zinc considerably in 2017. Nickel has underperformed zinc massively since 2010 with the nickel/zinc price ratio tumbling to a 17-year low (Chart 11, panel 1). Chart 10Downside Risks To Watch bca.ces_wr_2016_11_17_c10 bca.ces_wr_2016_11_17_c10 Chart 11Nickel Likely To Outperform Zinc In 2017 bca.ces_wr_2016_11_17_c11 bca.ces_wr_2016_11_17_c11 Even though our short Dec/17 LME zinc position was stopped out at $2500/MT with a 4% loss due to the short-term turbulence, we remain strategically bearish zinc, as we expect supply to rise in 2017 (Chart 11, panel 2).5 Given our assessments of the nickel and zinc markets, we recommend buying Dec/17 LME nickel contract versus Dec/17 LME zinc contract at 4.3 (current level: 4.38) (Chart 11, panel 3). If the order gets filled, we suggest putting a stop-loss level for the ratio at 4.15. Ellen JingYuan He, Editor/Strategist ellenj@bcaresearch.com 1 Our updated estimates of the cointegrating regressions for U.S. and eurozone 5y5y CPI swaps indicate 3-year forward WTI futures explain close to 87% of the U.S. swap levels and 82% of the eurozone swaps, in the post-GFC period (January 2010 to present). Please see Commodity & Energy Strategy Weekly Report "Inflation Expectations Will Lift As Oil Rebalances," dated March 31, 2016, available at ces.bcaresearch.com. 2 We also found that, over a longer period encompassing pre-GFC markets, gold prices shared a common trend with U.S. 5y5y CPI swaps, as well. Indeed, the evolution of 5y5y CPI swaps explained 84% of gold's price from 2004, when the 5y5y CPI swap time series begins, to present. 3 Previously, we estimated a gold model using the Fed's core PCE and the St. Louis Fed's 5y5y U.S. TIPS inflation index and found a 1% increase in the core PCE translates to a 4% increase in gold prices. Please see Commodity & Energy Strategy Weekly Report "A 'High-Pressure Economy' Would Be Bullish For Gold," dated October 20, 2016, available at ces.bcaresearch.com. 4 Please see Foreign Exchange Strategy Weekly Report "Reaganomics 2.0?," dated November 11, 2016, available at fes.bcaresearch.com. 5 Please see Commodity & Energy Strategy Weekly Report for zinc section "The Lithium Battery Supply Chain: Efficient Exposure To Electric-Vehicle Market," dated October 27, 2016, available at ces.bcaresearch.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Closed Trades

Highlights The inexorable shift of refining eastward would be accelerated if the Kingdom of Saudi Arabia (KSA) and Russia fail to curb crude oil production as we expect. Prolonging the crude oil market-share war - particularly between opposing camps led by KSA and Iran within OPEC, and Russia's campaign outside the Cartel - will advantage Asian refiners in the short term. Over the longer term, the expansion of oil refining in Asia and the Middle East likely will accelerate, as these warring camps invest directly in refining capacity in Asia and expand their domestic and regional refining and trading capacity. The risk Asian product markets will become super-saturated over the next 3 - 5 years remains elevated, as local refining capacity outgrows local demand and export markets are used to dispose of product surpluses. Like their upstream counterparts, refiners can be expected to fight for market share, leading to a compression in margins. Energy: Overweight. We continue to expect a production cut by KSA and Russia to be announced at the OPEC meeting this month. Base Metals: Neutral. LME aluminum prices still have upside as the market will likely remain supply deficit in the short term. We look to buy aluminum on weakness. Precious Metals: Neutral. We remain on the sidelines ahead of the Fed's December meeting. Ags/Softs: Underweight. We still look to go long wheat versus soybeans. We also look to go long corn versus sugar. Feature We continue to expect an announcement from KSA and Russia of a net 1mm b/d production cut at this month's OPEC meeting in Vienna, after accounting for the 400k b/d or so of seasonal production declines in KSA. A failure to follow through on a cut will prolong the global market-share war among OPEC and Russian oil producers seeking long-term customers in Asian refining markets, particularly in China. China's so-called teapots, which refine 60k to 70k b/d, only started importing crude oil for their own accounts late last year. These refiners represent about one-third of China's 14.3 mm b/d refining capacity as of 2015. It's been a slow ramp - some of these teapots only got started on importing their own crude this year - but they're definitely on a growth trajectory and should catch up with KSA and India in the near future. Some of them already are using hedge markets and setting up their own trading operations, according to media reports. Also, we're expecting to see increased investment in refining in China by KSA and others in the very near future, which will bring state of the art technology to the sector. In and of itself, a failure of KSA and Russia to agree a production cut would be bullish for the growth potential of Asian refiners, as Middle Eastern and Russian crude oil supplies continue to be aggressively marketed to them, allowing them to build capacity and grow their share of global exports (Chart of the Week). Chart of the Week (A)Asia/Middle East Refining Inputs Continue to ##br##Grow As OPEC Market-Share War Drags On bca.ces_wr_2016_11_10_c1a bca.ces_wr_2016_11_10_c1a Chart of the Week (B)Asia/Middle East Refiners' Market Share Of ##br##Gasoline Exports Is Growing bca.ces_wr_2016_11_10_c1b bca.ces_wr_2016_11_10_c1b Chart of the Week (C)...As Are ##br##Diesel/Gasoil Exports bca.ces_wr_2016_11_10_c1c bca.ces_wr_2016_11_10_c1c Our expectation for crude production cuts by KSA and Russia, perhaps with sundry cuts from their allies in the market-share war, would accelerate the draws in crude and product inventories globally. Absent a cut, inventories will continue to draw slowly, based on an assessment of data provided by the Joint Oil Data Initiative (JODI), a transnational oil-data service (Chart 2). The current cycle of supply destruction is being prolonged by high global inventory levels. High inventories keep prices under pressure, which, as we have often noted, raise the odds of civil unrest in cash-strapped states. The odds of unplanned production outages and loss of exports thus remains elevated. A price spike in such a scenario cannot be ruled out. Chart 2Inventories Will Continue To Fall Slowly ##br##If KSA-Russia Don't Cut Crude Output bca.ces_wr_2016_11_10_c2 bca.ces_wr_2016_11_10_c2 Chart 3Asia/Middle East Diesel Output##br## Growth Will Continue bca.ces_wr_2016_11_10_c3 bca.ces_wr_2016_11_10_c3 Global Refining and Storage Markets Continue Transformation Longer term, we see an inexorable shift in refining eastward, as local refiners expand their capacity in China and India, and financially stronger crude and product exporters expand their refining and trading operations by investing in existing or new Asian refining capacity - e.g., KSA in China and South Korea, and Russia's Rosneft in India alongside a major trading company. This will keep high-valued-added exports growing in Asia (Chart 3 and Chart 4), and will take market share from traditional processing centers - e.g., northwest Europe, and Singapore's processing refineries (Chart 5). Chart 4Along With ##br##Gasoline Output bca.ces_wr_2016_11_10_c4 bca.ces_wr_2016_11_10_c4 Chart 5Asia/Middle East Refiners ##br##Displace Traditional Processors bca.ces_wr_2016_11_10_c5 bca.ces_wr_2016_11_10_c5 With or without a production cut by KSA and Russia, the incidence of crude-oil supply destruction will continue to fall on the poorer OPEC producers outside the Gulf Cooperation Council (GCC), which lack the wherewithal to invest in higher crude-oil output domestically, or in refining and trading capacity domestically or abroad. These cash-strapped states also will be unable to make direct investments in refining assets in end-use markets, depriving them of assured outlets for crude production enjoyed by exporters like KSA with substantial refining investments domestically and worldwide.1 This means that, unlike KSA, where refined-product sales and trading will constitute a greater share of revenues over the medium term (out to 10 years), these cash-strapped producers will continue to depend on crude oil sales alone. Chart 6U.S. Product Exports Hold Up Well bca.ces_wr_2016_11_10_c6 bca.ces_wr_2016_11_10_c6 Given its technological edge and nearby crude supplies - Canadian heavy shipped south via pipeline, conventional and light-tight oil (LTO) from shale fields, and increasing volumes of Mexican crude following the sale of deep-water acreage next month - we do not expect U.S. refiners to lose export-market share in the high-value-added light-product markets (diesel and gasoline/aviation fuels) (Chart 6). Indeed, on a 5-year seasonal basis, U.S. refined-product exports actually are increasing, as nearby refiners - e.g., Mexico - continue to find it difficult to maintain operations. Even as Asia and the Middle East refining and trading markets develop, we continue to expect a deepening of crude and product flows among North and South American producers and refiners.2 China Policy Put Could Spur Refining Output In our earlier research, we noted the implicit put provided to Chinese refiners, after the National Development and Reform Commission mandated products be sold at a minimum crude oil reference price of $40/bbl. This was done to encourage conservation and to support domestic refiners and producers.3 So, if crude oil prices go below $40/bbl for Chinese refiners, this regulation incentivizes them to refine as much as possible, then store or export output surplus to domestic needs. Unless the government steps in to tax away the refining windfall resulting from this put whenever the reference crude price falls below $40/bbl, this policy will, at the margin, pressure global refined-product prices, and keep refining margin growth potential limited as Chinese capacity increases. This pattern was seen in Chinese agricultural markets, where crop price supports resulted in a massive accumulation of corn in storage, as farmers bought cheap corn on the international market and sold it into the government storage market. The crop price supports are being unwound, but it does illustrate the Ironclad Law of Regulation - markets always find a way to game regulations to their advantage. Refining Margins Will Remain Under Pressure Chart 7Refining Margins Will Remain Under Pressure bca.ces_wr_2016_11_10_c7 bca.ces_wr_2016_11_10_c7 The rapid expansion of refining capacity in Asia and the Middle East - driven by increased domestic and foreign investment in refining and trading capacity - suggests to us refined-product markets could be in for an extended period of oversupply, which will limit refiner margins going forward. OPEC's market-share war, and the massive supplies produced by U.S. shale-oil producers made it abundantly clear that crude oil is a super-abundant resource, particularly with shale-oil production ready to come on line as soon as prices move above $50/bbl. The buildout in refining capacity by KSA and other OPEC members, along with plans to expand Asian and Middle East refining capacity and, critically, to supply that capacity with aggressively priced crude charging stock, will keep refining margins under pressure going into 2017 (Chart 7). The risk of super-saturating Asian markets in the near future with unsold refined products as crude supplies and production are ramped up in the near future, therefore, poses a risk for refiners generally, since, at the right prices, crude and product can be moved anywhere on the globe. This poses a particular risk for KSA as it readies the IPO of is state-owned oil company Aramco. KSA is simultaneously attempting to grow its own refining capacity worldwide - from a current level of ~ 6mm b/d to as much as 10mm b/d - and retain and secure long-term customers for its crude. In effect, as a refiner it will be competing with the very customers to which it provides crude oil. This doubly compounds the difficulty of IPOing Aramco, as well, since investors will want to be assured the refining side of the enterprise is not being disadvantaged by the crude-oil supply side of the enterprise. However, for KSA as a sovereign state, this expansion of revenues earned from a massive refining presence worldwide is clearly a boon. KSA could, at the end of the day, refine, export and trade product volumes that equal or surpass its current crude export volumes, as it continues to invest and build out its global refining presence. This will further distance it from its OPEC brethren and other crude oil producers worldwide, making it less a crude exporter and more a global vertically integrated portfolio manager. Bottom Line: We see an inexorable shift of refining eastward, with or without a production cut by KSA and Russia. Failure to agree and implement a production cut would prolong the crude oil market-share and provide a tailwind to Asian refiners in the short term. With or without a production cut, we see the expansion of oil refining in Asia and the Middle East continuing apace, as direct investment flows to refining and trading. The risk that Asian product markets will become super-saturated over the next 3 - 5 years remains elevated, as local refining capacity outgrows local demand and exports from Asian and Middle East refineries grow. Like their upstream counterparts, refiners can be expected to fight for market share, leading to a compression in margins. Robert P. Ryan, Senior Vice President Commodity & Energy Strategy rryan@bcaresearch.com BASE METALS China Commodity Focus: Base Metals Aluminum: Buy On Weakness Tactically, we are bullish on LME aluminum prices and neutral on SHFE aluminum prices.4 Supply shortages will likely persist in the ex-China world over next three to six months. Strategically, we are neutral on LME aluminum prices and bearish on SHFE aluminum prices. Profitable Chinese smelters will continue boosting their aluminum production, which will eventually spill over into the global market. We recommend buying Mar/17 LME aluminum contract if it falls to $1,580/MT (current: $1,727/MT). We expect the contract price to rise to $1,900/MT over next three to five months. If the order gets filled, we suggest putting a stop-loss at $1,500/MT. Aluminum prices have gone up considerably this year (Chart 8, panel 1). Global aluminum producers cut their production sharply while global consumption only contracted slightly, reversing a deep supply-surplus market in 2015 to a significant supply-deficit market in 2016 (Chart 8, panel 2). Moreover, aluminum inventories in both LME and SHFE markets also have fallen to multi-year lows (Chart 8, panel 3). However, aluminum prices went nearly vertical in China with a 48% rally since late last November, while LME prices have been only up 21% during the same period of time (Chart 8, panel 1). Why have prices in China gone up much more than the global LME prices? Will the rallies in aluminum prices in both LME and SHFE markets continue? The answer is mainly in China. China: The Most Important Factor In The Global Aluminum Market As the world's largest aluminum producer and consumer, China accounts more than 50% of global aluminum production and consumption (Chart 9, panel 1). The country has also been the major contributor to the growth of both global supply and demand for at least the past 10 years (Chart 9, panels 2 and 3). Chart 8Aluminum: Still More ##br##Upside Ahead? bca.ces_wr_2016_11_10_c8 bca.ces_wr_2016_11_10_c8 Chart 9China: The Most Important Factor ##br##In Aluminum Market China: The Most Important Factor In Aluminum Market China: The Most Important Factor In Aluminum Market China And The Price Collapse In 2015 In November 2015, while LME aluminum prices plunged to their lowest levels since February 2009, aluminum prices in China (SHEF) collapsed to their lowest levels since at least 1994. There were four main factors driving for the price drop. Chinese aluminum output increased more than 3 million metric tons (Mn MT), which accounted 87% of global supply growth, and resulted in excessive global supply. At the same time, global aluminum demand growth experienced a sharp slowdown -- yoy growth was 6% in 2015, versus 16.1% in 2014. This was mainly led by China, where, last year, aluminum demand growth slowed from 27.5% in 2014 to 10.9% in 2015. Inventories at SHFE were boosted by about 68% in 2015, while inventories at LME remained elevated. With China producing much more than it consumed, the country started to encourage exports of semi-manufactured aluminum products last year to reduce the domestic supply surplus (Chart 9, panel 4). In April 2015, the country removed the export tariff on several major aluminum semi-manufactured products. In November 2015, the country implemented a policy of giving a 13-15% value-added tax rebate to exporters of semi-manufactured products. As a result, last year net Chinese unwrought aluminum exports increased 16.7% yoy, which have weighed on global LME aluminum prices. China And The Price Rally In 2016 Chart 10Positive Factors To Aluminum Prices Positive Factors To Aluminum Prices Positive Factors To Aluminum Prices Similarly, China was the major driving factor behind this year's rally as well. Global supply was cut massively for the last two months of 2015 and the first eight months of 2016, as extremely low aluminum prices resulted in huge losses for most global aluminum producers. According to the World Bureau of Metal Statistics (WBMS), for the first eight months of this year, China accounted for 55% of the global aluminum supply cuts, as the country suspended its high-cost producing capacity and started industry-wide coordinated production cutbacks in last December (Chart 10, panel 1). Extremely low inventory levels also spurred the price rally. Inventories at SHFE warehouses fell 76.5% from mid-March to late-September (Chart 10, panel 2). In addition, the social inventory at major cities (Wuxi, Shanghai, Hangzhou, Gongyi and Foshan) also fell to record lows. Surging coal prices and rising alumina prices have also pushed up domestic aluminum production costs (Chart 10, panel 3). In addition, China implemented its newly promulgated Road Traffic Management Regulations regarding overloaded and oversized trucks, and unsafe vehicles on September 21. It was common before these regulations were implemented for drivers to overload shipments of commodities in order to increase profits. This raised road transportation costs for commodities like steel, coal, aluminum, aluminum products and other metals. It also created a bottleneck for timely transporting of coal to aluminum smelters, which own self-generated power plants, and transporting primary aluminum from major producing provinces Xinjiang, Inner Mongolia and Ningxia to some inner-land provinces like Henan for further manufacturing. As China cut its aluminum production this year, the country's exports of semi-manufactured aluminum products also fell 1.9% yoy for the first nine months of this year. As for Chinese aluminum demand, the data are confusing: The WBMS data showed a contraction for the first eight months of 2016, but the domestic industry association reported a decent increase in Chinese aluminum demand so far this year. Based on domestic auto output and construction activity data, we are inclined to believe Chinese aluminum demand rose moderately on the back of this year's fiscal stimulus. Other Factors For The Price Rally In 2016 There are two factors besides China for this year's aluminum rally. U.S. aluminum output fell nearly 50% yoy this year as Alcoa and Century Aluminum massively cut capacity late last year in response to lower prices (Chart 10, panel 4). For the ex-China world, while its supply fell 1.2%, consumption actually grew 0.4% for the first eight months of this year. This increased the supply deficit for the world excluding China, which is positive for LME aluminum prices (Chart 10, panel 5). So, What's Next? Tactically, we are bullish on LME aluminum prices and neutral on SHFE aluminum prices. Chart 11Aluminum: Buy On Weakness bca.ces_wr_2016_11_10_c11 bca.ces_wr_2016_11_10_c11 Most of the aforementioned positive factors are still in place. Even though China has enough capacity to oversupply both its domestic market and global markets again, the key factor will be how fast China boosts its aluminum output. With new added capacity and idled capacity returned to service, China's operating capacity for aluminum has been rising every month so far this year. According to the data provided by Sublime China Information Group, as of the end of October, China's aluminum operating capacity was 35.1 MMt/y (million metric tons per year), a rise of 0.575 MMt/y from the previous month, and an increase of 2.034 mtpy from the end of 2015. Based on our calculations, so far, total aluminum output from January to September is still much lower than the same period last year. In addition, considering the possible output loss due to the Spring Festival in late January, we believe it will take another three to six months for China to meet its own domestic demand and inventory restocking. Therefore, as domestic supply becomes more ample, China's domestic prices - including SHFE aluminum prices - should have limited upside. At the same time, the downside also should be limited by low inventory and rebounding demand. We expect more upside for LME aluminum prices as the supply shortage will likely persist in the ex-China world over next three to six months. Currently, Chinese aluminum prices are about 20% higher than the LME prices (both are in USD terms), which will likely limit the supply coming from China's exports to the rest of the world. Strategically, we are neutral on LME aluminum prices and bearish on SHFE aluminum prices. Currently, about 85% of the China's aluminum operating capacity is profitable. With new low-cost capacity and more idled capacity coming back line, profitable Chinese smelters will continue boosting their aluminum production to maximize profits. This, over a longer term such as nine months to one year, should eventually spill over into the global market. Risks China has imposed stricter environmental regulations on the domestic metal smelting and refining process since 2014 to control domestic pollution. The government currently is sending environmental inspection teams to major aluminum producing provinces to check how well the smelters and refiners comply with state environment rules. Some unqualified factories may be ordered to close. If this occurs, domestic SHFE aluminum prices may go up further in the near term. On the other side, if unprofitable aluminum producers in China also increase their output quickly, in order to creating jobs and revenue for local governments, prices at both SHFE and LME may face a big drop. We will monitor these risks closely. Investment Strategy We probably will see increasing Chinese aluminum production in 2016Q4, which may induce price corrections in both LME and SHFE prices. We prefer to buy LME aluminum on weakness. We recommend buying the Mar/17 LME aluminum contract if it falls to $1,580/MT (current: $1,727/MT) (Chart 11). We expect the contract price to rise to $1,900/MT over next three to five months. If the order gets filled, we suggest putting a stop-loss level at $1,500/MT. Ellen JingYuan He, Editor/Strategist ellenj@bcaresearch.com 1 Please see Commodity & Energy Strategy Weekly Report for an extended discussion of increasing Asian and Middle Eastern refining capacity "KSA, China, India Ramping Oil Product Exports," dated July 28, 2016, available at ces.bcaresearch.com. 2 We will be exploring inter-American crude and product flows - and the potential for expanding this trade - in future research. 3 Please see Commodity & Energy Strategy Weekly Report p. 6 of the earlier-referenced "KSA, China, India Ramping Oil Product Exports," dated July 28, 2016, available at ces.bcaresearch.com. 4 LME denotes London Metals Exchange and SHFE denotes Shanghai Futures Exchange. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Closed Trades

Highlights By now, the Kingdom of Saudi Arabia (KSA) and Russia have figured out that if each cuts 500k b/d of production, the revenue enhancement for both will be well worth the foregone volumes. Even without additional cuts from other OPEC and non-OPEC producers - most of whom already have seen output drop as a result of OPEC's market-share war - KSA and Russia benefit. A 1mm b/d cut would accelerate the draw in oil inventories next year, allowing U.S. shale-oil producers to quickly move to replace shut-in output. Importantly, shale producers' marginal costs will then begin to set market prices. Longer term, KSA and Russia would have to manage their production in a way that keeps shale on the margin. Whether they can continue to cooperate over the long term remains to be seen. Energy: Overweight. We are recommending investors go long February 2017 $50 Brent calls vs. short $55 Brent calls, in anticipation of a production cut from KSA and Russia. Base Metals: Neutral. We remain neutral base metals, despite the better-than-expected PMIs for China reported earlier this week. Precious Metals: Neutral. We are moving our gold buy-stop to $1,250/oz from $1,210/oz, expecting higher core PCE inflation. Ags/Softs: Underweight. We are recommending a strategic long position in Jul/17 corn versus a short in July/17 sugar. Feature The options market gives a 43% probability to Brent prices exceeding $50/bbl by the end of this year (Chart of the Week). We think these odds are too low, given our expectation KSA and Russia will announce production cuts of 500k b/d each at the OPEC meeting scheduled for November 30, 2016 in Vienna. Chart of the WeekOptions Probability Brent Exceeds $50/bbl By Year-End Is Less Than 50% Raising The Odds Of A KSA-Russia Oil-Production Cut Raising The Odds Of A KSA-Russia Oil-Production Cut A production cut totaling 1mm b/d - plus whatever additional volumes are contributed by GCC OPEC members - will, in all likelihood, send Brent prices back above $50/bbl by year end. This is a fairly high-conviction call for us: We are putting the odds prices will exceed $50/bbl by year-end closer to 80%. As such, we are opening a Brent call spread, getting long February 2017 $50 Brent calls vs. short $55 Brent calls, in anticipation of this production cut from KSA and Russia.1 There are two simple facts driving our assessment: KSA and Russia are desperate for cash - they're both trying to source FDI, and will continue to need external financing for years. They can't wait for supply destruction to remove excess production from the market, given all they want to accomplish in the next two years. The vast majority of income for these states is derived from hydrocarbon sales - 70% by one estimate for Russia, and 90% for KSA - and both have seen painful contractions in their economies during the oil-price collapse, which forced them to cut social spending, raise fees, issue bonds and sell sovereign equity assets.2 With the exception of KSA, Russia, Iraq and Iran, most of the rest of the producers in the world have seen crude oil output fall precipitously - particularly poorer non-Gulf OPEC states (Chart 2), and market-driven economies like the U.S. (Chart 3). Thus, KSA's insistence that others bear the pain of cutting production has already been realized. Iran and Iraq, which together are producing ~ 8mm b/d, maintain they should be exempt from any production freeze or cut, given their economies are in the early stages of recovering from economic sanctions related to a nuclear program and years of war, respectively. Chart 2GCC OPEC Production Surges, ##br##Non-Gulf OPEC Production Collapses bca.ces_wr_2016_11_03_c2 bca.ces_wr_2016_11_03_c2 Chart 3Russia' Gains Lift Non-OPEC Production;##br## U.S. Declines Continue bca.ces_wr_2016_11_03_c3 bca.ces_wr_2016_11_03_c3 Why Would KSA And Russia Act Now? Neither trusts the other, which is why neither cut production unilaterally to accelerate storage drawdowns. Any unilateral cut would have ceded market share to the arch rival. Both states have gone to great efforts to show they can increase production even in a down market, just to make the point that they would not give away hard-won market share (Chart 4). Chart 4KSA and Russia Devoted##br## Significant Resources to Lift Production bca.ces_wr_2016_11_03_c4 bca.ces_wr_2016_11_03_c4 These states are at polar-opposite ends of the geopolitical spectrum - KSA is supporting Iran's enemies in proxy wars throughout the Middle East, while Russia is supporting Iran and its allies. In the oil markets, they are both going after the same customers in Asia and Europe. Each state had to convince the other it could endure the pain of lower prices, which brought both to the table at Algiers, and allowed their continued dialogue since then to flourish. Globally, the market rebalancing already is mostly - if not completely - done. Excess production has been removed from the market, and very shortly we will see inventory drawdowns accelerate. But, if KSA and Russia leave this process to the market, we may be looking at 2017H2 before stocks start to draw hard. By cutting production now, KSA and Russia accelerate the stock draw and hasten the day when shale is setting the marginal price in the market. While shale now is comfortably in the middle of the global cost curve, it still sits above KSA's and Russia's cost curve, which means the marginal revenue to both will be higher than if their marginal costs are driving global pricing. Both states have a lot they want to do next year and in 2018: Russia is looking to sell 19.5% of Rosneft; KSA is looking to issue more debt and IPO Aramco. Both must convince FDI that the money that's invested in their industries will not be wasted because production has not been reined in. And, they both must keep restive populations under control. Cutting production by 1mm b/d or more would push prices back above $50/bbl, perhaps higher, resulting in incremental income of some $50mm to $75mm per day for KSA and Russia. Viewed another way, the incremental revenue generated annually by higher prices brought on by lower production would service multiples of KSA's first-ever $17.5 billion global debt issue brought to market last month. Both KSA and Russia will be able to lever their production more - literally support more debt issuance - by curtailing production now. KSA will need that leverage to pull off the diversification it is attempting under its Vision 2030 initiative. Russia would be able to do more with higher revenues, as well. Balances Point To Supply Deficit Next Year The meetings - "sideline" and otherwise - in Algiers, Istanbul and Vienna over the past month or so at various producer-consumer conclaves were attended mostly by producers that already have endured painful revenue cutbacks brought on by the OPEC market-share war declared in November 2014. Even those producers that did not endure massive production cuts - e.g., Canada, where oil-sands investments sanctioned prior to the price collapse continue to come on line despite low prices - will see far lower E&P investment activity going forward, given the current price environment. Chart 5Oil Markets Will Go Into Deficit Next Year Oil Markets Will Go Into Deficit Next Year Oil Markets Will Go Into Deficit Next Year Global oil supply growth will be relatively flat this year and next (Chart 5). This will create a physical deficit in supply-demand balances, even with our weaker consumption-growth expectation: We've lowered our growth estimate to 1.30mm b/d this year, and expect 1.34mm b/d growth next year. We revised demand growth lower based on actual data from the U.S. EIA and weaker projections for global growth.3 Among the major producers, only Iran, Iraq, KSA, and Russia increased output yoy. North America considered as a whole is down despite Canada's gains, and will stay down till 2017H2, based on our balances assessments. South America is essentially flat this year and next. The North Sea's up slightly this year, down more than 5% yoy in 2017, while the Middle East ex-OPEC is flat. Lastly, we expect China's production to be down close to 7% this year, and almost 4% next year. Managing The KSA-Russia Production Cut If KSA and Russia can cut 1mm b/d of production, they'd have to actively manage global balances so that the U.S. shale barrel meets the bulk of demand increases, while conventional reserves fill in decline-curve losses. Iran and Iraq together will be up 1mm b/d this year, but only 350k b/d next year. Both states are going to have a tough time attracting FDI to accelerate production gains, although ex-North America, these states probably have a higher likelihood of attracting investment than Non-Gulf OPEC, which is in terrible shape, and will have a hard time funding projects. Recently recovered Libyan and Nigerian output likely is the best they will be able to do until additional FDI arrives.4 At low price levels, even KSA can't realize the full value of the assets it is attempting to sell and the debt it will be servicing (lower prices mean lower rating from rating agencies). This is a worry for KSA, as it looks to IPO 5% of Aramco and issue more debt.5 Without higher prices, they will need to continue to slash spending, cut defense budgets, salaries and bonuses, and begin to levy taxes and fees. Below $50/bbl Brent, Russia faces similar constraints, and cannot expect to realize the full value of the 19.5% share of Rosneft it hopes to sell into the public market. Net, if KSA and Russia can get prices up above $50/bbl by cutting 1mm from their combined production and increase their gross revenues doing so, it's a major win for them. Such a cut would bring forward the global inventory drawdown we presently see picking up steam in 2017H2 without any reductions in production. In addition, because International Oil Companies (IOCs) are limited in terms of capex they can deploy to invest in National Oil Company (NOC) projects, conventional oil reserves will not be developed in the near term due to funding constraints. That, and higher capex being devoted to the U.S. shales, will keep a lid on production growth ex-U.S. Given how we see investment in production playing out over the medium term - i.e., 3 - 5 years - it will fall to the U.S. shales and Iran-Iraq production to find the barrels to meet demand increases and to replace production lost to natural declines. Given that we expect non-Gulf OPEC yoy production in 2017 to be down close to 1.3mm b/d (or -13%), and that we expect Brazil to be flat next year, cutting 1mm b/d from KSA and Russia's near-record levels of production is a bet both states will find worth taking, in order to lift and stabilize prices over the medium term. GCC OPEC production is expected to be up ~ 1% next year, or ~ 150kb/d, so these states have some scope for reducing output, as well. Price Implications If KSA and Russia Cut If we do indeed see KSA and Russia reduce output 1mm b/d as we expect, we expect storage draws will likely accelerate next year, which will flatten WTI and Brent forward curves, and send both into backwardation (Chart 6). We also would expect prices to move toward $55/bbl in the front of the WTI and Brent forward curves, once the storage draws start backwardating these curves. This would be a boon to KSA's and Russia's gross revenues, generating ~ $75mm a day of incremental revenue post-production cuts. Chart 6Expect Backwardation With ##br##A KSA-Russia Production Cut bca.ces_wr_2016_11_03_c6 bca.ces_wr_2016_11_03_c6 Given this expected dynamic, we recommend going long a February 2017 Brent call spread: Buy the $50 Brent call and sell the $55/bbl Brent call. We also recommend getting long WTI front-to-back spreads expecting a backwardation by mid-year or thereabouts: Specifically, we recommend getting long August 2017 WTI futures vs. short November 2017 WTI futures. This scenario also will be bullish for our Energy Sector Strategy's preferred fracking Equipment services companies, HAL and SLCA. ...And if They Fail to Cut Production? If KSA and Russia fail to cut production, and instead freeze it or raise output following the November OPEC meeting, the market will quickly look through their inaction and continue to price to the actual supply destruction we've been observing for the better part of this year. In such a scenario, prices will push into the lower part of our expected $40 to $65/bbl price range for a longer period of time, which not only will prolong the financial stress of OPEC and non-OPEC producers, but will keep the probability of a significant loss of exports from poorer OPEC states elevated. Either way, global inventories will be significantly reduced by the end of 2017, either because of a production cut by KSA and Russia, or because of continued supply destruction brought about by lower prices. Bottom Line: We expect KSA and Russia to announce a 1mm b/d production cut at the upcoming OPEC meeting at the end of this month. This will rally crude oil prices above $50/bbl, and accelerate the drawdown in global storage levels, which will backwardate Brent and WTI forward curves. We recommend getting long Feb17 $50/bbl Brent calls vs. short $55/bbl Brent calls, and getting long Jul17 WTI vs. short Nov17 WTI futures in anticipation of these cuts. Robert P. Ryan, Senior Vice President Commodity & Energy Strategy rryan@bcaresearch.com SOFTS Sugar: Downgrade To Strategically Bearish, Look To Go Long Corn Vs. Sugar We downgrade our strategic sugar view from neutral to bearish, as we expect a much smaller supply deficit next year. We also downgrade our tactical sugar view from bullish to neutral, as prices have already surged over 120% since last August. We expect corn to outperform sugar in 2017. Brazil will likely increase its imports of cheaper U.S. corn-based ethanol. We look to long July/17 corn versus July/17 sugar if the price ratio drops to 17 (current: 17.94). If the position gets filled, we suggest a 5% stop-loss to limit the downside risk. Sugar prices have rallied more than 120% since last August on large supply deficits and an extremely low global stock-to-use ratio (Chart 7). Falling acreage and unfavorable weather have reduced sugarcane supplies from major producing countries Brazil, India, China and Thailand. Chart 7Sugar Tactically Neutral, Strategically Bearish bca.ces_wr_2016_11_03_c7 bca.ces_wr_2016_11_03_c7 Tactically, We Revise Our Sugar View From Bullish To Neutral. Sugar prices are likely to stay high over next three to six months on tight supplies. The global sugar stock-to-use ratio is at its lowest level since 2010 (Chart 7, panel 3). Inventories in India and China fell to a six-year low while inventories in the European Union (EU) were depleted to all-time lows. These three regions together accounted for 36.7% of global sugar consumption last year. However, we believe prices will have limited upside over next three to six months. Despite tight inventories, India and China likely will not increase imports. India currently has a 40% tax on sugar imports, and the government also imposed a 20% duty on its sugar exports in June to boost domestic supply. China started an investigation into the country's soaring sugar imports in late September. The probe will last six months, with an option to extend the deadline. In the meantime, other sugar importers likely will reduce or delay their sugar purchases because of currently high prices. Lastly, speculative buying is running out of steam, as traders already are deeply long sugar - net speculative positions as a percentage of total open interest is sitting at record-high levels (Chart 7, panel 4). Strategically, We Downgrade Our Sugar View From Neutral To Bearish. Assuming normal weather conditions across major producing countries next year, we believe the global sugar market will have a much smaller supply deficit over a one-year time horizon. Although sugar prices in USD terms reached their highest level since July 2012, prices in other currencies actually rose to all-time highs (Chart 8). Record high sugar prices in these countries will encourage planting and investment, which will consequently result in higher sugar production, especially in Brazil, India and Thailand. This year, due to adverse weather during April-September, the USDA has revised down its sugarcane output estimates for Brazil and Thailand by 3.2% and 7.1%, respectively. Assuming a return of normal weather next year, we expect sugarcane output in these two countries to recover. Farmers in China and India have cut their sown acreage for sugarcane this year on extremely low prices late last year and early this year. With prices up significantly in the latter half of this year, we expect sugar output in these two countries to rebound on acreage recovery as well. In addition, Brazilian sugar mills have clearly preferred producing sugar over ethanol so far this year on surging global sugar prices. According to the Brazilian Sugarcane Industry Association (UNICA), for the accumulated production until October 1, 2016, 46.31% of sugarcane was used to produce sugar, a considerable increase from 41.72% for the same period of last year. We expect this trend to continue in 2017, adding more sugar supply to the global market. Moreover, as the market becomes more balanced next year, speculators will likely unwind their huge long positions, which may accelerate a price drop sometime next year (Chart 7, panel 4). Where China Stands In The Global Sugar Market? China is the world's biggest sugar importer, the third-largest consumer and the fifth-biggest producer, accounting for 14.2% of global imports, 10.3% of global consumption and 4.9% of global production, respectively (Chart 9, panel 1). Chart 8Sugar Supply Will Increase In 2017 bca.ces_wr_2016_11_03_c8 bca.ces_wr_2016_11_03_c8 Chart 9Chinese Sugar Imports May Slow Chinese Sugar Imports May Slow Chinese Sugar Imports May Slow Sugar production costs are much higher in China than in Brazil and Thailand, due to higher wages and low rates of mechanization. Falling sugar prices in 2011-2015 further reduced the profitability of Chinese sugar producers. As a result, the sugarcane-sown area in China has dropped 24% in three years, resulting in a huge supply deficit (Chart 9, panel 2). Because domestic prices are much higher than global prices, the country has boosted its imports rapidly in recent years (Chart 9, panel 3). We believe, in the near term, the recently announced investigation into surging sugar imports will slow the inflow of sugar into the country, which will be negative for global sugar prices. In the longer term, the sugarcane-sown area in China will recover on elevated sugar prices, indicating the country's production is set to rebound, which likely will reduce its sugar imports. This is in line with our strategic bearish view. Chart 10Corn Is Likely To Outperform Sugar In 2017 bca.ces_wr_2016_11_03_c10 bca.ces_wr_2016_11_03_c10 Risks To Our Sugar View In the near term, sugar prices could rally further on negative weather news or if the USDA revises down its estimates of global sugar production and inventories. Prices also could go down sharply if speculators unwind their huge long positions before the year end. We will re-evaluate our sugar view if one of these risks materializes. In the long term, if adverse weather occurs and damages the Brazilian sugarcane yield outlook for next season, which, in general starts harvesting next April, we may upgrade our bearish view to bullish. How To Profit From The Sugar Market? In the softs market, we continue to prefer relative-value trades to outright positions. With regards to sugar, we look to go long corn vs. short sugar, as we expect corn to outperform sugar in 2017. Both sugar and corn are used in ethanol production. Ethanol is also a globally tradable commodity. While sugar prices rose to four-year highs, corn prices fell to seven-year lows, resulting in a significant increase in Brazilian sugar-based ethanol production costs and a considerable drop in U.S. corn-based ethanol production costs. We believe the current high sugar/corn price ratio is unlikely to sustain itself, as Brazil will likely increase its imports of cheaper U.S. corn-based ethanol (Chart 10, panels 1, 2 and 3). In addition, global ethanol importers will also prefer buying U.S. corn-based ethanol over Brazilian sugar-based ethanol. Eventually, this should bring down the sugar/corn price ratio to its normal range. Therefore, we look to long July/17 corn versus July/17 sugar if the price ratio drops to 17 (current: 17.94) (Chart 10, panel 4). If the position gets filled, we suggest a 5% stop-loss to limit the downside risk. In addition to the risks related to the fundamentals, this pair trade also faces the risk of a steep contango in the corn futures curve, and a steep backwardation in the sugar futures curve. The July/17 corn prices are 6.2% higher than the nearest futures prices and July/17 sugar prices are 5.2% lower than the nearest sugar futures prices. Long Wheat/Short Soybeans Relative Trade On another note, our long Mar/17 wheat/short Mar/17 soybeans relative trade was stopped out at a 5% loss on October 26. We still expect wheat to outperform soybeans over next three to six months. We will re-initiate this relative trade if the ratio drops to 0.41 (current: 0.426) (Chart 10, bottom panel). Ellen JingYuan He, Editor/Strategist ellenj@bcaresearch.com 1 The Feb17 options expire 22 December 2016, three weeks after the OPEC meeting. 2 Please see Commodity & Energy Strategy Weekly Report "Ignore The KSA - Russia Production Pact, Focus Instead On The Need For Cash," dated September 8, 2016, available at ces.bcaresearch.com. 3 The IMF expects slightly slower global GDP growth this year (3.1%), and a slight pick-up next year (3.4%). Please see "Subdued Demand, Symptoms and Remedies," in the October 2016 IMF World Economic Outlook. 4 Please see "OPEC Special-Case Nations Add 450,000 Barrels in Threat to Deal," by Angelina Rascouet and Grant Smith, published by Bloomberg news service November 2, 2016. 5 Please see Commodity & Energy Strategy Weekly Report "Desperate Times, Desperate Measures: Aramco And The Saudi Security Dilemma," dated January 14, 2016, available at ces.bcaresearch.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Closed Trades

In a February <i>Special Report</i> titled "Assessing Fair Value In FX Markets" we introduced a set of long-term valuation models based on various fundamentals. We have updated the results and added KRW, INR, PHP, HKD, CLP and COP to our analysis. The dollar still remains expensive, albeit with no signs of a dangerous overvaluation. The yuan is now at its cheapest level since 2009.

We put the odds of an oil-production freeze agreement between OPEC and Russian officials next week in Algiers at slightly better than a coin toss.

Forget about the production-cooperation pact agreed between Russia and KSA over the weekend at the G20 meeting in China. With or without it, rebalancing of the oil market will force global inventories to draw beginning in 2016Q4 and continue into next year, setting the stage for a gradual rise in prices - slightly above our central tendency for WTI of $50/bbl - to encourage more rigs to return to the U.S. shales.

Clearing the refined-product overhang in the global storage markets is not as straightforward as it used to be: The Kingdom of Saudi Arabia (KSA), China, and India all are making concerted efforts to boost refining capacity, which is leaving them with surplus product that ends up being sold in export markets.

While the Fed's recent forward guidance leading markets to increase the odds of a policy-rate hike earlier than previously expected will restrain the recovery in crude oil prices, fundamentals will dominate price formation now that markets have rebalanced.

A combination of physical rebalancing in the oil markets and geopolitical risk have pushed oil prices above $50/bbl. We therefore close our recommendation - made jointly with BCA's Commodity & Energy Strategy team - to long a December 2016 WTI $50/$55 call spread for a 106.3% gain.