Softs

Highlights Chart of the WeekTrade Fears Weighing On Ag Complex Trade Fears Weighing On Ag Complex Trade Fears Weighing On Ag Complex Bearish sentiment in ag markets is overdone. We believe prices have bottomed. But we are not yet ready to get bullish, given the elevated trade-policy uncertainty dominating markets at present. The evolution of grains and bean prices from here will depend on whether ongoing trade disputes between the U.S. and some of its largest ag markets are transitory or permanent (Chart of the Week). Highlights Energy: Overweight. We closed our Dec18 Brent $65 vs. $70/bbl call spread last week with a net gain of 80%. We remain long call spreads along the Brent forward curve in 2019, which are down an average 2.7%, and the SP GSCI, which is up 12.1%. Base Metals: Neutral. Aluminum prices are down ~ 1.6% in the past week, following indications from U.S. Treasury Secretary Steven Mnuchin sanctions against Russian aluminum supplier Rusal could be removed. Precious Metals: Neutral. Gold prices recovered slightly over the past week, but remain under pressure, given continued strength in the broad trade-weighted USD and real U.S. interest rates. We remain long gold as a portfolio hedge, nonetheless. Ags/Softs: Underweight. Fundamentals support higher grain and bean prices. However, trade-policy uncertainty - particularly re Sino - U.S. relations - will keep them under pressure (see below). Feature Weather-related uncertainty typically is center stage when it comes to forecasting ag prices during the growing season. This year, trade-policy uncertainty emanating from Washington will contend with weather risk as the dominant influence on prices. We do not expect ag-related trade policies to become more hostile. This means the path of ag prices will be contingent on whether the current trade disputes - primarily between the U.S. and China - are transient or permanent features of international trade. Given what we've seen already, we can expect American farmers will fare poorly in the ongoing trade spats. U.S. agricultural exports have been disproportionately hard hit by tariffs from their most important foreign consumer markets, levied in retaliation against U.S. tariffs (Chart 2). BCA Research's Geopolitical Strategy analysts assign a high probability to the escalation of current tensions into a full-blown trade war.1 Nevertheless, we believe the negative sentiment in ag markets is overdone, and that there is not much further downside from here. It is unsurprising that agriculture is a natural first target in this trade dispute. More than a quarter of U.S. crops are exported, with the share rising above 50% in many cases (Chart 3). This provides foreign consumers with ammunition in the dispute. Furthermore, these exports account for a large chunk of global ag trade, in some cases making American exports price makers in the global market. Importantly, many farmers and farm-belt voters cast ballots for Donald Trump. Chart 2American Ags Hit Hard##BR##By Trade Barriers... Policy Uncertainty Could Trump Ag Fundamentals Policy Uncertainty Could Trump Ag Fundamentals Chart 3...Because They Are Exposed##BR##To Foreign Markets Policy Uncertainty Could Trump Ag Fundamentals Policy Uncertainty Could Trump Ag Fundamentals The USDA's plans announced earlier this week to spend as much as $12 billion between September and end of harvest to help soften the impact of tariff retaliations against U.S. farm states loyal to Trump are not unexpected. The measures will entail (1) direct payments to soybean, sorghum, cotton, corn, wheat, dairy and pork farmers, (2) the procurement and subsequent re-distribution of ag products to nutrition programs, and (3) working with the private sector to promote trade and develop new export markets.2 Trade Spats Hit Grain Markets Hard Grain markets have been especially hard hit in the cross-fire between the U.S. and some of its key trade partners (Table 1). China's retaliatory tariffs are especially consequential, due to its outsized role as a main ag demand market. Table 1Ags Caught In The Crossfire Policy Uncertainty Could Trump Ag Fundamentals Policy Uncertainty Could Trump Ag Fundamentals All in all, the Thomson Reuters Equal Weight Grains & Oilseeds Index is down ~ 10% since end-May on the back of these tariffs. Soybeans lead the decline with a 17% loss. We have been foreshadowing this since the beginning of the year.3 Now that it's played out consistent with our previous expectations, it leaves us wondering "now what?" We see three potential scenarios unfolding in the ongoing trade skirmish: Scenario 1: The current tariffs remain in place with no significant increase in ag-relevant trade barriers.4 Scenario 2: The disputes peak soon, and de-escalate. In this scenario, tariffs imposed since the beginning of the year are reversed, ultimately leading to a free and now-fairer global trade order. Scenario 3: A complete breakdown in global trade. This scenario can take on a soft outcome whereby tariffs are increased, or to a more aggressive scenario, resulting in a seismic collapse in world trade agreements. The first two scenarios are clearly more optimistic. In Scenario 1, near-term downside to prices would be restrained, contingent on the responses of major ag consumers. We discuss their four main options and potential courses of action below. Scenario 2 is the most bullish, with price formation once again a function of supply-demand-inventory fundamentals. In this scenario, exogenous risks primarily stem from weather and U.S. financial variables. However, Scenario 3, in which a prolonged trade war pushes the global economy into a recession, would intensify the pain. This would lead to a contraction in the global flow of goods and services, reducing access to foreign markets. Additionally, it would hurt ag demand through the income channel. Consumption growth of ags is correlated with income growth. If the trade war bears down on incomes, it will reduce per-capita demand for ag commodities, which ultimately depresses prices. This is especially true in the case of lower income and emerging economies, where demand is more elastic. Impact Of Tariffs In face of higher costs brought on by U.S. tariffs, foreign buyers are essentially faced with four options: Reduce imports from the U.S., and opt to purchase more from other major producers; Reduce consumption of particular crops by substituting with others; Consume out of inventory, or Continue purchasing U.S. crops, but at a higher price. Chart 4Soybean Farmers Are Most Vulnerable Policy Uncertainty Could Trump Ag Fundamentals Policy Uncertainty Could Trump Ag Fundamentals Given the heightened risks surrounding the Sino-American trade dispute, we analyze these possibilities with reference to China. In addition, since soybeans are the most vulnerable of the crops hit by the trade dispute, we focus on beans, arguing that in most cases similar courses of action can be taken for other crops (Chart 4). Chinese authorities have already communicated that they plan to use options 1 - 3, and, as such, have assessed the impact of these restrictions on Chinese buyers to be minimal. Furthermore, according to a comment earlier this month by Lu Xiaodong, deputy general manager of state stockpile Sinograin, China is capable of fully meeting its needs without importing soybeans from the U.S.5 The extent to which buyers are successful in doing so will ultimately determine the overall impact of the trade dispute on U.S. ag markets. We expect China's solution will be a mélange of these four options. Below we assess these possibilities. Option 1: Chinese Buyers Are Turning To Other Major Producers An oft-noted change in Chinese purchasing behavior in reference to U.S. soybeans has been cited as the rationale for the negative sentiment towards U.S. ags. While it is true that Chinese buyers have been shunning American beans, the conclusion fails to recognize a few key points (Chart 5). Chart 5U.S. Soybean Exports Down On Weak Sales To China Policy Uncertainty Could Trump Ag Fundamentals Policy Uncertainty Could Trump Ag Fundamentals First, due to the difference in crop calendars - South American beans are harvested in spring while the U.S. crop is harvested in the fall - there is a clear seasonal pattern in China's purchasing behavior (Chart 6). Thus, greater Chinese imports of Brazilian soybeans are typical for this time of year. In addition, agricultural commodities are fungible, which means a reduction of China's imports of U.S. crops does not mean the U.S. crops will go to waste. While American crops are clearly trading at a disadvantage from the perspective of a Chinese buyer, there are still other foreign markets open to American ag exports. Now that these crops are selling at a discount, they have become much more competitive, incentivizing a shift in trade flows. This has already started - the U.S. has increased exports to consumers such as Egypt and Mexico, and even found soybeans buyers in Argentina and Brazil, both major producers of soybeans (Chart 7)! Chart 6Seasonality Is Partly To Blame Seasonality Is Partly To Blame Seasonality Is Partly To Blame Chart 7New Markets Opening Up For American Beans New Markets Opening Up For American Beans New Markets Opening Up For American Beans Option 2: China Will Adjust Its Feed Recipe China's decision to remove import tariffs on animal feed ingredients from Asian suppliers also highlights another policy route. To the extent possible, Chinese consumers will attempt to find substitutes for the now-more-costly U.S. imports. This includes supplies from alternative producers, and imports of substitute products. The potential from this option depends on the availability of close substitutes to replace ags exports affected by the Sino - U.S. trade dispute. In the case of soybeans, Chinese bean imports are crushed to produce meal and oil. The former is then used as a primary protein in livestock feed, while the latter is refined to be used in foods. Similarly, the majority of corn is also used as a critical ingredient in animal feed. As such, in face of higher costs, bean crushers will likely turn to meal from other protein substitutes such as rapeseed, peanuts and sunflower seeds. Nevertheless, soybean meal remains the optimal source of protein for livestock. Thus, while China will attempt to reduce its consumption of the tariff-laden U.S. ags, alternatives are not perfect substitutes. Consequently, this option does not completely eliminate the need for soybean imports. Option 3: Eat Into Ag Inventories Chart 8Chinese Stocks Will - Partially -##BR##Cushion The Blow Chinese Stocks Will - Partially - Cushion The Blow Chinese Stocks Will - Partially - Cushion The Blow Chinese ag inventories are relatively high and can cushion the blow to supply, at least temporarily (Chart 8). This means we may see a decline in Chinese stocks, on the back of drawdowns to fill in the gap left by lower imports from the U.S. While Beijing's stocks are notoriously large, there are reports that, in some cases, they are of low quality, and are unfit for human and animal consumption. Thus, this policy may appear more feasible on paper than in reality. Without accurate information regarding the size and quality of China's ag inventories, it is impossible to determine the potential of this option. Option 4: Absorb the Price Hike: Continue Importing - Now Pricier - U.S. Ags Chinese buyers likely will attempt to exhaust options 1 - 3 above, before resorting to purchasing now-pricier U.S. grains and beans. Nevertheless, it is inevitable - some U.S. ags will continue to flow to China. The relevant question - admittedly extremely difficult to quantify - is with regards to the magnitude of the impact. This essentially will depend on China's ability to use options 1 - 3, to avoid the now-higher import costs. While in the case of soybeans, U.S. exports have been shunned for now, the true test will come in the fall after the Brazilian harvest is over, and the market is flooded with the American crops. Furthermore, the 25% increase in costs due to the tariffs will, to some extent, be offset by the discount in the price of the American crops. Fundamentals Imply Higher Ag Prices While ag markets have taken several direct hits recently, we believe global fundamentals are not as bearish as current pricing conditions suggest. In the event there is a de-escalation of trade disputes - Scenario 2 above - prices will rebound to levels implied by fundamentals. While soybeans are expected to record a small surplus in the 2018 - 19 crop year, wheat and corn will be in a global deficit (Chart 9). Furthermore, global inventories - measured in stocks-to-use terms - are expected to come down. In the case of corn and soybeans, this will be the second consecutive annual decline (Chart 10). Chart 9Bullish Fundamentals On Back##BR##Of Corn And Wheat Deficits... Bullish Fundamentals On Back Of Corn And Wheat Deficits... Bullish Fundamentals On Back Of Corn And Wheat Deficits... Chart 10...And Falling##BR##Inventories ...And Falling Inventories ...And Falling Inventories In the corn market, the inventory drawdown is , to a large extent, driven by Chinese policy which is incentivizing the consumption of stocks by offering lower subsidies to corn farmers vs. soybeans, and through measures to encourage corn use for ethanol. This is expected to bring stocks down to levels last witnessed in the 1960s! On the other hand, U.S. soybean stocks are expected to continue increasing in line with lower demand for American beans by the world's largest soybean consumer (China). As always, weather is the biggest source of near term supply-side uncertainty. Wheat prices are supported by weather concerns in Europe - particularly the Black Sea region - which is damaging crops there. This is especially important given the expectation of a smaller crop there this year. Some Final Notes A couple of distinctions within the ags space reveals some ags are more vulnerable to the ongoing dispute than others. These are the number of sellers and the number of buyers in these markets. For instance, U.S. soybean exports have fewer foreign markets than corn, making them relatively more susceptible to downward price movements as supplies back up and are forced to find alternative markets. This is especially true since China is the single largest consumer of soybeans (Chart 11). Chart 11Global Wheat Market Relatively Insulated From Trade Frictions Policy Uncertainty Could Trump Ag Fundamentals Policy Uncertainty Could Trump Ag Fundamentals On the other hand, the global wheat market resembles a perfectly competitive market. This means that there are many buyers and sellers, each with limited ability to influence prices. Given that both the U.S. and China are price takers in this market, wheat prices will be relatively more insulated from trade headwinds. As such, we favor wheat in the current environment. Bottom Line: American farmers will be the losers in the still-evolving Sino - American trade disputes, as barriers are imposed on their exports, rendering them uncompetitive for their most significant foreign consumer. However, this will open markets for other global producers - most notably Brazil, Argentina, and the Black Sea region - making farmers there the winners in this dispute. Roukaya Ibrahim, Editor/Strategist Commodity & Energy Strategy RoukayaI@bcaresearch.com 1 Please see BCA Research's Geopolitical Strategy Special Report titled "The U.S. And China: Sizing Up The Crisis," dated July 11, 2018, available at gps.bcaresearch.com. 2 Please see "Factbox: USDA's $12 billion farmer relief package," dated July 24, 2018, available at reuters.com. 3 Please see BCA Research's Commodity & Energy Strategy Weekly Reports titled "Ags Could Get Caught In U.S. Tariff Imbroglio," dated March 15, 2018, page 9 from "Oil Price Forecast Steady, But Risks Expand," dated March 22, 2018, and "Ag Price Volatility Will Pick Up," dated May 3, 2018. 4 Our colleagues at BCA's Geopolitical Strategy team expect the trade dispute to intensify, especially before the mid-terms. However, tariffs already have been placed on most ag commodities we follow. This leaves little room for further risk from this direct channel, unless tariff rates are increased. 5 Please see "China does not need U.S. soybeans for state reserves: Sinograin official," dated June 12, 2018, available at reuters.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Policy Uncertainty Could Trump Ag Fundamentals Policy Uncertainty Could Trump Ag Fundamentals Trades Closed in 2018 Summary of Trades Closed in 2017 Policy Uncertainty Could Trump Ag Fundamentals Policy Uncertainty Could Trump Ag Fundamentals

Highlights In line with our House view, we expect the broad USD trade-weighted index (TWIB) to continue to appreciate over the next six to 12 months, as U.S. growth outpaces that of other DMs, and the Fed's pace of rate hikes outpaces that of other systemically important central banks. Ordinarily, this would be bad news for the overall commodities complex. However, most commodity prices disconnected from the U.S. dollar in 2015 - 16. This disconnect produced a not-often-seen positive correlation between commodities and the USD, which remained in place into 2017. Fundamentals are keeping oil and base metals correlations weaker vs. the USD. Precious metals and ags are most vulnerable to a stronger USD. Highlights Energy: Overweight. Cracks in Nigeria's Bonny pipeline system will further delay loadings already curtailed by a force majeure declaration, according to local sources. Elsewhere, the Kingdom of Saudi Arabia (KSA) apparently boosted production ahead of the regularly scheduled OPEC meeting in Vienna on June 22, as mounting losses in Venezuela and U.S. sanctions against Iran loom.1 KSA and Russia are pushing for higher production from OPEC 2.0 ahead of the Vienna meeting. Base Metals: Neutral. Although union negotiators took a conciliatory tone in discussions, contract terms between it and BHP Billiton in Chile's Escondida mine still have not been resolved. Among other things, the union proposed a salary increase of 5% and a $34,000 one-off bonus for workers.2 Precious Metals: Neutral. Gold prices held close to $1,300/oz going into this week FOMC meeting. Ags/Softs: Underweight: The USDA revised down its ending-stocks estimates for corn and soybeans for the 2017/18 and the 2018/19 crop years in its latest WASDE, which was released earlier this week. Feature Chart of the WeekUSD TWIB Vs. Chief Commodity Indices USD TWIB Vs. Chief Commodity Indices USD TWIB Vs. Chief Commodity Indices Broadly speaking, commodity prices are negatively correlated with the USD TWIB. The principal indices we follow - the CRB, Bloomberg and S&P GSCI index - all are cointegrated with the USD, i.e., they share a long-term trend, wherein commodity prices rise as the USD falls, and vice versa (Chart of the Week). Ordinarily, we would expect the near-term appreciation of the U.S. dollar to weigh on broad commodity indices' performance. These are not ordinary times. Surprisingly, what holds for these aggregate indices does not hold for individual commodity groups within the indices. We've ranked each commodity by industry group, and found that over the long term - and this is critical - oil and base metals are most sensitive to changes in the USD TWIB, while precious metals and ags are less sensitive. A 1% change in the U.S. dollar index leads to a change in the energy sub-index of the CRB of almost 5%, while a 1% change in the TWIB leads to a change of just under 4% for the base metals sub-index of the CRB. For the precious metals sub-index of the CRB, we would expect to see prices change by just under 3% for every 1% change in the dollar index, while for the ags sub-index of the CRB, broadly speaking, we could expect a change of just under 2.5%.3 USD's Complicated Relationship With Commodities To understand what's driving the broad indices and their component sub-indexes, we ran Granger-causality tests to get a better picture of what's driving what.4 On average, the U.S. dollar drives the broad indices, from a Granger-causality perspective. However, it does not drive the individual commodity sub-indexes in the same manner (Table 1). Table 1USD Vs. Commodities: What's Driving What? Correlations Vs. USD Weaken Correlations Vs. USD Weaken We found an interesting relationship between copper and oil: Copper's relationship with oil is stronger than its relationship with the USD - likely because both commodities respond to the same demand factors (e.g., global industrial growth), and that mining and refining copper are energy-intensive processes. We still see a long-term underlying common relationship with the U.S. dollar, but copper is more strongly tied to oil. Bottom Line: We ranked the four main commodity groups with respect to their historical sensitivity to the USD using two distinct metrics. Over the long haul, we found the order from most to least sensitive is (1) Energy, (2) Base Metals, (3) Precious Metals, (4) Ags. USD And Commodities Out Of Whack While most commodity indices exhibit strong and stable negative correlations with the U.S. dollar, many of these relationships were pushed out of their long-term equilibria in 2016, and, importantly, have remained out of whack for an unusually long period (Chart 2).5 In fact, we found most individual commodities and commodity groups haven't converged back to their long-term equilibrium correlation levels with the USD TWIB, and their respective divergences are once again moving higher (Chart 3). Chart 2CRB Sub-Indices Out Of Whack With USD Correlations Vs. USD Weaken Correlations Vs. USD Weaken Chart 3Short-Term Correlations Remain In Disequilibrium Correlations Vs. USD Weaken Correlations Vs. USD Weaken As we've shown in previous research, commodity prices can remain in disequilibrium with the dollar when important fundamental (supply - demand) shocks dominate price formation.6 Table 2 shows which commodity groups are most out-of-equilibrium since 2016 relative to their long-term historical correlation. Energy, especially oil, and base metals groups are at the top of this list. Despite the fact that both of these groups are the most sensitive to the USD, based on our long-term analysis discussed above, the fact that they remain in disequilibria with the USD suggests the increase in the U.S. dollar we expect over the next 6 months will have a limited impact on these commodities. This leaves ags and, notably, precious metals, most vulnerable to the USD appreciation foreseen in our House view. Table 3 shows how the sensitivities of the different commodity groups vs. the USD TWIB have changed from 2015 to now versus the 2000 to 2015 period preceding it.7 Moreover, we see that in the shorter period between 2015 and now, the base metals and oil sensitivities (in red) are not significant. Economically, this means prices have disconnected from the USD during this period, owing to the overwhelming influence of supply-demand fundamentals on the price-formation process. Table 2Rank Of Rolling Correlation Divergences##BR##In 6-Month Vs. 5-Year Rolling Correlations Correlations Vs. USD Weaken Correlations Vs. USD Weaken Table 3Fundamentals Overwhelm##BR##USD's Influence Since 2015 Correlations Vs. USD Weaken Correlations Vs. USD Weaken The most plausible explanation for this is base metals and oil markets experienced fundamental shocks over the period - especially since 2016, e.g. OPEC launching a market-share war in 2014 and surging production, followed by the OPEC 2.0 production cuts still in force in the market. In theory, and absent important fundamental (supply-demand) shocks in base metals and energy markets (e.g., a strike at major copper mines or an unexpected outcome at the OPEC 2.0 meeting next week), these correlations should converge back to the long-term equilibrium. However, the speed of convergence is unknown. As long as we observe a disequilibrium in the short-term correlations, we can assume that the disequilibrium will be maintained over the short term. The short-term correlation movements show most of the commodity groups were converging toward equilibrium in recent months, but have since reversed course, particularly oil (Chart 4 and Table 2). Chart 4Short- Vs. Long-Term Correlations Divergence Correlations Vs. USD Weaken Correlations Vs. USD Weaken We believe the historic correlation levels between base metals and oil prices and the USD TWIB gradually will be restored. However, a number of factors will have to be monitored in order to determine the timing and the level around which the correlations will stabilize - i.e., close to the 2008 - 2013 levels or to those of the 2000 - 2007 period (Chart 5). We found that the EM/DM business cycle - i.e., the relative performance of EM to DM economies - as well as the shape of the oil forward curve generally can act as mediating factors in restoring the correlations of the USD TWIB and commodity prices.8 The stronger EM economies are relative to DM economies, or the more in contango the oil forward curve is, the more negative the correlations between commodities, especially oil and base metals, and the USD TWIB. Obviously, should the opposite occur, we would expect the weaker correlations to persist, although this might not constitute a complete disequilibrium. The mediating factors we mentioned can diminish or enhance the USD - Commodity correlations, but that does not mean they completely break them down. Chart 5Oil Vs. USD TWIB Correlation Remains Out Of Whack Correlations Vs. USD Weaken Correlations Vs. USD Weaken Bottom Line: Commodity prices disconnected from the U.S. dollar in 2015 - 16, which led to a rare environment in which the correlations between the USD TWIB and commodities became positive. Surprisingly, this disconnect remained in place for an extended period, which led us to revise our USD-elasticity ranking of commodity groups. As long as the fundamental shocks in the energy and base metals groups continue to dominate price formation in these markets, precious metals and ags will remain the most vulnerable groups to U.S. dollar appreciation. Hugo Bélanger, Senior Analyst Commodity & Energy Strategy HugoB@bcaresearch.com Robert P. Ryan, Senior Vice President Commodity & Energy Strategy rryan@bcaresearch.com 1 Please see "More delays to Nigerian Bonny Light as crude pipeline closes," published by Naija247 in Nigeria on June 11, 2018, and "Saudis Start to Ramp Up Oil Output, Ahead of OPEC Meeting," published by The Wall Street Journal, June 8, 2018. See also BCA Research's Commodity & Energy Strategy Weekly Report, "OPEC 2.0 Guiding to Higher Output; Volatility Set To Rise ... Again," published on March 31, 2018. Available at ces.bcaresearch.com. OPEC 2.0 is the name we coined for the oil-producer coalition led by The Kingdom of Saudi Arabia (KSA) and Russia. 2 Please see "Escondida Union to Copper Investors: Bet on Quick Wage Deal," published by bloomberg.com, June 7, 2018, and "BHP responds to contract proposal from union at Chile's Escondida mine," published by uk.reuters.com on 11 June 2018. 3 These elasticities are the average coefficients for each commodity group we calculated using two different cointegrating regressions - Dynamic Ordinary Least Square and Panel - covering Jan 2000 to now. 4 Granger-causality measures the extent to which changes in one variable cause (or allow one to predict) changes in another variable. This is based on the work of the 2003 Nobel laureate, Clive Granger, who began publishing on this in 1969. Please see "Investigating Causal Relations by Econometric Models and Cross-spectral Methods," Econometrica, Vol. 37, No. 3 (Aug., 1969), pp. 424-438. 5 We make sure the correlations we estimate use cointegrated random variables, which means the empirical results we get provide consistent estimates of actual population correlations. Please see Johansen, Soren (2007), "Correlation, regression, and cointegration of nonstationary economic time series," published by the Center for Research in Econometric Analysis of Time Series at the Aarhus School of Business, University of Aarhus. 6 Please see BCA Research Commodity & Energy Strategy Weekly Report titled "OPEC 2.0 Vs. The Fed," dated February 08, 2018, available at ces.bcaresearch.com. 7 These sensitivities are coefficients in cointegrating regressions, which, given the construction of the regressions, are elasticities. 8 Using threshold regressions, we found the USD impact on BM and energy prices is, on average, weaker when DM stock prices outperform that of EM and when the oil forward curve is backwardated. These two variables act as mediators to the USD-Commodity relationship, and can be used to project the strength of the relationship. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Correlations Vs. USD Weaken Correlations Vs. USD Weaken Trades Closed in 2018 Summary of Trades Closed in 2017 Correlations Vs. USD Weaken Correlations Vs. USD Weaken

Highlights Feature Chart of the WeekAg Vol Will Rise Ag Vol Will Rise Ag Vol Will Rise Over the coming three months markets will be zeroing in on spring planting in the U.S., looking for deviations from the USDA's March intentions report. This will occur against the cyclical backdrop of increased volatility, as markets attempt to price the real impact of Chinese tariffs (Chart of the Week). Putting aside fundamentals, U.S. financial conditions will be a headwind to ag prices this year. Longer term, despite the more favorable USD outlook, a slowdown in China, which accounts for ~ 20% of global food demand, could be bearish for ag prices. Highlights Energy: Overweight. U.S. crude oil output rose to a record 10.3mm b/d in February according to the U.S. EIA. U.S. crude production exceeded Saudi Arabia's in 1Q18; we expect it to exceed Russia's output of 11.2mm b/d by December, 2018. Base Metals: Neutral. Permanent waivers on steel and aluminum tariffs were granted to Australian, Argentine, and Brazilian imports by U.S. firms, while exemptions on imports from the EU, Canada and Mexico were extended to June 1. Precious Metals: Neutral. USD strength is weighing on gold and silver: Our long positions on both metals are down 3.0% and 6.2%, respectively, over the past two weeks. Ags/Softs: Underweight. Ag market volatility will increase, as markets assess U.S. spring planting progress against a backdrop of a possible trade war in ags between the U.S. and China (see below). Feature All Eyes On U.S. Planting Progress It is a busy time of year for U.S. farmers as spring planting is underway. Based on the USDA's annual Prospective Planting Report, released end-March, corn and soybean plantings will fall 2% y/y and 1% y/y, respectively. If realized, corn planted area in the 2018/19 crop year will be the lowest since 2015, and, for only the second time in the history of the series, will fall behind soybean acreage (Chart 2). The USDA's survey also indicates U.S. corn and soybeans will lose ground to wheat, where farmers intend to expand acreage by 3%. Even so, wheat planting intentions are the second lowest on record since the beginning of the series in 1919, surpassed only by last year's all-time low. Mother Nature is not co-operating either: unseasonably cold and wet weather is hindering planting this spring (Table 1). Planting of corn and spring wheat are significantly behind average for this time of the year. Similarly, heading of winter wheat - which accounts for ~ 70% of total wheat intentions - is also behind schedule. Furthermore, harsh winter weather reduced the condition of almost 40% of the crop to poor or very poor, with only 33% qualifying as good or excellent, compared to last year's assessment of 13% and 54%, respectively. Chart 2U.S. Soybean Acreage To Surpass Corn In 2018/19 U.S. Soybean Acreage To Surpass Corn In 2018/19 U.S. Soybean Acreage To Surpass Corn In 2018/19 Table 1U.S. Farmers Are Behind Schedule Ag Price Volatility Will Pick Up Ag Price Volatility Will Pick Up Weather-related delays are less of a risk for soybean plantings, which begin and end later in the summer. Progress is currently in line with historical averages, and, since farmers have an additional month of planting compared to corn and wheat, it is possible they will opt to switch their unplanted corn and wheat acreage to beans. This is a downside risk to the soybean market: When all is said and done, June soybean acreage may exceed targets indicated in the USDA's March intentions report. Although farmers' current lack of headway on the fields is cause for concern, it is still possible that farmers will be able to catch up, attaining their targeted acreage. A Backdrop Of Falling Inventories The termination of China's corn stockpiling scheme, which, prior to 2016 led to the rapid buildup of domestic inventories, was accompanied by policies designed to incentivize soybean plantings over corn. In the case of corn, these policies have paid off. By the end of the current crop year we expect the drawdown in Chinese inventories - along with U.S. stockpiles - to drag world corn reserves lower for the first time since 2010/11 (Chart 3).1 China's pro-soybean production policy is expected to yield a 1.1% expansion in the oilseed's planting area, leading to a 12.8% increase in output this crop year. Regardless, domestic inventories expressed in stocks-to-use (STU) terms are projected to fall (Chart 4). Similarly, world soybean reserves will contract on the back of a decline in Argentine output, which will lead to the largest - and one of only three on record - soybean deficits in the domestic market. In the case of wheat, although U.S. output is forecast to come down this year, weighing on domestic inventories, global markets remain well supplied (Chart 5). In fact, even though USDA's monthly revisions to U.S. production have been downward, forecasts of total use also were revised down. This means the net impact on the balance will be a wider-than-expected surplus. In the case of global markets, world wheat STU ratio will increase to levels last seen in 1986. Net, despite unfavorable weather weighing on the quality and quantity of U.S. wheat crops, there is no shortage of wheat in the world, unlike corn and soybeans. Chart 3Corn Deficit Eating##BR##Away At Stockpiles Corn Deficit Eating Away At Stockpiles Corn Deficit Eating Away At Stockpiles Chart 4China STU Falls Despite##BR##Pro-Soybean Policies China STU Falls Despite Pro-Soybean Policies China STU Falls Despite Pro-Soybean Policies Chart 5Global Wheat Markets Well Supplied##BR##Amid U.S. Supply Concerns Global Wheat Markets Well Supplied Amid U.S. Supply Concerns Global Wheat Markets Well Supplied Amid U.S. Supply Concerns Bottom Line: Given the slower-than-average planting progress this year, near term prices will likely reflect developments in the U.S., as farmers rush to get the crops in the ground. While winter wheat appears to be of poor quality this year, corn and spring wheat plantings are significantly behind schedule. This raises the risk that their acreages will be abandoned in favor of soybeans, which has a later planting window. All in all, if the June acreage report aligns with farmers' planting intentions, we expect to see an increase in wheat acreage at the expense of corn and soybean, which will provide some supply relief to domestic wheat markets. U.S. Farmers Less Competitive, Especially In Soybean Markets In theory, China's announced plans to levy duties on U.S. ag imports puts U.S. farmers - part of President Trump's base - at a disadvantage. But, reality may not be as bearish. The outcome hinges on whether the U.S. will be able to ramp up its exports to other markets amid declining imports from the top bean consumer. Given the impact of weather on soybean output in Argentina - where drought cut soybean output by 30% y/y - there will be a void in global supply. Since soybeans are fungible, we expect ex-China demand to remain supported on the back of limited global supply. This will provide an opportunity for the U.S. to export its surplus, at least in this crop year. To date, there appears to be some evidence of this. Domestic supply will be insufficient to cover Argentinian consumption this year (Chart 6). In an unusual move, USDA export sales data shows Argentina booked a 240k MT purchase of U.S. soybeans for delivery in the next marketing year. Argentina traditionally is a net exporter of soybeans. While we expect tariffs to reshuffle trade flows as China attempts to ensure supplies while avoiding U.S. soybeans, the net effect in terms of global demand for U.S. soybeans may not be as bearish as is feared. China simply does not have the domestic supply to satisfy its demands for beans. While opting for Brazilian or Argentinian beans may be way around importing U.S. supplies, this will open up other export opportunities for the U.S. variety, leading to a simple restructuring of trade flows.2 Recent declines in Chinese imports of U.S. soybeans amid growing imports from Brazil have been cited as evidence of a gloomy future for U.S. soybean farmers. However, this phenomenon is part of the Chinese import cycle: Brazilian soybeans flood Chinese markets in the second and third quarters, while American supplies flow in during the last and first quarters of any given year (Chart 7). Furthermore, U.S. soybean imports have been on the downtrend since the middle of last year. Thus, this observation alone does not signal a change in trend. Chart 6Weak Argentine Output##BR##Restrict Global Supplies Weak Argentine Output Restrict Global Supplies Weak Argentine Output Restrict Global Supplies Chart 7Chinese Preference For Brazilian Beans##BR##Typical For This Time Of Year Chinese Preference For Brazilian Beans Typical For This Time Of Year Chinese Preference For Brazilian Beans Typical For This Time Of Year In fact, the premium paid for Brazilian beans over those traded in Chicago spiked earlier last month. Although it has since come down slightly, it suggests Chinese consumers will have to bear the brunt of more expensive imports. Furthermore, this makes U.S. beans relatively cheaper - and more attractive - in the global market. All the same, higher costs may entice Chinese consumers to look at adjusting the feed formula by diversifying the source of feed. Although our baseline scenario is that these tariffs will remain in place, U.S. Treasury Secretary Steven Mnuchin and U.S. Trade Representative Robert E. Lightizer's trip to Beijing may be the opening salvo to less hostile trade developments. If this is the case, we would expect these trade-related risks to ease. Bottom Line: Tariffs on U.S. soybean imports to China are, in theory, bearish for U.S. markets. However, China's reliance on these beans, along with a tight market this year, makes the outlook less gloomy. Courses of action that may be pursued by China are (1) diversifying the source of the bean, (2) reducing demand for the bean by adjusting feed formula, and (3) continuing to raise domestic soybean acreage. Given the cyclical nature of China's soybean imports, we are entering a period of naturally low demand for U.S. soybeans. Thus, we will not likely see the real impact of current trade disputes until China's demand for American beans kicks in again in 4Q18. In the meantime, a global deficit will open up alternative opportunities for U.S. exports. U.S. And Foreign Financial Conditions Drive Long Run Outlook As weather and the on-going trade tensions between the U.S. and China evolve, the U.S. financial backdrop - particularly real interest rates and the broad USD trade-weighted index (TWIB) - will remain crucial to ag markets. In line with BCA Research's House View, we expect Fed rate hikes to exceed those of other central banks, providing support to a stronger USD over the next 12 months. This will weigh on ag prices.3 Chinese economic growth also could figure prominently, based on recent research from the CME Group, which operates the world's benchmark grain futures markets.4 The relationship between China's unofficial economic gauge - the Li Keqiang Index (LKI) - and ag prices appear to operate through the currency channel. A weaker Chinese economy - reflected in the LKI - suppresses industrial commodity demand, which ends up weighing on the currencies of major commodity exporters. This means the local costs of production for these exporters fall, which, with a 1- to 2-year lag, incentivizes crop plantings in these regions. The increased supply at the margin is bearish for ag prices, all else equal. Given the current environment of a slowing Chinese economy, this relationship is relevant to the longer-term outlook. The significance of the LKI in our grains models provides some evidence of this relationship (Chart 8). When applying the analysis to Brazilian and Russian ag markets, we find the LKI to be positively correlated with the Brazilian Real and the Russian Ruble. This, in turn, explains the inverse correlation we find between the LKI and future ag production in these two markets (Chart 9). A weaker domestic currency does appear to entice farmers to increase plantings of ag commodities, allowing them to take advantage of greater local currency profits from USD-denominated ag exports. Chart 8China Slowdown May Weigh Down On Ags... China Slowdown May Weigh Down On Ags... China Slowdown May Weigh Down On Ags... Chart 9...By Incentivizing Production Ag Price Volatility Will Pick Up Ag Price Volatility Will Pick Up Bottom Line: This preliminary analysis uncovers a supply side channel through which China may impact global ag supplies. It implies that a slowing Chinese economy may in effect spur greater global ag supplies, eventually weighing down on ag prices. Roukaya Ibrahim, Editor/Strategist Commodity & Energy Strategy RoukayaI@bcaresearch.com Hugo Bélanger, Senior Analyst HugoB@bcaresearch.com 1 Despite the increase in domestic supply amid greater offerings of state reserves, much of the state corn stocks are reportedly in poor condition, only suitable as a source for ethanol production - cited as the justification for upward revisions to corn consumption this year. As such, imports will likely remain indispensable. Overall it appears that China intends to raise its industrial consumption of corn in order to digest its stockpiles, with limited impact on prices. Late last year, China announced its target of nationwide use of bioethanol gasoline by 2020. It estimates that corn stockpiles are sufficient to meet near term demand for the grain used as the ingredient in E10, and hopes to achieve a physical corn market balance within five years. 2 Please see the Ags/Softs back section titled "Can China Retaliate With Agriculture," in BCA Research Commodity & Energy Strategy Weekly Report titled "Oil Price Forecast Steady, But Risks Expand," dated March 22, 2018, available at ces.bcaresearch.com. 3 For a more detailed discussion of the impact of U.S. financial variables on ag markets, please see BCA Research Commodity & Energy Strategy Weekly Report titled "Global Financial Conditions Will Drive Grain Prices In 2018," dated November 30, 2017, available at ces.bcaresearch.com. 4 Please see "Will A Sino-U.S. Trade War Impact Grain, Meat Markets?" dated March 28, 2018, available at cmegroup.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Ag Price Volatility Will Pick Up Ag Price Volatility Will Pick Up Trades Closed in 2018 Summary of Trades Closed in 2017 Ag Price Volatility Will Pick Up Ag Price Volatility Will Pick Up

Highlights Escalating trade tensions - most notably between the U.S. and China, and the U.S. and its NAFTA partners - threaten the outperformance ags posted in 1Q18, which was driven by unfavorable weather and transportation disruptions in major producing regions, along with a weak dollar. Energy: Overweight. The IPO of Saudi Aramco apparently will be delayed into 2019, according to various press reports. New York, London and Hong Kong remain in contention for the foreign listing of KSA's national oil company. Base Metals: Neutral. China's iron ore and copper imports in January - February 2018 were up 5.4% and 9.8% y/y, respectively. China's year-to-date (ytd) steel product exports are down 27.1% y/y, while ytd aluminum exports are up 25.8% y/y. The aluminum data are consistent with our assessment that the global aluminum deficit will likely ease this year.1 Precious Metals: Neutral. A global trade war would boost gold's appeal, and we continue to recommend it as a strategic portfolio hedge. Ags/Softs: Underweight. Weather and transport disruptions boosted global ag markets in 1Q18. However, this outperformance is under threat as global trade tensions build (see below). Feature Chart of the WeekAgs Are Off To A Good Start Ags Are Off To A Good Start Ags Are Off To A Good Start Weather concerns in highly productive regions of South America as well as the U.S. have supported ag prices since the beginning of the year (Chart of the Week). Corn and wheat bottomed in mid-December, and have since gained 14.8% and 25.4%, respectively, while soybeans bottomed mid-January and have since gained 10.6%. This pushed the Grains and Oilseed CCI up 12.6% since the beginning of the year. Drought ... And Flooding In The U.S. Erratic weather in the U.S. could affect yields. The chief areas of concern are the U.S. mid-South and lower Midwest, which have recently experienced flooding, and are raising fears of lower yields of winter wheat. At the same time, the area from Southwestern Kansas to Northern Texas experienced unusually dry weather, causing winter grains to suffer. On top of that, high water levels in the Ohio River also led to shipping disruptions. Although the U.S. Department of Agriculture (USDA) did not lower its 2017/18 estimates of U.S. wheat yields in its latest World Agricultural Supply and Demand Estimates (WASDE), yield estimates stand significantly lower than those of the last crop year (Chart 2). In addition, American wheat farmers are expected to harvest the smallest area recorded in the history of the series, which dates back to the 1960/61 crop year. U.S. wheat production is expected to be the lowest since 2002/03 - a 25% year-on-year (y/y) drop in output. As a result, the U.S. supply surplus will likely be the smallest since 2002, weighing on U.S. exports. The U.S. generally accounts for only ~8% of global wheat production, and increases elsewhere, primarily in Russia and India, are expected to more than offset the fall in U.S. output. Despite the poor conditions in the U.S., global supply is expected to continue growing this year with the wheat market in surplus and inventories swelling to record levels (Chart 3). Chart 2Depressed Yield, Record Low Acreage In U.S. Depressed Yield, Record Low Acreage In U.S. Depressed Yield, Record Low Acreage In U.S. Chart 3World Remains Well Supplied World Remains Well Supplied World Remains Well Supplied Drought In Argentina Supporting Soybean, And To A Lesser Extent Corn Prices In addition to the unfavorable North American weather, warm and dry weather in Argentina have resulted in a fall in estimated yields of Argentine corn and soybeans.2 Argentina accounts for 14% and 3% of global soybean and corn production, respectively. The USDA cut back its estimate of Argentine soybean production by 13% in the latest WASDE, causing a downward revision of ~4 mm MT in global inventories (Chart 4). Although Argentina's estimated corn output was also reduced, the resulting decline in its exports is expected to be picked up by U.S. exports. American farmers thus are benefitting from the unfavorable weather in Argentina. As is the case with soybeans, the net effect on corn is a 4 mm MT downwards revision to global inventories. In addition, grain exports from Argentina's main agro-export hub of Rosario were stalled last month due to a truckers' strike. While the strike has now eased, it led to transportation bottlenecks and contributed to limited global supply earlier this year. Back in the U.S., the Trump administration's lack of clarity regarding where it stands on the Renewable Fuel Standard (RFS), which mandates refiners blend biofuels like corn-based ethanol into the nation's fuels, is worrying farmers. While the energy industry is unsatisfied with the current policy, claiming that the RFS is unfair and costly, it gives a lifeline to corn farmers with excess stock. Bottom Line: Unfavorable weather and transportation disruptions, primarily in the U.S. and Argentina, have been bullish for ags since the beginning of the year. Lower production is expected to push both soybeans and corn to deficits in 2017/18 (Chart 5). The longevity of the impact of these forces hinges on whether the weather will improve between now and harvest, causing yields to come in better-than-expected. Chart 4Weather Weighs On Soybean And Corn Yields Weather Weighs On Soybean And Corn Yields Weather Weighs On Soybean And Corn Yields Chart 5Corn And Soybeans In Deficit This Year Corn And Soybeans In Deficit This Year Corn And Soybeans In Deficit This Year "We Can Also Do Stupid"3 In addition to the impact of his domestic immigration policy on the availability of farm workers, President Trump's controversial trade policies are threatening to spill into ags.4 In direct response to the 25% and 10% tariff Trump slapped on steel and aluminum imports, several of America's key ag trading partners have already reacted by communicating the possibility of imposing similar tariffs on their imports of American goods - chiefly agricultural goods. Among the commodities rumored to be at risk are Chinese soybean, sorghum and cotton imports, and EU agriculture imports including corn and rice imports. While President Trump's stated aim is to make America great again by reviving industries hurt by cheap imports and unfair trade, his strategy is proving risky as many of the trade partners he is threatening to rock ties with are in fact major consumers of U.S. agricultural products (Chart 6). In fact, the top three importers of U.S. ag products - collectively accounting for 42%, or $58.7 billion worth of U.S. ag exports in 2017 - are Canada, China, and Mexico (Charts 7A and 7B). Chart 6Risky Strategy, Mr. President Ags Could Get Caught In U.S. Tariff Imbroglio Ags Could Get Caught In U.S. Tariff Imbroglio Chart 7ASoybeans Appear To Be At Risk... Ags Could Get Caught In U.S. Tariff Imbroglio Ags Could Get Caught In U.S. Tariff Imbroglio Chart 7B... As Is Cotton Ags Could Get Caught In U.S. Tariff Imbroglio Ags Could Get Caught In U.S. Tariff Imbroglio However, when it comes to the bulk commodities we cover, China is by far the U.S. ag industry's biggest customer - importing more than 30% of all U.S. exports, equivalent to $14.9 billion. Thus, China appears to have significant leverage in the case of a trade war, and U.S. farmers are worried of the impact from trade disputes. China has already indicated that it is investigating import restrictions on sorghum. Chinese trade restrictions - if implemented - will have a significant impact on U.S. sorghum farmers. In value terms, sorghum exports contributed less than 1% to U.S. agricultural product exports last year, but exports to China made up more than 80% of all U.S. sorghum exports. Sino-American Trade Dispute Would Hurt U.S. Ags...But Not As Much As Is Feared Chart 8Relatively Low Soybean Inventories Relatively Low Soybean Inventories Relatively Low Soybean Inventories The biggest fear among U.S. farmers is not the loss of sorghum exports, but that China will impose restrictions on its imports of U.S. soybeans. Soybeans are the U.S.'s largest ag export - contributing 16% to the value of all agricultural product exports. Nearly 60% of U.S. soybean exports, and more than a third of U.S. soybeans, end up in China. Thus it may appear that China has some leverage there. In fact, Brazil, which is already China's top soybean supplier, has already communicated that it would be willing to supply China with more soybeans. However, China's ability to find alternative suppliers is questionable. While China imported ~32 mm MT of soybeans from the U.S. last year, Brazil's total soybean inventories stand at ~22 mm MT. Brazil simply does not have enough excess supply to cover all of China's needs. In fact, global soybean inventories are ~95 mm MT - only three times the amount of China's annual imports from the U.S. On top of that, although China generally tries to shield itself from supply shocks by building large inventories, its soybean inventories - measured as stocks-to-use - are significantly lower than that of other ags (Chart 8). In fact, Beijing has already tightened its scrutiny on U.S. soybeans, announcing at the beginning of the year that it would no longer accept shipments with more than 1% of foreign material. Half of last year's shipments reportedly would have failed this criterion, and the net effect of this new policy is higher costs for U.S. farmers. Cotton is another agricultural commodity that China has indicated may be caught up in a trade dispute. 16% of U.S. cotton exports went to China last year, but although the U.S. is the dominant global cotton exporter, its value accounts for less than 5% of total U.S. agricultural products exports. Given that China's inventories are extremely high - enough to cover a year's worth of consumption - and that Chinese imports from the U.S. are equivalent to ~3% of global inventories, there is significant opportunity for China to diversify its imports and find an alternative supplier to the U.S. Bottom Line: Although China would be better able to implement restrictions on cotton imports from the U.S. compared to soybeans, the impact on U.S. farmers would be less painful given that they are not as dependent on China as U.S. soybean farmers are. U.S. Ags Dominate Exports, But Substitutes Abound The U.S. is the world's top exporter of corn and cotton, and the second largest exporter of wheat and soybeans. While it remains a dominant player in global export markets, its share of global agriculture exports has been declining sharply over time (Chart 9). While in levels, the general trend for U.S. agriculture exports - with the exception of wheat - appears to be upward, the share of U.S. exports as a percentage of global exports has actually been falling. Compared to the year 2000, the global share of U.S. corn and wheat exports has almost halved, going from 64% to 36%, and 29% to 14%, respectively. In the soybean market, U.S. soybean exports now account for 37% of exports, down from half of global trade. Lastly, U.S. rice exports now account for 7% of global exports, a fall from 11% in 2000. Unlike most other ag commodities, U.S. cotton has captured a larger share of the global market - currently at almost 50%, from 26% in 2000. Russian, Canadian, and European wheat farmers have been tough competitors. This crop year, Russia is expected to surpass the U.S. as the top wheat exporter for the first time (Chart 10). In addition, while the U.S. was the dominant wheat exporter just 10 years ago, more recently, Canada and the EU have on some occasions exported more wheat than the U.S. Chart 9U.S. Exports Relatively Less Attractive U.S. Exports Relatively Less Attractive U.S. Exports Relatively Less Attractive Chart 10U.S. Exports Face Growing Competition Ags Could Get Caught In U.S. Tariff Imbroglio Ags Could Get Caught In U.S. Tariff Imbroglio In the case of soybeans, Brazilian exports have grown significantly since 2010, consistently exporting more than the U.S. since 2012. Brazilian corn exports are also catching up to the U.S., as are Argentine corn exports which have been growing steadily. If these trade disputes prove to be an ongoing trend, we see two potential scenarios panning out: U.S. farmers could move away from farming crops most impacted by trade restrictions, and instead increase the farmland allocated to crops that are consumed domestically, and thus insulated from the Trump administration's trade policy decisions. In this scenario, the longer term impact would be an increase in the supply of locally consumed ags and a decrease in the U.S. supply of exportable ags. Global ag trade flows could shift, such that U.S. allies begin importing more of their ag products from the U.S., while countries that are in trade disputes with the U.S. switch to other ag suppliers. NAFTA Is Still At Risk The ongoing re-negotiation of NAFTA ultimately could lead to an abrogation of the treaty. Should this evolve with no superseding bilateral trade agreements, it would mark a significant blow to the U.S. agricultural industry. Mexico is the second-largest destination for U.S. agricultural exports after China, accounting for 13% of all U.S. exports of agricultural bulks, while Canada makes up a much smaller 2% share. Nearly 30% of U.S. corn exports and 23% of U.S. rice exports end up in Mexico. As a result, these two bulks are especially vulnerable in the event of a treaty abrogation. Wheat, cotton and soybeans - Mexico accounts for 14%, 7%, and 7% of these exports, respectively - would also be impacted by a trade dispute. In the interest of diversifying its sources of ag imports, Mexico has already started exploring other suppliers from South America. Its corn imports from Brazil are reported to have increased 10-fold last year. Furthermore, government officials and grain buyers have been visiting Brazil and Argentina to investigate other ag suppliers for Mexico. BCA Research's Geopolitical Strategy service assign a 50/50 probability to a breakdown in the NAFTA negotiations. In the event of a NAFTA abrogation, they assign a 25% chance of a failure to strike bilateral agreements - resulting in a conditional probability of only 12.5%. Bottom Line: The shrinking role of the U.S. as a global ag supplier at a time when global storage facilities are well-stocked will - in most cases - allow its global consumers to diversify away from U.S. exports. In the case of soybeans, however, this is less certain. A Weaker USD Also Helped Buoy Ag Prices In 1Q18 Chart 11A Stronger Dollar Would Weigh On Ags A Stronger Dollar Would Weigh On Ags A Stronger Dollar Would Weigh On Ags A weaker dollar has been supportive of commodities prices so far this year (Chart 11). The recent bout of U.S. import restrictions has investors expecting the USD to further weaken on the back of a trade war. However, our FX Strategists believe the current set of tariffs will have a muted effect on the dollar.5 In fact, given that the U.S. economy is currently at full employment, and their expectation that the Fed will be proactive, tariffs will likely generate inflationary pressures, causing the tighter monetary policy, which does not support further weakening of the USD. Bottom Line: A pick-up in the dollar along with an escalation in trade disputes or the scrapping of NAFTA would be bearish for ags. For now, bullish weather forecasts prevail, and are keeping prices well supported. Roukaya Ibrahim, Associate Editor Commodity & Energy Strategy RoukayaI@bcaresearch.com 1 Please see BCA Research's Commodity & Energy Strategy Weekly Report titled "Global Aluminum Deficit Set To Ease," dated March 1, 2018, available at ces.bcaresearch.com. 2 Soybean and corn plantings are reported to be half their typical height. Please see "Argentina Drought Bakes Crops Sparks Grain Price Rally," available at reuters.com. 3 As expressed by EU Commission President Jean-Claude Juncker's about the potential tit-for-tat retaliatory measures in response to steel and aluminum import tariffs. 4 According to Chuck Conner, president of the National Council of Farm Cooperatives, and former deputy agriculture secretary during the George W. Bush administration, roughly 1.4 million undocumented immigrants work on U.S. farms each year, or roughly about 60% of the agriculture labor force. 5 Please see BCA Research's Foreign Exchange Strategy Weekly Report titled "Are Tariffs Good Or Bad For the Dollar?," dated March 9, 2018, available at fes.bcaresearch.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Ags Could Get Caught In U.S. Tariff Imbroglio Ags Could Get Caught In U.S. Tariff Imbroglio Trades Closed in 2018 Summary of Trades Closed in 2017 Ags Could Get Caught In U.S. Tariff Imbroglio Ags Could Get Caught In U.S. Tariff Imbroglio

Highlights Agricultural markets are informationally efficient for the most part, which is to say that at any given time, prices already reflect most public information available to traders, and a lot of private information as well. Even so, we believe markets are underestimating the Fed's resolve in normalizing interest-rate policy next year - particularly when it comes to the number of rate hikes we are likely to see - and thus are underestimating the likelihood of lower grain prices in 2018. Energy: Overweight. Oil markets will emerge from their suspended animation following OPEC 2.0's Vienna meeting today. Our Brent and WTI call spreads in May, July and December 2018 - long $55/bbl calls vs. short $60/bbl calls - are up an average 50.2%. Our long Jul/18 WTI vs. short Dec/18 WTI trade anticipating steepening backwardation is up 13.3%. Base Metals: Neutral. China's refined zinc imports were up 145% yoy to 61,355 MT in October, based on customs data. Metal Bulletin noted tight domestic supplies accounted for the increase. Precious Metals: Neutral. Gold is breaking away from its attachment to $1,280/oz., as the USD weakens. Our long gold portfolio hedge is up 5.2% since inception May 4, 2017. Ags/Softs: Neutral. Global financial conditions will become increasingly important to grain prices going forward, a trend we explore below. Feature Record output and ending stocks will ensure that ag markets remain well supplied globally next year. While we see risks as balanced in the upcoming year, and remain neutral ags generally, we believe markets are underestimating the Fed's resolve when it comes to normalizing interest rates, and thus underestimate upside USD potential. This means the likelihood of lower grain prices also is being underestimated. Weather will add volatility to the mix, as well. We believe the fundamentals supporting the assessment of record output and season-ending stocks-to-use ratios are fully reflected in prices. However, financial conditions - particularly USD strength next year - are not being fully priced by markets. This makes grains, in particular, vulnerable to the downside. Financial conditions driving ag markets: Fed policy & real rates: we expect U.S. financial conditions to tighten, and for the Fed to hike rates once more this year, and up to three more times in 2018.1 FX rates: With higher U.S. policy rates next year, the USD is likely to strengthen. This will weaken grain prices generally. Wheat, in particular, is most vulnerable to a strengthening USD and a weakening of the currencies of some of the commodity's top exporters - the European Union, Russia, and Australia. We've narrowed down the fundamental factors to look out for in 2018 as follows: Strong demand amid an extension of supply cuts by the OPEC 2.0 coalition will support oil prices in 2018. Higher energy prices will increase profit-margin pressure in ag markets through input and shipping costs. Weather risks from La Nina threaten to curb yields this winter, especially in Argentina and Brazil, which will add volatility to prices. Policy shifts in Argentina, China, and Brazil will influence farmers' planting decisions in the upcoming crop year. A Look Back At 2017 Chart of the WeekGrains Outperformed Softs This Year Grains Outperformed Softs This Year Grains Outperformed Softs This Year As predicted in our 2017 outlook, grains reversed their 2016 underperformance vis-à-vis softs this year, and outperformed them.2 While prices for sugar, coffee, and cotton were up 28%, 8%, and 12% in 2016, they have since declined by 21%, 8%, and 2%, respectively. In fact, sugar - our top ag in 2016 - took the biggest hit this year (Chart of the Week). On the other hand, as a complex, grains currently stand at largely the same level as the beginning of last year. However, there are some idiosyncrasies within the class. The two worst performing grains last year - rice and wheat - have been the strongest performers so far this year. Rice rallied 30% year-to-date (ytd) on the back of tighter supplies, completely reversing its 19% decline in 2016. Similarly, wheat, which lost 13% of its value last year, is up a modest 3% ytd. On the other hand, soybeans surrendered its title as the most profitable grain in 2016. After gaining 14% last year, its fate turned and it fell 3% ytd. Finally, out of the lot, corn is the only ag we cover that has fallen in both years consecutively, by a minor 1.9% in 2016, and an additional 4.4% so far this year. A Recap Of Long Term Trends According to the International Grains Council's November estimates, grains production is projected to come down this crop year. With an increase in consumption, this will ultimately lead to a 5.2% decline in ending stocks - the first drawdown in five years. Despite the year-on-year (y-o-y) decline, grain inventories are expected to stand at their second highest level on record (Table 1). Table 1Grain Production Down While Consumption Inches Higher Global Financial Conditions Will Drive Grain Prices In 2018 Global Financial Conditions Will Drive Grain Prices In 2018 The decline in expected grain ending stocks is mainly driven by corn, which - despite a large upwards revision to U.S. yields in the most recent WASDE - is expected to experience a 3.6% decline in production. This, together with a boost in consumption, leads to a 13.6% fall in ending stocks - the first drawdown since the 2010/11 crop year. The decline in corn expectations reflects a shift in the planting preferences of some of the major producers. The U.S., Brazil, Argentina, and China are the top soybean and corn exporters - accounting for 78% and 49% of global soybean and corn area harvested in the 2016/17 crop year, respectively. What is significant in the current cycle is that farmers in these countries are moving away from planting corn and towards more soybeans (Chart 2). China, which accounted for 19% of global corn area harvested and 6% of global soybean area harvested in 2016/17, is leading this change. While corn area harvested fell by an average 4.2% in the 2015 and 2016 crop years, soybean area harvested gained 9.8% during that period. Similarly, in Brazil, which accounted for 10% and 28% of global corn and soybean area harvested in 2016/17, respectively, corn area harvested by farmers has been growing at a much slower rate than soybean area harvested, with the former expanding by 16.4% and the latter by 39.6% since 2010/11. Likewise, harvested area in the U.S., which accounted for 18% and 29% of global corn and soybean area harvested, respectively, shrunk by 0.9% in the case of corn, and expanded by 21.3% in the case of soybeans since 2010/11. The exception to this rule is Argentina. Argentine farmland accounted for 3% and 15% of global corn and soybean area harvested in 2016/17, respectively. Since 2010/11, both corn area harvested as well as soybean area harvested increased by roughly the same level - 1.6 Mn Ha for the former and 1.5 Mn Ha for the latter - representing a 44.4% and 8.6% increase in area harvested for corn and soybeans, respectively. However, this is due to export policies, which in effect, encourage corn production over soybeans. As we discuss below, soybean export tariffs will be phased out in the coming years, likely changing the incentives structure for Argentine farmers. This trend is mirrored in production data, with global soybean output gaining 32% since 2010/11, compared to a 25% increase in global corn production. However, this shift is in large part due to demand patterns which also favor soybeans to corn. Over the same period, global soybean consumption increased by 36%, compared to 24% in the case of corn (Chart 3). Chart 2Farmers Favor Soybeans Over Corn... Farmers Favor Soybeans Over Corn... Farmers Favor Soybeans Over Corn... Chart 3...As Do Consumers ...As Do Consumers ...As Do Consumers In fact, at 28%, global soybean stock-to-use ratios are significantly more elevated than that of corn, which stand at 19%. Furthermore, while soybeans are expected to record a 3.9mm MT surplus by the end of the current crop year, corn is projected to experience a 17.7mm MT deficit. Powell's Fed And Dollar Movements Our modelling of ags reveals that U.S. financial factors are important determinants of agriculture commodity price developments.3 Fed policy decisions and their impact on real rates have a direct effect on ag commodity prices, as well as an indirect effect through the exchange rate channel (Chart 4). Chart 4Fed Policy Drives Ag Markets Fed Policy Drives Ag Markets Fed Policy Drives Ag Markets While U.S. inflation has remained stubbornly low, forcing the Fed to slow down their interest rate normalization process, the anticipation - and eventual acceleration - of the Fed tightening cycle will weigh on ag prices. However, thanks in part to softer-than-expected inflation readings coming out of the U.S. this year, the USD broad trade-weighted index (TWIB) has weakened by 6.8% since the beginning of the year. In terms of the impact of real rates, monetary policy impacts agriculture markets through the following channels: The Fed's interest-rate normalization process will, all else equal, increase borrowing costs for farmers, and discourage investments in general - impacting both agricultural investments as well as outlays in research and development. Tighter credit also leads to a slowdown in growth which - ceteris paribus - depresses consumption and demand for goods and services generally, and agricultural commodities specifically. Finally, real rates have an indirect effect on agricultural commodity prices through its effect on the U.S. dollar. Higher U.S. rates encourage investment in U.S. bonds and entail a strengthening of the U.S. dollar making U.S. exports less competitive vis-à-vis those of its international competitors. Since commodities are priced in U.S. dollars while costs are priced in local currencies, a weakening of the domestic currency vis-à-vis the dollar would increase profitability for farmers selling in international markets. This can incentivize farmers to plant more, despite depressed global ag prices, which increases supply. As our modelling reveals, the net effect is an inverse relationship, whereby easier monetary policy is generally more favorable for agriculture markets. The Fed Will Remain Behind The Inflation Curve Our U.S. Bond Strategy team expects the Fed to remain behind inflation, in which case the USD will remain weak in the beginning of next year. The 2/10 Treasury curve is flat highlighting the market's belief that the Fed will continue with interest rate normalization despite below target levels of inflation.4 Since this would be a huge error on the part of new Chairman Powell, our U.S. bond strategists believe that the Fed will avoid such a policy mistake. Consequently, if inflation does not pick up soon, the Fed will be forced to turn dovish. In any case, U.S. monetary policy will "fall behind the curve." This means that the U.S. dollar will remain weak until inflation starts to tick higher, and the Fed can resume its interest rate normalization process. In fact, our bond strategists find that there is a resemblance between the current cycle and that of the late 1990s where the unemployment rate significantly undershot its natural level before inflation started to accelerate. Thus, they find it significant that most of the indicators that predicted the 1999 increase in inflation are now positive. This reinforces our faith that inflation will soon rebound, allowing the Fed to fall behind the curve and simultaneously hike rates at a pace of one more hike this year, and three more in 2018.5 In terms of the future path of the U.S. dollar, our foreign exchange strategists argue interest rate differentials will be a more significant determinant of dollar dynamics going forward. They expect inflation will start its ascent sometime before the end of 1H2018, which would lift the interest rate curve and the dollar. Our expectation is that inflation will bottom towards the end of this year/beginning of next, giving room for the Fed to proceed with its anticipated rate-hiking cycle, resulting in two to three hikes next year. Markets are pricing one to two rate hikes next year, which means our out-of-consensus rates call could cause the USD to rally far more than what markets have priced in to the USD TWIB. Following a 4.4% appreciation in trade weighted terms in 2016, the U.S. dollar has depreciated by 6.8% so far this year. The U.S. accounts for a larger share of global exports of corn and soybeans than rice and wheat, which means a strengthening of the USD TWIB will likely have a bigger impact on wheat and rice, in which the U.S. faces greater international competition for market share (Table 2). Table 2Wheat & Rice Vulnerable To USD Dynamics Global Financial Conditions Will Drive Grain Prices In 2018 Global Financial Conditions Will Drive Grain Prices In 2018 This is, in fact, in line with the price behavior that we have observed. Wheat and rice prices fell the most in 2016 as the U.S. dollar appreciated, and have outperformed soybeans and corn so far this year, as the U.S. dollar depreciated. Thus, in the absence of supply shocks that affect a particular grain, changes in the U.S. dollar going forward will have a greater impact on rice and wheat than on corn and soybeans. Keep An Eye On The Brazilian Real Of the major ag exporters, Brazil is most vulnerable to USD depreciation risk. Poor productivity trends have made our foreign exchange strategists single out the Brazilian Real (BRL) as one of the most expensive currencies they track. While they expect the BRL to depreciate over a one- to two-year horizon, the current strength in EM asset prices means that the BRL is likely to remain at its current level in the near term. However, given that the BRL provides an high carry, it will likely move sideways until U.S. interest rate expectations adjust to a rebound in inflation - which we expect toward the end of this year, or beginning of next. Brazil is a major ag producer - making up 45%, 44%, 27%, 23% and 12% share of the global export pies for soybeans, sugar, coffee, corn and cotton, respectively. Thus, a weaker BRL vis-à-vis the USD is a major downside risk to these commodity prices. Downside FX Risks Will Keep Wheat Prices Depressed Chart 5Downside FX Risks For Wheat Exporters Downside FX Risks For Wheat Exporters Downside FX Risks For Wheat Exporters In addition to the risks from an overvalued BRL, our foreign exchange strategists have highlighted the EUR, RUB, and AUD as currencies that are at risk of falling back to their fair value in the near term. Given that these regions are major wheat exporters, this would weigh on the grain's price as exports increase (Chart 5).6 On the back of expectations that the European Central Bank will adopt a significantly less aggressive monetary policy than the Fed, our foreign exchange strategists expect the EUR to weaken toward the end of the year and beginning of next. Given that Europe is a major wheat exporter - making up ~20% of global exports - a weaker EUR would make European wheat more attractive, weighing on prices in 2018. The currencies of other major exporters could be drawn in different directions in the near term. Our FX strategists see the Russian Rouble (RUB) as overvalued and at risk of weakening when U.S. inflation starts accelerating late this year or early next. However, higher oil prices would push up the ruble's fair value, correcting some of its overvaluation. As with the EUR, the wheat market is most vulnerable to a weaker RUB since Russia accounts for 14% of global wheat exports. Likewise, Australia - another major wheat exporter which accounts for 10% of world exports - has been identified as having an expensive currency. It is at risk of a depreciation over the next 24 months, but could rally if iron ore markets turn higher. Some Additional (Potential) Fundamental Forces Among the news and noise in the ags sphere, we see higher oil prices and La Nina as the most significant near-term risks to current supply/demand dynamics. Longer term, shifting policies in China, Argentina, and Brazil will become more relevant in determining the trajectory of ag markets. Our Out-Of-Consensus Call On Oil Is Bullish For Ags Chart 6Higher Energy Prices Upside Risk Higher Energy Prices Upside Risk Higher Energy Prices Upside Risk We expect oil prices will tread higher next year - averaging $65/bbl for Brent and $63/bbl for WTI - on the back of stronger demand and an extension of the OPEC 2.0 coalition's supply restrictions.7 This will support ag commodity prices. Higher oil prices affect ags by increasing input costs and global shipping prices. In addition, the supply of ocean-going transport for grains is tight. The Baltic Dry index, a measure of the global cost of shipping dry goods, and has been on the uptrend this year, as freight costs have more than doubled since mid-February, mostly on the back of a slowdown in shipping transportation supply (Chart 6). La Nina: A Literal Tailwind? Against a backdrop of falling stocks-to-use ratios in the corn and soybean markets, weather will add volatility to prices into 1H2018. In the near term La Nina, which is predicted to continue through the 2017-18 Northern Hemisphere winter, threatens to curb agricultural output. This phenomenon affects weather and rainfall, causing floods and droughts, by cooling the Pacific Ocean. Australia's Bureau of Meteorology recently pegged the chance of a La Nina at 70%, expecting it to last from December to at least February. However, this season's La Nina is forecast to be weak and weather conditions are expected to neutralize in 1Q2018.8 In the case of ags, the greatest threat from La Nina is the risk of droughts in Brazil and Argentina which could hurt the regions soybean, corn, sugar, and cotton harvests. Furthermore, excess rainfall in Australia and Colombia threaten wheat, cotton, and sugar yields in the former and coffee output in the latter. Furthermore, the weather phenomenon raises chances of a potential drought in the U.S. Midwest.9 However, it is noteworthy that by the time La Nina hits, much of the harvest in the Northern Hemisphere will have been completed. So the main risk will be to harvests in the Southern Hemisphere. Gradualismo In Argentina, Stockpiling In China, And Ethanol In Brazil 1. Since taking office late 2015, Argentine President Mauricio Macri has reversed his predecessor's unfavorable agricultural policies - allowing the Argentine peso to float, and eliminating export taxes on wheat and corn. Marci's Gradualismo reforms have been successful - incentivizing plantings and leading to record harvests (Chart 7). While a 30% export tax remains on soybeans - Argentina's main cash crop - it is down from 35% under the presidency of Macri's predecessor. Further cuts to soybean export taxes have been delayed in order to finance the country's fiscal deficit, however they are expected to resume next year with a 0.5pp reduction/month for the next two years. This would stimulate soybean plantings, if it materializes. Argentine farmers produce 18% of global soybean output, and account for 9% of global soybean exports. The change in export policy, as it unfolds, will thus weigh on soybean prices as Argentine farmers increase their soybean acreage in the coming crop years. 2. Although we will likely get more clarity regarding Chinese ag policies with the release of China's Number 1 Central document - which for the past 14 years has focused on agriculture - in February, we expect Beijing to continue incentivizing soybean farming over corn. China's soybean inventory levels stand significantly lower than its notoriously massive stocks of corn, wheat, and cotton (Chart 8). Chart 7Argentine Reforms Will Raise Soybean Exports Argentine Reforms Will Raise Soybean Exports Argentine Reforms Will Raise Soybean Exports Chart 8China's Soybean Stocks Are Relatively Low China's Soybean Stocks Are Relatively Low China's Soybean Stocks Are Relatively Low As such, China's top corn producing province - Heilongjian - cut the subsidy for corn farmers by 13 percent this year. Farmers there now receive 8.90 yuan/hectare of corn, down from the 10.26 yuan/hectare they received last year. This compares with subsidies for soybean farmers which at 11.56 yuan/hectare is much higher. According to the China National Grain and Oils Information Center, corn acreage in Heilongjiang is down 9.3 percent in 2016/17. However, with corn prices in China increasing, the higher subsidy for soybeans may not be sufficient. Nonetheless, according to a report by the Brazilian state Mato Grosso's official news agency, over the next five years the Chinese commodities trader COFCO intends to almost double its soybean imports from the Brazilian grains state. This means that China's demand for soybeans will drive the market in the near term as they look to buildup soybean reserves and bring down their corn stocks.10 Chart 9Higher Oil Prices Incentivize Ethanol Over Sugar Higher Oil Prices Incentivize Ethanol Over Sugar Higher Oil Prices Incentivize Ethanol Over Sugar 3. Ethanol Demand will raise the opportunity costs of bringing sugar and corn to market. In addition to the direct effect of higher oil prices on ag commodities in general, our forecast of increasing prices will pressure sugar prices indirectly through the ethanol channel in Brazil. Since July, Brazil's state-controlled oil company, Petrobras, has shifted its pricing policy allowing gasoline and diesel prices to follow those of international oil markets. As a result, the gasoline-ethanol price gap is widening.11 This will revive demand for the biofuel, which will cause mills to divert sugarcane away from the sweetener in favor of producing more ethanol (Chart 9). In fact, according to UNICA - the Brazilian sugarcane industry association - mills in the country's center-south region - from which 90% of Brazil's sugar output is derived - are favoring ethanol production over sugar. Data for the first half of October shows that 46.5% of sugarcane was diverted to producing sugar, down from 49.6% in the same period last year. However, in the near term, increased production from the EU amid their scrapping of domestic sugar production quotas will likely keep the global market in balance.12 Global sugar supply is forecast to remain strong on the back of supplies from Thailand, Europe and India. There are reports that ethanol producers in Brazil are evaluating the adoption of "corn-cane flex" ethanol plants.13 However this is a longer run risk which would increase demand for corn, and reduce demand for sugar. Bottom Line: Financial conditions will drive ag prices in 2018. The Fed's resolve to normalize interest rates - more so than markets expect - will keep a lid on prices. This will offset risks from higher energy prices. Nonetheless, some weather induced volatility is likely into 1Q2018. Roukaya Ibrahim, Associate Editor Commodity & Energy Strategy RoukayaI@bcaresearch.com 1 In fact, our Global Investment Strategists expect the Fed to hike rates in December 2017, and again four more times in 2018. Please see BCA Research's Global Investment Strategy Weekly Report titled "A Timeline For the Next Five Years: Part I," dated November 24, 2017, available at gis.bcaresearch.com. 2 Please see BCA Research's Commodity & Energy Strategy Weekly Report titled "2017 Commodity Outlook: Grains & Softs," dated December 22, 2016, available at ces.bcaresearch.com. 3 A 1% move in the USD TWI is associated with a 1.4% change in the CCI Grains & Oilseed Index, in the opposite direction. Similarly, a 1pp move in 5-year real rates is associated with a 18% change in the CCI Grains & Oilseed Index, in the opposite direction. The adjusted R2 is 0.84. 4 Please see BCA Research's U.S. Bond Strategy Portfolio Allocation Summary titled "Into The Fire," dated November 7, 2017, available at usbs.bcaresearch.com. 5 Please see BCA Research's U.S. Bond Strategy Weekly Report titled "The Fed Will Fall Behind The Curve," dated October 24, 2017, available at usbs.bcaresearch.com. 6 Please see BCA Research's Foreign Exchange Strategy Weekly Report titled "Updating Our Long-Term Fair Value Models," dated September 15, 2017, available at fes.bcaresearch.com. 7 Please see BCA Research's Commodity & Energy Strategy Weekly Report titled "Oil Balances Continue To Point To Higher Prices," dated November 23, 2017, available at ces.bcaresearch.com. 8 El Nino/Southern Oscillation (ENSO) alternates between warm ("El Nino") and cool ("La Nina") phases, impacting global precipitation and temperatures. These episodes are identified by looking at temperatures in the "Nino region 3.4" whereby readings of at least 0.5 degrees Celsius above or below seasonal average for several months would qualify as an El Nino or La Nina. 9 La Nina is often associated with wet conditions in eastern Australia, Indonesia, the Philippines, Thailand, and South Asia. It usually leads to increased rainfall in northeastern Brazil, Colombia, and other northern parts of South America, and drier than normal conditions in Uruguay, parts of Argentina, coastal Ecuador and northwestern Peru. The effect on the U.S. and Canada tends to be milder since they are located further away from the heart of ENSO, on the other hand it has the greatest impact on countries around the Pacific and Indian Oceans. 10 Please see BCA Research's Commodity & Energy Strategy Weekly Report titled "Ags in 2017/18: Move To Neutral," dated October 5, 2017, available at ces.bcaresearch.com. 11 Flex-fuel vehicles in Brazil means that ethanol demand is not constrained by a "blending wall". Thus ethanol is a substitute for gasoline- rather than a complement to, as in the U.S. 12 France, Belgium, Germany and Poland reportedly have the capacity to ramp up sugar beet production. 13 Please see "Brazil mills eye corn-cane flex plant to extend production cycle," dated November 7, 2017, available at reuters.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Global Financial Conditions Will Drive Grain Prices In 2018 Global Financial Conditions Will Drive Grain Prices In 2018 Commodity Prices and Plays Reference Table Trade Recommendation Performance In 3Q17 Global Financial Conditions Will Drive Grain Prices In 2018 Global Financial Conditions Will Drive Grain Prices In 2018 Trades Closed in 2017 Summary of Trades Closed in 2016

Highlights The uptick in world oil demand in the wake of a strengthening global upturn - the first since the Global Financial Crisis (GFC) - coupled with continued production discipline by OPEC 2.0, will accelerate inventory draws, and lift prices above our previous expectation. Even though we expect - and model for - U.S. shale producers to step up drilling as a result, we are lifting our base case forecast for 2018 Brent and WTI to $65.15/bbl and $62.95/bbl, respectively. These estimates are up $5.51 and $5.98/bbl from our forecast last month.1 Energy: Overweight. Given our view (discussed below), we are taking profits on the long Dec/17 WTI call spread we recommended June 15 - long $50/bbl calls vs. short $55/bbl calls - on the close tonight. This position was up 116% Tuesday. We will replace this spread with long $55/bbl WTI calls vs. short $60/bbl WTI calls in Jul/18 and Dec/18. Base Metals: Neutral. We closed our short Dec 2016 copper trade last week, after our trailing-stop of $3.10/lb was elected, with a 0.75% return. Our trade was up 6% by the end of September, however bullish data in October - including an earthquake in Chile and worries over a potential metal shortage in China - lifted prices back up. Chinese copper import data showed a 26.5% year-on-year (yoy) jump in September. Even so, we expect copper imports to end 2017 with a yoy decline. Precious Metals: Neutral. Palladium continues to trade premium to platinum following its breakout at the end of September. We expect this to continue, given the supply-demand fundamentals we highlighted in June.2 Ags/Softs: Neutral. The USDA's latest World Agricultural Supply and Demand Estimates (WASDE) is supportive of our grains view - projections for 2017/18 wheat ending inventories were revised upward, while corn and soybeans stock estimates were lowered. Our long corn vs. short wheat position recommended October 5 is up 1.5% (please see p. 8 for further discussion.) Feature The global uptick in GDP growth noted this month by the IMF, along with continued production discipline from OPEC 2.0 - the producer coalition led by the Kingdom of Saudi Arabia (KSA) and Russia - will lift 2018 average Brent and WTI prices to $65.15/bbl and $62.95/bbl, respectively. These estimates are up $5.51 and $5.98/bbl from our forecast last month (Chart of the Week). Chart of the WeekHigher Demand, Lower Supply,##BR##Tighter Inventories Lift Prices Higher Demand, Lower Supply, Tighter Inventories Lift Prices Higher Demand, Lower Supply, Tighter Inventories Lift Prices We expect the fortuitous combination of fundamentals - for oil producers, that is - to accelerate the drawdown in oil inventories globally, which also will be supportive for prices (Chart 2). This, in turn, will set off a new round of U.S. shale-oil production, which will temper the price rise we expect, but still force inventories to draw harder than expected (Chart 3). Our base case calls for OPEC 2.0 to extend its 1.8mm b/d production cutting deal to end-June 2018, and for compliance within the KSA-Russia-led coalition to remain strong. OPEC 2.0 member states compliance with self-imposed quotas stood at 106% of agreed cuts, according to a state-by-state tally published by S&P's Global Platts earlier this month.3 Iraq continues to flaunt its OPEC 2.0 production quota, at 4.54mm b/d by our estimate, or 153k b/d over its quota. OPEC as a whole is producing 32.74mm b/d of crude oil, by our reckoning, vs. Platts' estimate of 32.66mm b/d. We have Libya and Nigeria, which are not parties to the OPEC 2.0 Agreement, producing 930k b/d and 1.71mm b/d last month, vs. Platts' estimates of 910k b/d and 1.84mm b/d, respectively (Table 1). KSA and Russia continue to lead OPEC 2.0 by example, with the former's crude oil production coming in at 9.97mm b/d in September, vs. 9.95mm b/d in August; the latter's total liquids production was 11.12mm b/d, vs. 11.13mm in August (Chart 4). Chart 2Market Will Get##BR##Tighter Sooner Market Will Get Tighter Sooner Market Will Get Tighter Sooner Chart 3BCA Expects Sharper##BR##Inventory Draw Than EIA BCA Expects Sharper Inventory Draw Than EIA BCA Expects Sharper Inventory Draw Than EIA Chart 4KSA And Russia Continue##BR##Providing Leadership To OPEC 2.0 KSA And Russia Continue Providing Leadership To OPEC 2.0 KSA And Russia Continue Providing Leadership To OPEC 2.0 Global GDP, Oil Demand Growth Strengthens The IMF earlier this month raised its forecast for global GDP growth this year to 3.6% and to 3.7% for next year, up 0.1% for each year vs. previous forecasts. In its analysis, the Fund drew attention to: Notable pickups in investment, trade, and industrial production, coupled with strengthening business and consumer confidence, are supporting the recovery. With growth outcomes in the first half of 2017 generally stronger than expected, upward revisions to growth are broad based, including for the euro area, Japan, China, emerging Europe, and Russia. These more than offset downward revisions for the United States, the United Kingdom, and India.4 On the back of the IMF's revised global growth estimates, we lifted our 2017 and 2018 oil demand expectation to just under 47.5mm b/d on average for the OECD and to just under 52mm b/d for non-OECD economies (Table 1). This translates into global demand growth of 1.65mm b/d in 2017 and 1.69mm b/d in 2018. Notably, we expect global demand to exceed 100mm b/d on average next year in our base case. Table 1BCA Global Oil Supply - Demand Balances (mm b/d) Oil Forecast Lifted As Markets Tighten Oil Forecast Lifted As Markets Tighten Our estimated demand is driven by global growth projections, particularly for EM economies, which make up the bulk of demand and growth in our balances estimates (Table 1). And, as before, our estimates remain above the EIA's (Chart 5). The indicators we look at to confirm or refute our demand assessment - global trade, particularly EM imports, and manufacturing - remain strong. Global trade continues to expand, particularly in EM ex-Middle East and Africa, as does manufacturing globally, both of which supports the IMF's assessment of growth generally (Charts 6 and 7). Rising incomes lead to rising trade, and also to increased oil and base metals consumption in EM economies. Chart 5We Continue To##BR##Estimate Higher Demand Than The EIA We Continue To Estimate Higher Demand Than The EIA We Continue To Estimate Higher Demand Than The EIA Chart 6Rising Trade Volumes##BR##Support Growth Story ... Rising Trade Volumes Support Growth Story ... Rising Trade Volumes Support Growth Story ... Chart 7... Expanding Manufacturing##BR##Does, Too .. Expanding Manufacturing Does, Too .. Expanding Manufacturing Does, Too Higher Prices, Greater USD Risk Expected In 2018 Given the upward revisions to global growth and our expectation OPEC 2.0 compliance will remain fairly stout, our baseline forecast now calls for WTI prices to average $56.40/bbl in 4Q17 and $62.95/bbl in 2018. Brent is expected to average $58.40/bbl in 4Q17 and $65.15/bbl next year (Chart 1 and Table 2). These estimates are up from last month's averages of $54.89 and $57.44/bbl for 4Q17 and 2018 WTI, and $56.67 and $59.17/bbl for 4Q17 and 2018 Brent.5 Our increasing bullishness is tempered by the risk of a stronger USD, particularly the broad trade-weighted USD index, which captures EM currency weakness. With the Fed set on a course to lift rates - our House view anticipates a Dec/17 rate hike and two or three hikes next year - and the oil market getting fundamentally tighter, we have seen the oil-USD linkage being re-established recently (Chart 8). Table 2Upgrading Our##BR##Price Forecasts Oil Forecast Lifted As Markets Tighten Oil Forecast Lifted As Markets Tighten Chart 8Expect The USD To Be Less##BR##Determinant For Oil Prices Expect The USD To Be Less Determinant For Oil Prices Expect The USD To Be Less Determinant For Oil Prices The persistent negative correlation between oil prices and the USD broke down following the global asset sell-off in 1Q16. However, this relationship converged to its long-term equilibrium in recent months. In our view, this reflects market participants' increasing conviction - expressed in market-cleared prices - that OPEC 2.0 will maintain its supply-management accord for an extended period, and that supply is now stabilizing. With demand remaining robust as the global synchronized upturn continues, the fundamental side of price determination has stabilized, and financial variables once again will strongly influence oil prices at the margin. Given our view the USD will trade off interest-rate differentials going forward, and our expectation that U.S. rates are set to increase relative to other systemically important rates, the USD likely will appreciate over the next 12 months. This will be a headwind for oil prices, and may be an additional factor OPEC 2.0 member states have to account for in 2018. Bottom Line: We are raising our price forecast for 4Q17 and 2018 in line with our expectation for stronger global growth and continued strong compliance from OPEC 2.0. With markets getting tighter, we expect the USD to become more important to the evolution of oil prices in 2018. Ag Update: Stay Long Corn, Short Wheat Global grain fundamentals continue to be supportive to our long corn vs. short wheat position, recommended October 5. The USDA's latest WASDE are projecting higher 2017/18 ending wheat inventories, while corn and soybeans stock estimates were lowered (Chart 9).6 Chart 9Fundamentals Support Long Corn##BR##Vs. Short Wheat Trade Fundamentals Support Long Corn Vs. Short Wheat Trade Fundamentals Support Long Corn Vs. Short Wheat Trade The USDA lowered its expected global corn stocks-to-use ratio, and increased its wheat stocks-to-use ratio for the current crop year. Revisions to the estimates for the 2016/17 crop year also reflect similar dynamics. We expected this going into the WASDE report at the beginning of the month when we published our Special Report on the Ag markets, and got long corn vs. short wheat. December 2017 corn futures traded on CME are up 0.14% since October 5, while wheat futures are down 1.36%. This brings the return on our long corn/short wheat trade to 1.5%, to date. Highlights from the current WASDE include: Upward revisions to wheat production from India, the EU, Russia, Australia, and Canada more than offset greater projected global demand, most notably from India and the EU. Overall, global ending stocks were revised up by 4.99mm MT, and are projected to stand at 268mm MT by the end of the 2017/18 marketing year. Greater projected corn demand, most notably from the U.S. and China, more than offset the ~ 6mm MT upward revision to global production in the USDA's estimates. Higher projected Chinese demand reflects greater food and seed demand, and higher expected industrial use. Corn stocks are expected to end 2017/18 at 200.96mm MT - 1.51mm MT below September projections. Similarly, in its October Chinese Agricultural Supply and Demand Estimates, China's Agriculture Ministry increased its forecast for the 2017/18 corn deficit to 4.31mm MT from 0.89mm MT projected last month. The Ministry expects lower output and greater consumption on the back of stronger demand from ethanol plants.7 Furthermore, in a move towards market pricing, Heilongjiang - China's top corn province - will be reducing the subsidy it gives corn farmers from 153.92 yuan/mu last year to 133.46 yuan/mu. The province will reorient its subsidies to incentivize more soybean production.8 In soybean markets, USDA projections for ending stocks were reduced by 1.48mm MT to 96.05mm MT by end-2017/18, largely on the back of lower expected U.S. and Brazilian inventories in 2016/17. Robert P. Ryan, Senior Vice President Commodity & Energy Strategy rryan@bcaresearch.com Roukaya Ibrahim, Associate Editor Commodity & Energy Strategy RoukayaI@bcaresearch.com Hugo Bélanger, Research Assistant HugoB@bcaresearch.com 1 Please see BCA Research's Commodity & Energy Strategy Weekly Report "OPEC 2.0 Will Extend Cuts To June 2018," published September 21, 2017. It is available at ces.bcaresearch.com. 2 Please see "Precious Metals Update," in the June 29, 2017 issue of BCA Research's Commodity & Energy Strategy Weekly Report "EM Trade Volumes Continue Trending Higher, Supporting Metals". It is available at ces.bcaresearch.com. 3 Please see S&P Global Platts OPEC Guide published October 6, 2017. 4 Please see Chapter 1 of the IMF's World Economic Outlook for October 2017, which is available online at https://www.imf.org/en/Publications/WEO/Issues/2017/09/19/world-economic-outlook-october-2017. 5 Our base case continues to call for an end-June 2018 extension of the OPEC 2.0 production deal. Should the deal be extended to end-December 2018, we estimate 2018 WTI prices would average $67.35/bbl, while Brent prices would average just under $70.00/bbl. We are becoming increasingly confident OPEC 2.0 will become a durable production-management coalition, given the increasing cooperation and mutual investment between KSA and Russia. We will be exploring this further in future research. Please see "King Salman Goes To Moscow, Bolsters OPEC 2.0," published October 11, 2017, by BCA Research's Energy Sector Strategy. It is available at nrg.bcaresearch.com. 6 Please see Commodity & Energy Strategy Special Report titled "Ags In 2017/18: Move To Neutral," dated October 5, 2017, available at ces.bcaresearch.com. 7 Please see "China Raises Forecast For 2017/18 Corn Deficit On Lower Output," dated October 12, 2017, available at reuters.com. 8 Please see "Top China Corn Province Cuts Subsidy For Farmers Growing the Grain," dated October 16, 2017, available at reuters.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Oil Forecast Lifted As Markets Tighten Oil Forecast Lifted As Markets Tighten Trades Closed in 2017 Summary of Trades Closed in 2016

Highlights 2017/18 fundamentals are supportive for corn. Lower production and stronger demand will put the market into a deficit. China's E10 mandate is a boon for ethanol, and the ags used to produce it. Imports will be needed in the transition phase. Fed's interest-rate normalization is a headwind to U.S. ag exports and will encourage foreign production. Move ags to neutral, stay strategically long corn/short wheat. Feature Lower production and stronger demand will put the corn market in a supply deficit. Wheat and soybeans, meanwhile, are projected to record a smaller surplus in 2017/18 compared to 2016/17 (Chart of the Week). The corn supply deficit will draw down ending stocks. Still, with a stocks-to-use (STU) ratio of 26%, global grain inventories remain at healthy levels. The small dip in STU ratios projected for the 2017/18 crop year signals a minor change from the generally upward trend since the 2007/08 world food-price crisis (Chart 2). However, China's still-massive inventories have been distorting our view of global grain markets. Policymakers are moving to reduce huge corn stocks and encourage ethanol production. This will be bullish for corn. We are lifting our weighting to neutral for ags, and are recommending a strategic long corn vs. short wheat position at tonight's close (Chart 3). Chart of the WeekGlobal Grain Markets##BR##Slowly Rebalancing Global Grain Markets Slowly Rebalancing Global Grain Markets Slowly Rebalancing Chart 2Despite Dip,##BR##Global STU Remain Healthy Despite Dip, Global STU Remain Healthy Despite Dip, Global STU Remain Healthy Chart 3Move Ags to Neutral On##BR##Shrinking Supply Surplus Move Ags to Neutral On Shrinking Supply Surplus Move Ags to Neutral On Shrinking Supply Surplus China's Massive Stockpiles Blur The View Of Grains Vulnerability World grains STU ratios remain more or less unchanged at ~ 27% since 2014/15. Within the grains complex, we see a decline in projected corn area planted in 2017/18, and an increase in area harvested for wheat and, to a larger extent, soybeans (Chart 4). In the case of corn and soybeans, this also reflects acreage expectations in the U.S., where corn farmers are projected to decrease their 2017 planted area by 3%, and increase soybean planted area by 7%. However, when we remove Chinese stocks from the world tally, the global STU ratio stands much lower, at ~ 20%. China's grains and soybean STU ratios have been holding at ~ 50% since 2014/15 (Table 1). Nonetheless, given China's relatively higher prices, we believe it is safe to say that Chinese stocks are not accessible to the world. China accounted for only ~0.3% of world grain exports in recent years. Thus, we do not consider them a supply-side risk factor. STU ratios are an indication of a commodity's vulnerability to demand- or supply-side shocks. When STU ratios are healthy, a shortage can be cushioned by the stored inventory. Thus, a lower ratio signifies that a shock would have a greater impact on the price. However, given that China's STU ratios are significantly greater than the rest of the world - China accounts for ~ 22% of world grain demand, and more than 60% of the world's grain inventories - they skew our view of the market (Chart 5). Chart 4Farmers Favor##BR##Soybeans Over Corn Farmers Favour Soybeans Over Corn Farmers Favour Soybeans Over Corn Table 1Stocks-To-Use*:##BR##China Is Distorting Our View Ags In 2017/18: Move To Neutral Ags In 2017/18: Move To Neutral Chart 5China's Inventories Account For##BR##Huge Chunk Of World Inventories Ags In 2017/18: Move To Neutral Ags In 2017/18: Move To Neutral Consequently, we find that excluding China from world inventory levels and STU ratios gives us a better indicator of the susceptibility of world ag markets to price shocks. This reveals that corn is more vulnerable to price changes compared to wheat and soybeans. Nevertheless in terms of demand, China remains an important market driver. Thus, ongoing changes to China's agriculture policies are a significant factor affecting our outlook. China's Evolving Ag Policies China's government is continuing down its path towards modernizing the country's agriculture policies by making them more market-oriented, and moving away from its one-policy-fits-all strategy. In the past, China's ag policies were motivated by efforts to prioritize food security and promote farming incomes. These policy goals manifested themselves in price floors across the board, which were continuously adjusted to the upside with rising input prices. While these policies were successful in incentivizing farmers to increase agricultural output, they also resulted in a "triple high" phenomenon: (1) high domestic production, (2) high imports, and (3) high domestic stocks (Chart 6). Domestic consumers increased their imports to take advantage of lower international prices, which meant that state agriculture stockpiles ballooned (Chart 7). Chart 6China "Triple High" Phenomenon China "Triple High" Phenomenon China "Triple High" Phenomenon Chart 7China Prices Still Too High China Prices Still Too High China Prices Still Too High In acknowledgement of these drawbacks, China has taken steps to remedy the "triple high phenomenon," most recently communicating the following changes: In rice and wheat markets, policymakers will attempt to improve the minimum-procurement price policy to reorient incentives. In cotton and soybean markets, a new target-price system will be put in place, which ensures that farmers are compensated when market prices fail to reach the stated target prices. Corn markets will see the biggest change in the government's procurement policy, as it will be eliminated and replaced with market-driven pricing. Subsidies to farmers will be unrelated to corn prices. Although the Central Committee of the Communist Party of China and the State Council has communicated a more receptive attitude towards imports in its "No. 1 Central Document," tariff rate quotas remain in place for wheat, rice, corn, cotton and sugar.1 Bottom Line: China's massive inventories distort global STU ratios. Nevertheless in term of demand, China remains significant. Do not discount the impact of China's evolving ag policies. Among Ags, Corn Is China's Priority Chart 8China Corn Deficit To Widen China Corn Deficit To Widen China Corn Deficit To Widen Among the changes outlined above, the largest shift in policy will be in the corn market. Tackling the huge stockpiles and rising output is a clear priority for the Chinese government. In fact, according to the latest USDA projections, China's corn market will be in a deficit in 2017/18 for the second year in a row. This follows five years of strong imports, which persisted despite domestic surpluses. What is notable about the 2017/18 deficit is that, according to USDA projections, it is largest on record. At 23mm metric tonnes (MT) it is more than 1.5 times the second-largest deficit recorded in 2000/01 (Chart 8). Although China's corn stockpiles make up more than 40% of global stocks, and the government has expressed a keenness to draw them down, there are reports that the corn in storage has deteriorated so much that it is no longer fit for animal or human consumption. Thus, in face of falling corn area harvested in China, and amidst higher domestic prices, corn imports are expected to continue filling the void.2 They are projected to record only a slight decline in 2017/18. The global corn balance will likely show the same trend. Even though world ex-China corn market is expected to remain in surplus, production is projected to fall while consumption is expected to increase. This will bring the surplus down to 1.8mm MT from 54.4mm MT in 2016/17. In fact, ending stocks in both China and the rest of the world are expected to come down in 2017/18. This will be the second year of declining inventories for China following five successive years of buildup, and is a clear result of the change in China's agricultural policies. Bottom Line: The biggest shift in China's policies is in the corn market. Efforts will remain focused on bringing down the massive stockpiles. However, domestic prices remain relatively high. This will continue incentivizing cheaper imports. China Ethanol Mandate: Two Birds With One Stone In an effort to get rid of the corn glut and reduce pollution, China's National Energy Administration (NEA) recently announced 2020 as the target for introducing E10 ethanol to the gasoline pool in the world's largest automobile market. Although Beijing had previously announced plans to double ethanol production by 2020, the E10 mandate is a more concrete step in that direction. It is a reiteration of the state's intention to draw its massive corn stocks and prioritize environmental conservation. Meeting China's ethanol needs would require an additional 36 ethanol plants, each with an annual capacity of 379mm liters, adding up to an additional 45mm MT of corn a year - more than 4% of current world demand - according to estimates from Reuters.3 However, as one of the main goals of the ethanol mandate is to reduce corn stockpiles, a Chinese official recently refuted the view that China will need to rely on imports. This seems overly optimistic. It is doubtful these ethanol plants will all be up and running in China by 2020. Thus, the country will likely rely on ethanol imports during the transition phase. This would be a boon for ethanol, and the ags used to produce it. Amid low corn prices, U.S. ethanol producers have been producing record quantities of the gasoline additive. However, the "blend wall" - which describes the limitation of mandating more ethanol content in gasoline due to its harmful effects on car engines - has limited domestic consumption of the biofuel. Furthermore, U.S. car sales have been anemic this year (Chart 9). Nonetheless, U.S. farmers have been able to take advantage of their low-cost production and export excess supplies to Brazil, where sugarcane-based ethanol has recently been relatively more expensive (Chart 10). Chart 9Strong U.S. Ethanol Production##BR##Despite Blend Wall Strong U.S. Ethanol Production Despite Blend Wall Strong U.S. Ethanol Production Despite Blend Wall Chart 10Tariffs A Buzzkill For##BR##U.S. Ethanol Exports Tariffs A Buzzkill For U.S. Ethanol Exports Tariffs A Buzzkill For U.S. Ethanol Exports The Ethanol Trade War Is On On August 23, as U.S. corn farmers prepared for a record harvest, Brazil - the main export destination for U.S. ethanol - imposed a 20-percent tariff-rate quota on ethanol imports from the U.S., which covered more than 1 million gallons a year. This came after U.S. exports to Brazil swelled by 300% in 1H17, and represented a serious blow for the U.S. ethanol export market. Similarly, China increased its tariffs on U.S. ethanol earlier this year. However, in an effort to protect its food crops, Beijing reportedly will invest in large-scale cellulose-based ethanol production and advanced biofuels by 2025.4 If successful, this would make the corn and sugar rally short-lived. Bottom Line: China's E10 mandate is a boon for ethanol, and the ags used to produce it. Especially given declining corn plantings. Imports will be needed in the transition phase. China Policies Encourage Soybean Production Chart 11Chinese Farmers Also Favor##BR##Soybeans Over Corn Chinese Farmers Also Favor Soybeans Over Corn Chinese Farmers Also Favor Soybeans Over Corn While state-directed incentives in China are set to reduce corn stockpiles, farmers are now shifting towards soybean production over corn (Chart 11). The area of corn harvested in China is projected to continue shrinking - and at a faster rate. The second annual decline in land dedicated to corn plantings comes after 12 years of continuous expansions at an average 4% p.a. On the flip side, Chinese farmers are expected to increase land dedicated to soybeans by 8% in 2017/18, after expanding it by 11% in the previous year. These increases follow a 6% average annual decline since 2010/11 to reach the smallest soybean area harvested on record in 2015/16. This is in line with China's efforts to ensure food security. Unlike other ag commodities, soybean STU ratios in China have been consistently below the global ratio. Weak USD Improved Competitiveness Of U.S. Exports A subdued U.S. dollar benefitted U.S. ag exports this year, and kept ag markets tight. With the exception of the Argentine Peso - which depreciated ~ 10% vis-à-vis the USD since the beginning of the year - currencies that are relevant to ags have strengthened slightly or remained largely stable since the beginning of the year (Chart 12). On one hand, a relatively weak USD makes U.S. ags more affordable for foreign markets. On the other hand, since commodities are priced in dollars, while costs are in local currencies, farmers in other ag-exporting nations lose on exchange-rate differentials. In trade-weighted terms, the USD reached its 2017 nadir in the beginning of September - depreciating by almost 9% since the beginning of the year. It has since appreciated by ~ 2% (Chart 13). The exchange-rate effect is evident in the data: U.S. ag exports were up in 2016/17 - by an estimated 36% year-on-year (yoy) for wheat, 21% for corn, and 12% for soybeans (Chart 14). Chart 12Ags Relevant Currencies##BR##Have Held Their Ground Ags Relevant Currencies Have Held Their Ground Ags Relevant Currencies Have Held Their Ground Chart 13But Strengthening USD##BR##Bearish For Ags Going Forward But Strengthening USD Bearish For Ags Going Forward But Strengthening USD Bearish For Ags Going Forward Chart 14U.S. Exports:##BR##Will Slow Down In 17/18 U.S. Exports: Will Slow Down In 17/18 U.S. Exports: Will Slow Down In 17/18 In fact, U.S. wheat, which has been losing market share since 2012/13, is estimated to have accounted for 16% of the global export market in 2016/17, up from 12% in the previous year. With its exchange-rate advantage, the U.S. beat the EU as the top wheat exporter in 2016/17, exporting an estimated 29mm MT - a 36% yoy jump. The global market balance will become more fluid as the Fed proceeds on its path of interest-rate normalization. A stronger USD likely will favor grain exporters ex-US. At the September FOMC meeting, Fed Chair Janet Yellen strongly indicated a December rate hike was still on the table. If the Fed's normalization policy results in an additional one to two rate hikes by the end of next year - BCA's House view - then U.S. exports of wheat and corn can be expected to be especially hard hit by the currency headwind. The USDA projects an 8% and 19% fall in U.S. exports of wheat and corn in 2017/18, respectively. However, supportive weaker fundamentals in the soybean market are expected to keep U.S. exports strong. Unlike wheat and corn, Chinese imports of soybean are expected to continue increasing in 2017/18. Bottom Line: A subdued U.S. dollar benefitted U.S. exporters since the beginning of 2017. Going forward, the global market balance will become more fluid as the Fed proceeds with interest-rate normalization. Views And Recommendations Despite expanding soybean acreage, we do not foresee much price downside. Supportive China fundamentals in the form of an STU ratio that is below the rest of the world - an abnormality for agriculture commodities - will ensure that China's demand remains strong. However, U.S. supplies - and, most importantly, exports - will remain strong. Thus, within the grains complex, we are neutral soybeans. The corn market is a different story. Given that China's ethanol mandate will draw down the state's massive corn reserves, we have a strategically bullish bias when it comes to corn. Although China has expressed its intention to be self-sufficient in ethanol production, we expect that it will need to import the biofuel, at least in the short run. This is expected to be a boon for ethanol producers, especially since it comes as Chinese farmers divert their land away from corn. While wheat is expected to remain in surplus in 2017/18, corn is projected to record a 21mm MT deficit. Furthermore, STU ratios are projected to fall in the case of corn, and increase in the case of wheat. Bottom Line: We are tactically neutral grains, but have a strategically bullish bias for corn. In addition to China's continued focus on modernizing its agricultural policies, we expect stronger oil prices to pull up costs in the longer run. A stronger-than-expected USD is a downside risk to our view. It would encourage foreign farmers to increase production, and render U.S. ags less competitive in international markets. We are lifting our overall weighting to neutral, given our assessment of global fundamentals. In addition, we are recommending a strategic long corn vs. short wheat position to capitalize on the bullish fundamentals we see emerging in corn. Roukaya Ibrahim, Associate Editor Commodity & Energy Strategy RoukayaI@bcaresearch.com 1 The WTO responded to U.S. complaints over Chinese tariff rate quotas (TRQs) on certain agricultural commodities. It set up a dispute panel on September 22, 2017. 2 Please see "China to import more corn to meet ethanol fuel use: analyst," dated September 21, 2017, available at reuters.com. 3 Please see "China set for ethanol binge as Beijing pumps up renewable fuel drive," dated September 13, 2017, available at reuters.com. 4 Cellulosic ethanol is produced by breaking down cellulose in plant fibers. However, its production process is more complicated than the ethanol fermentation process. While large potential sources of cellulosic feedstocks exist, commercial production of cellulosic fuel ethanol is relatively small. Potential feedstocks include trees, grasses and agricultural residues. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Ags In 2017/18: Move To Neutral Ags In 2017/18: Move To Neutral Trades Closed in 2017 Summary of Trades Closed in 2016

Highlights China's supply-side structural reforms will focus mainly on its coal and steel markets this year. In addition, environmental policies will become stricter in 2017, as Beijing puts more weight on environmental protection than economic development. As as result, supply growth will slow, particularly in steel markets, which will be good news for global steel producers and bad news for iron ore exporters in Australia and Brazil. While we are more bearish on iron ore than steel due to supply-side reforms and stricter environmental policies, we remain cautious getting short iron ore, given the Dalian Commodity Exchange's iron-ore futures are backwardated (prompt prices exceed deferred prices). This indicates buyers are willing to pay more for prompt delivery (e.g., next week) than they are for deferred delivery (e.g., next year). Energy: Overweight. The Saudi-Russia production deal will slow the rate of growth in supply relative to demand, which will tighten physical markets. This will cause inventories to draw, and the backwardation in crude to deepen. Our long Dec/17 vs. short Dec/18 WTI recommendation is up 700%. We are long at +$0.04/bbl, and will risk the spread going to -$0.05/bbl. We will take profits at $0.50/bbl. Base Metals: Neutral. Supply-side reforms, coupled with environmental restrictions will slow the growth of steel production in China this year, benefiting producers ex-China. Precious Metals: Neutral. Gold markets will become increasing volatile, with the Fed likely to keep any rate-hike decision on hold until it has greater clarity re the incoming Trump administration's fiscal policy intentions. Ags/Softs: Underweight. The USDA's most recent supply-demand balances continue to paint a bearish picture for grains, with global ending stocks expected to grow. Feature China will continue its supply-side structural reforms this year, focusing mainly on its coal and steel markets. China environmental policies will become stricter in 2017. This year will mark the first time the central government puts more weight on environmental protection over economic development in evaluating officials' performance since 1949, when the People's Republic of China was established. Supply growth will be slower than last year due to continuing reforms, and stricter environmental policies in the country. Among base metals and bulks, the steel and iron ore markets will be most affected. This will be good news for global steel producers and bad news for global iron ore producers. We are more bearish on iron ore than steel strategically, due to these supply-side reforms, stricter environmental policies, scrap steel substitution, and rising global iron ore supply. That said, we remain cautious getting short iron ore, given the Dalian Commodity Exchange's iron-ore futures are backwardated (prompt prices exceed deferred prices). This indicates buyers are willing to pay more for prompt delivery (e.g., next week) than they are for deferred delivery (e.g., next year). We are downgrading nickel from bullish to neutral, both tactically and strategically. We also are downgrading our tactically bullish stance on aluminum to neutral, as the Indonesian government on January 12 unexpectedly allowed exports of nickel ore and bauxite under certain conditions. China's Supply-Side Reforms In 2017 In 2016, steel prices rallied more than 90% from year-end 2015 levels, but Chinese crude steel and steel products production rose a mere 0.4% and 1.3% yoy, respectively. Back in 2009, when steel prices rose about 30% from November 2008 to August 2009, production grew 12.9% and 17.8% yoy for Chinese crude steel and the output of steel products, respectively (Chart 1). Chart 1China: A Slower Steel Production##br## Recovery Than In 2009 China: A Slower Steel Production Recovery Than In 2009 China: A Slower Steel Production Recovery Than In 2009 One reason for these disparate performances can be found in the massive production cuts made in China last year to crude steel capacity. In February 2016, China's central government announced that it planned to cut 100 to 150 million metric tons (mmt) of crude steel capacity over the five-year period of 2016-2020. While the country aimed to cut 45 mmt in 2016, the actual reduction accelerated in 2016H2 making the full year decrease much larger. According to the China Iron and Steel Association (CISA), 70 mmt of crude steel capacity was taken off line last year, equivalent to 6.2% of total crude steel production capacity in China. This explains, in part, the much slower crude steel production recovery last year when compared to the post-Global Financial Crisis (GFC) recovery in 2009. How much crude steel production capacity will China cut in 2017? Even though last year's 70 mmt capacity cut means about half of the five-year 100-150 mmt capacity-cut target was already achieved, the Chinese government does not show any sign of moderating its desire to see additional cuts. The Chinese Central Economic Work Conference (December 14-16, 2016) emphasized that 2017 will be a year to deepen supply-side structural reforms. Although the central government still has not finalized its 2017 target, we believe a further 40-50 mmt cut in 2017 is possible. For example, China's largest steel producing province - Hebei - has already announced its 2017 crude steel capacity reduction target, which will be 14.39 mmt, similar to its 2016 target of 14.22 mmt. We would note here that the actual cut for the Hebei province in 2016 was 16.24 mmt, much higher than the target, indicating officials will seek to err on the high side when it comes to taking production off line. In December 2016, the country launched a nationwide crackdown on production of so-called shoddy steel, also known as ditiaogang in Chinese - low-quality crude steel made from scrap metal, which is commonly used to produce substandard construction steel products. This material accounts for about 4% of Chinese crude steel output. Last week, the Chinese government ordered a full ban on "shoddy steel" production to be completed before June 30, 2017. This month, 12 inspection groups were sent to major shoddy steel producing provinces to oversee the implementation of the directive. In 2017, the Chinese government also plans to: rein in new steel production capacity; scrutinize new projects; push for more mergers; and generally tighten supervision in the steel sector. In early January, China's top economic planner - the National Development and Reform Commission (NDRC) - toughened its tiered electricity pricing to limit availabilities to outdated steel producers, and to advance its goal of capacity cuts. According to the NRDC website, the new measures raised the price paid by "outdated" steelmakers by 66.7% to 0.5 yuan per kWh, effective on Jan. 1, 2017. Outdated steelmakers, in the government's reckoning, are those scheduled to be phased out - for example, those shoddy steel producers - most of which are privately owned small- or medium- scale mills. Bottom Line: A further capacity cut will limit Chinese steel production growth in 2017. China's Environmental Policies In 2017 In 2016, the Chinese government increased the frequency at which it sent environmental inspection teams to major metal-producing provinces and cities, to ensure the smelters and refiners comply with state environmental rules. Factories that failed to meet environmental standards were ordered to permanently or temporarily shut down, depending on the severity of their violations. This year, with persistent and intensifying smog becoming a greater threat to the health of China's population, environmental policies will only get stricter, resulting in more frequent supply disruptions, especially in its steel industry. In addition to plant-specific environmental measures, in late 2016, China rolled out rules to evaluate the "green" efforts of local governments. For the first time since 1949, when the People's Republic of China was established, the central government indicated it would put more weight on environmental protection than on economic development, as measured by GDP, in evaluating local government officials' performance. This likely will reduce the local governments' incentive to support unqualified or unprofitable steel/aluminum production. Bottom Line: China's stricter environmental policies will cause more supply disruptions and increase production costs for the Chinese metal sector, especially the steel industry. Our Views On Iron Ore And Steel In 2017 We are strategically neutral on steel prices and bearish on iron ore prices. Supply-side reforms and stricter environmental policies in China likely will result in zero growth or even a small contraction in Chinese steel production, which may well support steel prices while reducing iron ore demand. This will be good news for global steel producers ex-China, and bad news for global iron ore producers. China is determined to cull all "shoddy steel" production by the end of June, which will make considerable volumes of scrap steel available to be used in good-quality steel production. Chinese steel producers are currently willing to replace iron ore with scrap steel in their steel production, given scrap steel prices are cheap versus iron ore and steel product prices (Chart 2). In addition, using scrap as an input to produce crude steel will save steel producers money on coking coal, the price of which has surged over the past year. Chinese steel demand growth may remain robust in 2017H1. Last year's stimulus still has not run out of steam, and this year's fiscal and monetary policy will stay accommodative.1 Raw-material costs in the form of iron ore, coking coal and oil soared versus levels seen last year, which means the production costs of steel now are much higher than last year. This will support steel prices (Chart 3). Chart 2More Scrap Steel Will Replace##br## Iron Ore In Steel Production More Scrap Steel Will Replace Iron Ore In Steel Production More Scrap Steel Will Replace Iron Ore In Steel Production Chart 3Cost Push Will Support ##br##Steel Prices Cost Push Will Support Steel Prices Cost Push Will Support Steel Prices Steel product inventories at the major cities in China are still low; producers' inventory holdings have declined to levels last seen in 2014, which also will be supportive of steel prices (Chart 4). China's iron ore inventories are high, while domestic iron ore production is recovering (Chart 5, panels 1 and 2). With slowing domestic steel production, Chinese iron ore import growth likely will be subdued this year (Chart 5, panel 3). Global iron ore supplies are increasing. The "Big Three" producers - Vale, Rio Tinto, and BHP - all plan to boost production in response to profitable iron ore prices this year. Indeed, this month, Vale started its first iron-ore shipments from the giant new S11D mine. Chart 4Low Inventory Supports Steel Prices As Well Low Inventory Supports Steel Prices As Well Low Inventory Supports Steel Prices As Well Chart 5Limited Chinese Iron Ore Import Growth In 2017 Limited Chinese Iron Ore Import Growth In 2017 Limited Chinese Iron Ore Import Growth In 2017 Bottom Line: The outlook for steel prices this year is brighter relative to iron ore in 2017, although, the backwardation in the Dalian Commodity Exchange's iron-ore futures suggests markets may be pricing in tighter iron-ore supply in the near term. We will explore this in future research. Downgrading Our Nickel And Aluminum Views We are downgrading nickel from bullish to neutral, both tactically and strategically. Chart 6Downgrading Nickel And Aluminum View Downgrading Nickel And Aluminum View Downgrading Nickel And Aluminum View In November, we expected the global nickel supply deficit to widen on rising stainless steel demand and falling nickel ore supply. One major reason we were bullish nickel was that there was no sign Indonesia's export ban - imposed in January 2014 - would be removed. With elevated global nickel output, surging Chinese nickel pig iron (NPI) imports, and rebounding Indonesian nickel ore exports, Chinese NPI production will recover in 2017, which will reduce the country's need for refined nickel imports (Chart 6). Our long Dec/17 LME nickel contract versus Dec/17 LME zinc contract was stopped out for a 5.1% loss this week. We are no longer bullish nickel versus zinc. We also are downgrading our tactically bullish stance on aluminum to neutral, after the Indonesian government unexpectedly allowed exports of nickel ore and bauxite under certain conditions earlier this month. We are removing our buy limit order to go long Mar/17 aluminum contracts if it falls to $1,640/MT from our shopping list. Ellen JingYuan He, Editor/Strategist ellenj@bcaresearch.com 1 Please see Commodity & Energy Strategy Weekly Report "China Commodity Focus: How China's Monetary And Fiscal Policy Will Affect Metal Markets," dated January 12, 2017, available at ces.bcaresearch.com Grains/Softs Global Grain Stocks Set To Rise Overall: Despite some positive developments in the U.S. - where corn supplies are falling faster than demand - we remain underweight grains. This is largely because of the continued growth of production relative to consumption globally, which looks like it will lift global stocks by the end of the 2016-17 crop year in September. While we do expect a slight decrease in output this year, it is difficult to upgrade our view at this point (Table 1). Table 1World Grains Estimates - January 2017 China Commodity Focus: Supply Cuts, Environmental Restrictions Will Hit Metals China Commodity Focus: Supply Cuts, Environmental Restrictions Will Hit Metals Wheat: Worldwide, output growth in Argentina, Russia and the EU added 1.3mm tons of production to global supplies. In the U.S., ending stocks are projected to reach levels not seen since the late 1980s, according to the USDA. Global consumption, meanwhile, is projected to increase a mere 100k tons, according to the USDA, which will lift ending stocks 1.2mm tons by the end of the crop year to a record 253.3mm tons. Corn: U.S. production is expected to fall, which, along with higher usage in the ethanol market, will contribute to lower stocks. However, on a global basis, production is set to outstrip consumption resulting in higher ending stocks at the end of the crop year. Soybeans: Same story here: Production growth outstripping consumption, leaving ending stocks higher by close to 7% yoy, based on the USDA's estimates. Rice: In relative terms, the rice market has the most bullish fundamentals - global production and consumption are roughly balanced, leaving expected ending stocks slightly above last year's level. We continue to favor rice over the other grains (save wheat) for this reason. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed In 2017 China Commodity Focus: Supply Cuts, Environmental Restrictions Will Hit Metals China Commodity Focus: Supply Cuts, Environmental Restrictions Will Hit Metals

Highlights The tactical environment is dynamic, chaotic and unpredictable. ...Chaos also brings opportunity. We must recognize and exploit opportunities when chance presents them. Look for recurring patterns to exploit.1 Feature Highlights Strategically, major commodity markets are balanced with the exception of ags, where we remain underweight on the back of record grain harvests and high stock-to-use ratios. Otherwise, broad exposure to the asset class is warranted. However, within the larger investment context, we believe tactical positioning once again will produce higher returns than strategic index exposure to commodities. Chart of the WeekTactical Positioning ##br##Rewarded In Oil Markets Tactical Positioning Rewarded In Oil Markets Tactical Positioning Rewarded In Oil Markets Supply-driven price volatility and erratic monetary policy presented commodity markets strategic and tactical opportunities in 2016, particularly in oil, where our recommendations returned an average of 95% (Chart of the Week). We remain overweight oil, expecting continued opportunities from volatile markets. Going forward, the contribution of demand-side risk to price volatility will increase. This will be evident in iron ore, steel and base metals, where the opacity of China's fiscal and monetary policy - especially re heavily indebted state-owned enterprises (SOEs) and the banks that support them - in the lead-up to the Communist Party's Congress abounds. Continued adjustments by the U.S. Fed to random-walking data will again contribute to volatility, particularly in oil and gold markets. A stronger dollar resulting from continued Fed tightening will hit U.S. ag exports, and benefit competitors such as Argentina and the EU. However, uncertainty re the Trump administration's fiscal and trade policies could keep the Fed looser for longer, particularly if border-adjusted taxation favoring exports over imports is realized. Geopolitics - particularly vis-à-vis U.S. and China trade and military policy - will become more important if America tilts toward dirigisme, i.e., actively managing its economy by adjusting taxation and policy to support favored industries. Governments typically allocate resources inefficiently, which distorts fundamentals. If border-adjusted taxation becomes law in the U.S. we will look to get long volatility across commodity markets: Such legislation likely would rally the USD, which would lower global demand for commodities generally and lift supply by lowering local costs. This would run smack into higher U.S. inflation arising from the increasing cost of imported goods. This is a recipe for heightened uncertainty and price volatility. Russia lurks in the background: U.S. sanctions in the wake of alleged interference in American presidential elections, and Russia's response, will keep oil markets on edge. 2017 Weightings Energy: Overweight. The OPEC-Russia co-operation pact to limit production could evolve into a durable modus operandi for managing oil supply. Markets will judge the pact effective if tanker chartering out of the Persian Gulf falls, and global inventories draw by mid- to end-February. Base Metals: Neutral. Bulks and base metals prices will remain rangebound, until greater clarity on China's fiscal and monetary policy emerges. Fiscal stimulus in the U.S. will have a marginal effect on demand toward year-end. Precious Metals: Neutral. Gold will remain sensitive to shifts in U.S. fiscal and monetary policy expectations. The possibility of border-adjusted taxes in the U.S. will hang like the proverbial Sword of Damocles over the gold market. Should it pass, the Fed could be forced to keep interest rates lower for longer to offset the massive tightening in financial conditions such a tax would impose. Ags/Softs: Underweight. We see limited downside for grains, despite record harvests. We favor wheat and rice over corn and beans. A stronger USD will be bearish for grain exports. Feature Commodities as an asset class remain attractive. However, constantly changing information flows affecting these markets compel us once again to favor tactical positioning over a broad strategic exposure to the asset class. Fundamentals - supply, demand, inventories - and financial variables remain in a state of flux. In the oil market, the durability of the OPEC-Russia co-operation pact to reduce oil production will be tested, following a year-end surge in global production. Markets will closely follow shipping activity - particularly out of the Persian Gulf - and global oil inventory levels for signs the production cuts engineered late last year by OPEC, led by the Kingdom of Saudi Arabia (KSA), and non-OPEC producers, led by Russia, are taking hold. Uncertainty regarding the incoming Trump administration's tax and trade policies - and responses from states targeted by such policies (e.g., China and Mexico) - will keep decisions affecting supply and demand fluid. The incoming Trump administration's trade policies could alter global oil flows: e.g., a re-working of NAFTA that reduces U.S. refined-product exports to Latin America would result in lower demand for crude at American refineries, and present an opening to Chinese refiners. In addition, as mentioned above, legislation authorizing border-adjusted taxes favoring exports and penalizing imports likely will be taken up this year in the U.S. Congress. If we did see tax policy favouring U.S. exports over imports, we believe it would prompt a USD rally via reducing America's current account deficit. This would, all else equal, send commodity prices sharply lower, as EM commodity demand will contract, owing to higher USD prices for commodities, and production ex U.S. will increase, due to lower local costs. That said, border-adjusted taxation in the U.S. also would increase the price of imports, and lift realized and expected inflation. How this plays out is highly uncertain at present. A border-adjusted tax bill likely will be taken up in the current session. If it passes, it would have major implications for pricing relationships globally - chiefly WTI vs. Brent, and Brent vs. Dubai crudes, along with product differentials that drive shipping economics. If such a bill looks like it will pass, we expect a sharp increase in commodity-price volatility globally. If the odds do favor such a tax regime shift, we would look to get long WTI and short Brent further out the curve, expecting higher U.S. exports and lower imports. In addition, we would look to get long gold volatility - buying puts and calls - as policy uncertainty effects resolve themselves. Heightened Uncertainty Means Tactical Positioning Once Again Trumps Passive Commodities Allocation The primacy of tactical positioning was demonstrated in 2016 in the oil market, when strategic positions quickly became tactical, either because they were stopped out or reached their P&L targets quicker than expected. Supply destruction dominated price formation last year, following OPEC's decision to abandon its strategy to support prices via production management in November 2014. This destruction occurred mostly in non-Gulf OPEC, which was down 7.0% yoy in 2016 (Chart 2), and non-OPEC producers, particularly the U.S. shale-oil fields, where yoy production was down 12.0% by year-end 2016 (Chart 3). Chart 2Low Prices Crushed Non-Gulf Production... Low Prices Crushed Non-Gulf Production ... Low Prices Crushed Non-Gulf Production ... Chart 3...And U.S. Production ... and U.S. Production ... and U.S. Production Even in states where production increased - chiefly KSA and Russia (Chart 4) - domestic finances crumbled, leaving them in dire straits. By our estimates, between July 2014, just prior to its decision to launch OPEC's market-share war, and December 2016, KSA had burned through $220 billion of it foreign reserves, equivalent to 30% of its central-bank holdings. Russia had drawn down its official reserves by $77 billion over the same period, or 16% of its holdings; its burn rate was reduced by allowing its currency to depreciate, which lowered the local cost of producing oil and boosted profitability of exports priced in USD. This was the background that forced OPEC, led by KSA, and non-OPEC, led by Russia, to negotiate the year-end pact that resulted in an agreement to cut production by up to 1.8 mm b/d. The stated volumes to be cut are comprised of 1.2 mm from OPEC, 300k b/d from Russia, and another 300 from other non-OPEC producers. The goal of this agreement is to reduce global oil inventories to more normal levels (Chart 5). Chart 4KSA, Russia Production Ramp ##br##Exacerbated Price Weakness KSA, Russia Production Ramp Exacerbated Price Weakness KSA, Russia Production Ramp Exacerbated Price Weakness Chart 5KSA-Russia Production Pact Aimed ##br##At Lowering Inventories KSA-Russia Production Pact Aimed at Lowering Inventories KSA-Russia Production Pact Aimed at Lowering Inventories Throughout 2016, as the supply-destruction drama was unfolding, numerous opportunities opened up to investors to fade market overshoots, brought about by over-reactions to fast-moving news flows. Unrestrained output by OPEC and non-OPEC producers strained oil-storage facilities early in the year, taking markets to the brink of breaking down entirely. Unexpected shifts in U.S. monetary policy - driven by random-walking data - also contributed to oil price volatility and opened numerous trading opportunities. Markets essentially ignored the cumulating right-tail price risks last year, following the supply destruction wrought by OPEC's declaration of a market-share war, and Russian overtures to OPEC seeking a production-allocation dialogue, which were very much in evidence in January 2016. The continual OPEC-Russia dialogue, which appeared to be bearing fruit in Doha before it was scuppered by KSA at the last minute in April, was the underlying geopolitical driver last year, and kept the odds of a production deal elevated. Based on our modeling, the supply surge following OPEC's decision made getting long contingent upside price exposure extremely compelling, particularly as it imperiled the finances of all oil producers - rich and poor, but mostly the poorer states like Venezuela and Nigeria. Our reasoning was lower prices would accelerate rebalancing of global markets and raise the odds of a major supply disruption at one of these failing states.2 Our modeling consistently indicated global oil markets would rebalance in 2016H2.3 Ultimately, this is how things played out, aided in no small measure by mid-year wildfires in Canada, which temporarily removed move than 1mm b/d from global markets, and sabotage of pipelines and loading facilities in Nigeria. Even with that, markets remained under pressure as Canadian barrels returned, and foreign reserves in KSA and Russia were rapidly depleted. These fundamentals, along with constantly changing Fed guidance, provided numerous opportunities to exploit recurring patterns thrown up by chance, as is evident in the returns on recommendations we made - averaging 95.1% last year - that naturally followed from our analysis (Table 1). Our favored exposure was getting long contingent exposure (i.e., options), using deferred call spreads in WTI and Brent, given our assessment the odds of higher prices exceeded the market's. Later in the year, following the OPEC-Russia pact, we got long a front-to-back crude oil spread (Dec/17 WTI vs. Dec/18 WTI) expecting the goal of the deal - reducing global inventories - stood a good chance of being realized. We got lucky putting the trade on as the market was correcting, but just ahead of the statement by KSA's oil minister that the Kingdom would do "whatever it takes" to make the deal work. This transformed a strategic position - one we expected to hold for months - into a one-week exposure that returned 493% (Table 1). Table 1Energy Trades Closed In 2016 Tactical Focus Again Required In 2017 Tactical Focus Again Required In 2017 In order to obtain a more detailed assessment of our energy portfolio's performance, we built an information ratio (IR) to evaluate how our energy recommendations performed compared to a selected benchmark, the S&P GS Commodity Index (GSCI). Essentially, our IR is used to assess whether an active portfolio has outperformed the selected benchmark in a consistent manner during the period of analysis, given the risk it incurred. To that end, our ratio looks at the average excess return of the active portfolio against the benchmark. This average excess return is then divided by its standard deviation (also referred to as the tracking error volatility) in order to get a risk-adjusted metric to evaluate whether the risk we took were compensated by the returns we generated. Our IR thus is calculated as: Formula Tactical Focus Again Required In 2017 Tactical Focus Again Required In 2017 The higher the IR, the better the risk-adjusted relative performance of the portfolio. Three elements can explain a high IR: high returns in the portfolio, low returns in the benchmark, or low tracking error volatility. Hence, this measure helps analyzing the notion of risk-reward tradeoff; it tells us whether or not the risk assumed in our trades was compensated by larger returns. In our case, to get the risk-adjusted returns of the energy portfolio, we selected the GSCI as a benchmark, as it is heavily skewed towards Energy commodities (around 60% of its composition). We believe this is a plausible benchmark alternative to our energy trade recommendations for an investor, whose choice is passive index exposure with a significant energy weighting. Our portfolio's average return in 2016 was 95%, while the GSCI return was 11%. The tracking error volatility was 56%.4 Using these inputs, we calculated the IR of our recommendations was 1.47. This is an excellent risk-adjusted return, and indicates the high volatility of our returns was more than compensated for by consistent positive excess returns our recommendations generated relative to passive GSCI exposure, which also can be used as a benchmark for energy-heavy commodity index exposure (i.e., "commodity beta"). Remain Overweight Oil We expect the combination of production cuts and natural declines will remove enough production from the market this year to restore global oil stocks to five-year average levels toward the end of 2017Q2 or early Q3 (Chart 5), even with cheating by OPEC and non-OPEC producers capable of increasing production. As a result, in 2017, we expect the OPEC-Russia deal to result in inventory draws of ~ 10% by 2017Q3. On the demand side, we continue to expect global growth of ~ 1.3 to 1.5mm b/d. Given these expectations, we expect U.S. benchmark WTI crude prices to average $55/bbl, up $5 from our 2016 forecast, on the back of the end-year OPEC-Russia pact. We are moving the bottom of the range in which we expect WTI prices to trade most of the time to $45/bbl and keeping the upside at $65/bbl. Markets already are pricing in a normalization of global inventories by year end (Chart 6 and Chart 7). We will look for opportunities to re-establish our long front-to-back positions, expecting the backwardation further out the curve will steepen. Chart 6Backwardation Steepening Near Term... Backwardation Steepening Near Term ... Backwardation Steepening Near Term ... Chart 7...And Further Out the Curve ... And Further Out the Curve ... And Further Out the Curve Further out the curve - i.e., mid-2018 and beyond - our conviction is lower: The massive capex cuts seen in the industry for projects expected between 2015 - 2020 will place an enormous burden on shale producers and conventional oil producers, chiefly Gulf Arab producers and Russia. It will be difficult to offset natural decline-curve losses - which will increase as U.S. shales account for a larger share of global supply - and meet increasing demand. As we've often noted, any indication U.S. shales or conventional supplies (Gulf states and Russian production) will not be able to move quickly enough to meet growing demand and replace natural declines could spike prices further out the curve. We expect U.S. oil exports to increase this year, which means the international benchmark, Brent crude oil, will increasingly price to move WTI into global markets. We expect U.S. WTI exports to increase from an average ~ 500k b/d, which should keep the price differential roughly around +$1.50/bbl differential (Brent over) for 2017. If we see border-adjusted taxation laws take effect, we would look to get long WTI vs. short Brent, and long U.S. products (e.g., U.S. Gulf gasoline and distillate exposure) vs. short Brent exposure. Remain Neutral Bulks, Base Metals Over in the bulks and base metals markets, a full-fledged iron-ore market-share war at the beginning of last year threatened to take prices to $30/ton. Then, seemingly out of the blue, an unexpected pivot by Chinese policymakers toward stimulating the "old economy" caught many bulks and base-metals traders and analysts - ourselves included - flat-footed. Powerful rallies in iron ore, steel and base metals early in the year on Chinese exchanges were dismissed as irrational exuberance on the part of retail investors. But, at the end of the day, these market participants were responsible for well-informed price signals that fully reflected low inventories and surging demand.5 The -0.5% average return in our bulks and base metals recommendations last year attests to how difficult we found these markets to read and anticipate (Table 2). Table 2Base Metals Trades Closed In 2016 Tactical Focus Again Required In 2017 Tactical Focus Again Required In 2017 As always, the evolution of China's economy will, as always, be critical to these markets, given that country's outsized role in iron ore, steel and base metals. We are broadly neutral the complex, and, with the exception of the nickel market, see supply and demand relatively balanced to slightly oversupplied globally and in China. Production globally and in China is growing yoy, while consumption shows signs of slowing. (Chart 8 and Chart 9). Chart 8World Base Metals Consumption Slowing,##br## Relative to Production... World Base Metals Consumption Slowing, Relative to Production ... World Base Metals Consumption Slowing, Relative to Production ... Chart 9...As Is ##br##China's ... As Is China's ... As Is China's Uncertainty re the direction of China's fiscal and monetary policy - chiefly, whether policymakers will, once again, resort to stimulating the "old economy" - will keep us broadly neutral bulks and base metals until we get further clarity on the direction of policy. We expect the monetary and fiscal stimulus that massively boosted China's housing market this year will wind down, bringing an end to the run-up in iron ore, steel and base metals prices. Odds favor "reflationary" policies to continue going into the Communist Party Congress next fall, but we do not expect anything along the lines of the surge in policy stimulus seen earlier this year: Unwinding and controlling property-market excesses and high debt levels will limit policymakers' desire to turbo-charge the housing market again, limiting the boost such policies provide. The fate of border-adjusted taxation in the U.S. Congress is critically important to bulk and base-metals markets, since it would encourage exports and discourage imports (along with raising their prices). Tax policy favouring U.S. exports over imports likely would prompt a USD rally, which would send commodity prices generally sharply lower. It would boost U.S. steel production and base metals exports, while raising the cost of imports. A border-adjusted tax bill likely will be taken up in the current session of Congress. We are downgrading our tactically bullish view on iron ore to neutral. Strategically, we retain a bearish bias, as rising iron ore supply may overwhelm the market again in 2017H2. We remain tactically neutral and strategically bearish steel. Low steel inventories and production disruptions caused by China's recently launched environmental inspection program likely will continue to support steel prices in the near term. However, persistently high steel output and falling demand from the Chinese property sector will eventually knock down prices in 2017H2. Manufacturing will play a larger role in copper markets, and will drive the demand side this year. However, if we see a stronger USD - either as a result of Fed policy or U.S. fiscal policy - price appreciation will be limited. We remain neutral copper, expecting a concerted effort to slow the housing boom in China. Reflationary policies will still support real demand for copper, but will reduce demand from new construction. The supply deficit in nickel will widen on the back of rising stainless steel demand and falling nickel ore supply in 2017, which will support prices. We expect nickel will outperform zinc over a one-year time horizon. For zinc, we remain tactically neutral and strategically bearish. We expect zinc supply to rise considerably in response to current high prices. Aluminum supply - for the moment - will lag demand globally, which keeps us tactically bullish and strategically neutral. Supply shortages will likely persist ex-China over the next three to six months. Stay Neutral Precious Metals Precious metals, gold in particular, staged an impressive rally on the back of unexpected easing by the U.S. Fed in response to weaker-than-expected sub-1% GDP growth in 1Q16 GDP. Markets had been pricing in as many as four interest-rate hikes earlier in the year into short-term expectations, which were quickly dashed. Markets lowered their expectations for multiple rate hikes last year, which weakened the USD and U.S. real rates, setting the stage for the gold rally. Nonetheless, gold proved a difficult commodity to trade last year, as our results indicate - the average return on our precious metals recommendations amounted to a paltry -0.65% (Table 3). For the near term - i.e., until greater clarity on Fed policy and the incoming Trump administration's fiscal policy direction becomes clear - we remain neutral precious metals, and will avoid taking any further exposure other than perhaps getting long gold volatility - i.e., buying puts and calls in the gold market - if the odds of border-adjusted taxation legislation passing increase. Such legislation likely would rally the USD, which would lower global demand and increase supply ex U.S. at the margin for commodities generally, oil and base metals in particular. This would be deflationary, given the high correlations between oil and base metals consumption and U.S. inflation (Chart 10).6 However, such a taxation scheme also would raise U.S. inflation by increasing the cost of imported goods, sending the U.S. core PCE, the Fed's preferred inflation gauge, higher. The global disinflationary impulse from a stronger USD would run headlong into higher U.S. inflation, which would be a recipe for heightened uncertainty and price volatility. Table 3Precious Metals Trades ##br##Closed In 2016 Tactical Focus Again Required In 2017 Tactical Focus Again Required In 2017 Chart 10Risk of Deflation Will Rise If Border-Adjusted ##br##Taxes Prove Deflationary Risk of Deflation Will Rise If Border-Adjusted Taxes Prove Deflationary Risk of Deflation Will Rise If Border-Adjusted Taxes Prove Deflationary This will complicate U.S. monetary policy. We believe the Fed also will be waiting on such direction, and that interest-rate policy will, therefore, remain pretty much be on hold, keeping precious metals - gold, in particular - rangebound. For the moment, the possibility of border-adjusted taxes in the U.S. will hang like the proverbial Sword of Damocles over the gold market. We are taking profits on the tactical long gold position we opened December 15, 2016, as of today's close. Remain Underweight AGS Lastly, Ag markets provided us no joy, as the El Nino wreaked havoc on our recommendations. Our average -1.0% return for the year amply demonstrates the difficulty of trading markets so heavily influenced by weather (Table 4). Going into 2017, we believe there is a limited downside for grains. The downtrend since August 2012 like forms a bottom this year, if, as we are modeling, we see a return to normal weather conditions. That said, the principal upside risk remains unfavorable weather in major grain-producing countries, which could send badly battered grain prices surging as they did in 2016H1. Among grains, we favor wheat and rice over corn and soybeans. Global soybean acreage is likely to expand as the crop provides higher returns than other grains. South American corn output will continue rising on favorable policies and weak currencies, adding further pressure to already-high U.S. corn inventories, in particular, and global inventories globally (Chart 11). Table 4AGS Trades Closed In 2016 Tactical Focus Again Required In 2017 Tactical Focus Again Required In 2017 Chart 11Global Grain Inventories Remain High Global Grain Inventories Remain High Global Grain Inventories Remain High Softs - cotton and sugar - likely will underperform grains in 2017, reversing their outperformance this year. We are tactically bearish cotton, as U.S. cotton acreage is likely to increase next spring. Strategically, we are neutral cotton. For the global sugar market, barring extremely unfavorable weather, we are tactically and strategically bearish. This year's extreme rally in prices may result in a small supply surplus in 2017. Our Ag strategies will continue to focus on relative-value investments. Robert P. Ryan, Senior Vice President Commodities & Energy Strategy rryan@bcaresearch.com Hugo Belanger, Research Assistant hugob@bcaresearch.com 1 Please see "Tactics Cliff Notes; A Synopsis of MCDP 1-3 Tactics," published by the United States Marine Corps, Marine Corps Warfighting Lab, Marine Corps Combat Development Command, Quantico, Virginia. 10 May 1998 (pp. 2, 3. sf). 2 In our January 7, 2016, publication we noted investors were ignoring growing upside price risk and suggested they get long a Dec/16 $50/$55 WTI call spread to gain exposure to higher volatility. We also recommended remaining long Dec/16 and Dec/17 WTI vs. Brent following passage of legislation to allow U.S. crude exports. We ultimately took profits on these recommendations of 172% on the call spread in June, and 97% on the Dec/16 WTI vs. Brent spread in June, and 88% on the Dec/17 WTI vs. Brent spread in July, respectively (Table 1). Please see "Oil Market Ignores Right-Tail Saudi Risks" in the January 7, 2016, issue of BCA Research's Commodity & Energy Strategy, which is available at ces.bcaresearch.com. 3 In our January 21, 2016, Commodity & Energy Strategy article entitled "Global Oil Sell-off Will Accelerate Rebalancing," we noted, "We expect oil markets to rebalance by late 2016Q3 or early Q4. We remain long Dec/16 $50 calls vs. $55 calls, in anticipation of rebalancing and as a hedge against geopolitical risk." 4 Note: In order to find the standard deviation of the portfolio's excess returns (tracking error volatility), we averaged the daily percentage change in each trade's underlying assets. Any given trade only weighed in the daily average return if it was open during that day of the year. We are not accounting for the type of trades (spreads, pairs or single trades), we only track the underlying asset returns. From these daily average returns we subtracted the daily return of the preferred benchmark to obtain the daily excess return. Using this, we computed an historical standard deviation (based on 20-day periods) for every day during which a trade was open in our portfolio (we had 203 days with at least one energy trade opened). Lastly, we annualized this standard deviation to obtain our tracking error volatility. 5 Please see "Dead-Cat Bounces Notwithstanding, Iron Ore Will Trade Lower" in the January 21, 2016 issue of BCA Research's Commodity & Energy Strategy, and "Fade The Copper Rally" in the February 25, 2016 issue. Both are available at ces.bcaresearch.com. 6 In earlier research, we've shown U.S. core PCE inflation is highly correlated with EM oil and base metals demand. Please see "2017 Commodity Outlook: Precious Metals" published December 15, 2016. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed In 2017 Tactical Focus Again Required In 2017 Tactical Focus Again Required In 2017

Dear Client, We are pleased to present our 2017 Outlook for Grains & Softs, covering corn, wheat, soybeans and rice in the grain markets, and cotton and sugar. This is our last regular Weekly Report for the year. You should have received BCA's annual "Mr. X" interview on December 20, and we trust you found it stimulating and insightful. We will resume regular publishing on January 5th with our annual Review and Outlook summarizing the performance of our market recommendations for 2016, with an eye on where we see value going into the New Year. As a preview, the average return on our recommendations this year was 33.1%, led by our Energy recommendations, which were up an average 95.1% in 2016. Please see page 15 of this week's report for a summary. The Commodity & Energy Strategy team wishes you and yours a wonderful holiday season and a prosperous New Year. Turning to the Ags, we believe there is a limited downside for grain prices in 2017. The downtrend since August 2012 may form a bottom next year under the assumption of normal weather conditions. However, the principal upside risk remains unfavorable weather in major grain-producing countries, which could send badly battered grain prices surging as they did in 2016H1. Among grains, we favor wheat and rice over corn and soybeans. Global soybean acreage is likely to expand as the crop provides higher returns than other grains. South American corn output will continue rising on favorable policies and weak currencies, adding further pressure to already-high U.S. corn inventories. Softs - cotton and sugar - likely will underperform grains in 2017, reversing their outperformance this year. We are tactically bearish cotton, as U.S. cotton acreage is likely to increase next spring. Strategically, we are neutral cotton. For the global sugar market, barring extremely unfavorable weather, we are tactically and strategically bearish. This year's extreme rally in prices may result in a small supply surplus in 2017. Our Ag strategies will continue to focus on relative-value investments. We have three investment strategies: We look to go long wheat versus cotton, long corn versus sugar, and long rice versus soybeans. Kindest regards, Robert P. Ryan, Senior Vice President Chart 1Ag In 2017: A Reversal Of Grain ##br##Underperformance? bca.ces_wr_2016_12_22_c1 bca.ces_wr_2016_12_22_c1 Feature Limited Downside For Grains; Softs ... Not So Much As of December 20, the CCI grain index had declined 0.3% since the beginning of this year. In comparison, sugar and cotton prices rallied 19.8% and 9.6% during the same period of time, respectively. For individual grains, soybean prices were up 15.4%, while corn, wheat and rice declined 2.4%, 14.2% and 18.2%, respectively. Cotton and sugar outperformed grains considerably this year (Chart 1, panel 1). Among grains, soybeans had the best run, while wheat and rice had the worst (Chart 1, panel 2). Going forward, the question is: Will these trends continue into 2017, or is a reversal likely to occur? For now, we cannot rule out the possibility of a continuation of these trends, but a reversal is possible, depending on weather conditions. We will tread water carefully and re-evaluate our calls next April when U.S. farmers' planting decisions are made, and the outlook for the South American soybean and sugar harvests become clearer. Grains In 2017: Likely Bottoming With Potential Upside We believe there is limited downside for grain prices in 2017. Four consecutive years of supply surpluses have driven grain prices down by more than 50% since August 2012, when grain prices reached all-time highs (Chart 2, panels 1 and 2). In the meantime, global grain inventories also rose to their highest levels since 2002 (Chart 2, panel 3). True, it is difficult to get bullish on such elevated inventories. Another year of supply surpluses obviously would send prices lower. Will that happen? No doubt, it could. But we believe the odds are fairly low. A Dissection Of This Year's Supply Increase Global grain output grew 5.2% this year, the second highest rate of growth since 2005. Yield growth, mainly due to extremely favorable weather, contributed 87% of the supply increase, while acreage expansion accounted for the rest (Chart 3, panels 1 and 2). Chart 2Grain: Too Much Supply In 2016... bca.ces_wr_2016_12_22_c2 bca.ces_wr_2016_12_22_c2 Chart 3...Less Supply in 2017? bca.ces_wr_2016_12_22_c3 bca.ces_wr_2016_12_22_c3 Now, with yields of corn, soybeans and wheat all at record highs, and rice yields near their record highs, grain yields are more likely to have a pullback than a continuation of growth in 2017. If global grain yields revert to their trend line as the third panel of Chart 3 suggests, global grain yields will decline 1.4% in 2017. This year, the world aggregate harvested grain acreage only grew 0.7%. Currently low grain prices are discouraging grain plantings, while new supportive policies in Argentina and a strengthening dollar are likely to encourage grain sowing in the southern hemisphere. Taking all related factors into account, we expect a 0.2 - 0.5% expansion in global grain acreage next year. Based on our analysis, we believe world grain output is likely to decline about 1% next year, assuming normal weather conditions. On the other side of the ledger, global grain demand has been growing steadily over the past 30 years (Chart 3, panel 4). Last year demand grew 3.4%. In 2017, low prices likely will boost consumption. Therefore, we expect similar growth in global grain demand next year. In the current crop year, the global grain market has a supply surplus of 55 million metric tons (mmt). Based on our calculations, given the assumptions we've outlined above, a 1% decline in global grain output coupled with 3.4% growth in global grain demand will swing the grain market into a supply deficit of 58 mmt. If we assume a more conservative scenario in which global grain output does not decline at all, a 2.2% rate of growth in global consumption still will send the global grain market into a supply deficit. The odds of seeing this scenario unfold are relatively high, given that the average growth in global grain consumption was 2.5% over the past 10 years, and 2.9% over the past four years, when grain prices were mired in a downtrend. We believe this would clearly be positive to global grain prices. Considering the elevated global grain inventories and the expected supply deficit we foresee, we believe, even if prices do not move to the upside, the downside for grain prices should be at least limited in 2017 as inventories are drawn down. In addition to the supply deficit, rising oil prices are supportive to grain prices as well. All else equal, higher oil prices will increase the production cost of grains. Bottom Line: We expect limited downside for grain prices next year. The 2017 Outlook For Individual Grains Corn, soybeans, wheat and rice prices are highly correlated with each other (Chart 4, panel 1). In terms of end consumption, they can all be consumed as either human food or animal feed. In terms of supply, farmers rotate among these crops depending on their profit outlook, soil conditions, and government policies. In 2017, we believe wheat and rice likely will outperform corn and soybeans, for two reasons: Crop-rotation economics and inventories. Chart 4Wheat & Rice May Outperform ##br##Corn & Soybeans In 2017 bca.ces_wr_2016_12_22_c4 bca.ces_wr_2016_12_22_c4 Firstly, global acreage rotation still favors soybeans most, then corn, over wheat and rice. If we rebase grain prices back to the beginning of 2006, corn and soybean prices are currently 62% and 67% higher than they were at the start of this interval. In comparison, wheat and rice prices are only 19% and 16% higher, respectively (Chart 4, panel 1). The U.S. is the world's biggest corn exporter, the second-largest soybean and wheat exporter. Informa Economics, a private consulting firm, projects 2017 soybean plantings will rise 6.2% to 88.862 million acres, while corn and winter wheat plantings will fall 4.6% and 8.1% to 90.151 million acres and 33.213 million acres, respectively. If these projections are realized, the 2017 U.S. winter wheat planted acreage will be the lowest since 1911. Winter wheat accounts for about 70% of U.S. total wheat production. Secondly, wheat and rice inventories ex-China declined, while corn and soybean inventories ex-China increased. Yes, it is true that the world wheat and rice stocks-to-use ratios rose to the highest since 2002 and 2003, respectively. (Chart 4, panel 2). But this does not show the full picture for these markets: 58% of global rice inventories and 44% of global wheat inventories are in China, even though that country accounts for only 12% of global rice imports and 2% of global wheat imports. China is unlikely to export these inventories to the world: the country tends to hold massive grain inventories, in order to prevent domestic food crises. This means that global wheat and rice importers outside China, which account for about 88% of the global rice trade and 98% of the global wheat trade, will compete for inventories outside China. The third panel of Chart 4 shows the rice stocks-to-use ratio for the ex-China world has already dropped to its lowest level since 2008, while the wheat stocks-to-use ratio ex-China already has declined for two years in a row. This is positive for wheat and rice prices. In comparison, the soybean and corn stocks-to-use ratios ex-China looks much less promising. Both ratios are at or near record highs (Chart 4, panel 3). China only accounts for 2% of the global corn trade, therefore corn importers outside China will have more abundant supplies available to them in 2017. China is the largest buyer of soybeans, accounting for 63% of the global soybean trade. The country will have more bargaining power, on the back of increasing competition among major soybean exporters (the U.S., Brazil and Argentina). In the meantime, China's central policy is currently focused on encouraging domestic soybean plantings mainly at the cost of corn, which is negative for global soybean prices and good for global corn prices. In 2016, the corn acreage in China fell for the first time since 2004 while its soybean acreage jumped 9.1% - the largest increase since 2001 (Chart 4, panel 4). Chart 5Downside Risks To Grains bca.ces_wr_2016_12_22_c5 bca.ces_wr_2016_12_22_c5 Downside Risks To Our Grain View Grain prices could decline more than 10% from current levels next year, if favorable weather results in a slight drop (less than 1.4%) or even an increase in global grain yields. Also, if grain prices rise significantly in 2017H1 - for whatever reason - this likely would spur plantings and depress prices. If either of these events transpire, we will re-evaluate our grain view. A strengthening dollar is also a major risk to our view. BCA's Foreign Exchange Strategy expects a further 5%-7% appreciation in U.S. dollar in 2017. We believe most of the negative effects of a strengthening dollar already are reflected in depressed grain prices, as the U.S. dollar has already appreciated 36% since July 2011. At the end of last week, the U.S. dollar was only 2% lower than all-time highs reached in February 2002 (Chart 5, panel 1). Another risk to watch is acreage expansion in Argentina, Brazil and the Former Soviet Union (FSU) region. All of these countries/regions had massive currency depreciations and supportive agricultural policies this year, especially in Argentina (Chart 5, panels 2, 3 and 4). However, our calculations show that for corn and wheat, acreage increases in these countries/regions are mostly offset by declines in the U.S. With an expectation of a continuing decline in U.S. wheat and corn plantings, we expect an insignificant growth in overall global wheat and corn acreage. For soybeans, however, the acreage expansion could pose a downside risk as all top three producers (the U.S., Brazil and Argentina) are likely to increase their plantings. We will re-evaluate the grain market at the end of March, when the U.S. posts its planting intentions for all major crops. Softs In 2017: Less Positive Than Grains Both cotton and sugar prices had strong rallies in 2016, following the second consecutive year of supply deficits (Chart 6). Global cotton acreage has declined 19% during the past five years when cotton prices fell significantly from peak prices in 2011. This is the main reason for the 18.3% decline in global cotton production during the same period of time and also for the two consecutive years of supply deficit in 2015 and 2016. For sugar, the El Niño phenomenon that ended this past summer hurt sugar plantings and crop development in major producing countries (Brazil, India, China and Thailand) in both 2015 and 2016, resulting in two years of supply deficit and a supercharged rally in 2016 sugar prices. Both cotton and sugar prices fell from their 2016 highs, with a 9.6% drop for cotton and a 23.4% decline for sugar. However, we are still tactically bearish on both commodities as speculators' net long positions are still crowed (Chart 7). Chart 6Cotton & Sugar: Supply Deficit in 2016 bca.ces_wr_2016_12_22_c6 bca.ces_wr_2016_12_22_c6 Chart 7Cotton & Sugar: Crowed Net Long Spec Positions bca.ces_wr_2016_12_22_c7 bca.ces_wr_2016_12_22_c7 Strategically, we are neutral cotton and bearish sugar. For cotton, global demand will stay sluggish in 2017. Even though there has been no growth at all in global cotton demand for the past three years, the bad news is that there still are no signs of improvement in global textile demand (Chart 8). On the supply side, global cotton output may rise significantly next year, if farmers shift some of their grain acreage to cotton due to a better profit profile for cotton (Chart 9). We believe, barring extreme weather, the global cotton market will become more balanced next year, leaving us neutral in our price outlook. For sugar, with weather patterns back to normal and the extreme rally in prices this year, sugar output in India, Thailand, China and the EU (European Union) should receive a strong boost. In addition, a strengthening U.S. dollar will also encourage sugar production in those countries whose currency had massive depreciation like Brazil, Russia and India (Chart 10). Chart 8Cotton: Demand Does Not Look Good bca.ces_wr_2016_12_22_c8 bca.ces_wr_2016_12_22_c8 Chart 9Cotton: Supply Will Increase In 2017 bca.ces_wr_2016_12_22_c9 bca.ces_wr_2016_12_22_c9 Chart 10Sugar Production Will Recover bca.ces_wr_2016_12_22_c10 bca.ces_wr_2016_12_22_c10 On the demand side, average global sugar consumption growth was only 1.3% p.a. during 2013-2015, even though average sugar prices declined every year during that period. This year, global demand growth slowed to only 0.6%, as average sugar prices were 35% higher than last year. If sugar prices go sideways, the average prices will still be higher than this year, which may result in an even slower growth in global sugar demand. Given an extremely oversupplied corn market, cheaper corn syrup will replace sugar in its industrial uses. Chart 11Ag Investment Strategies: ##br##Focus On Relative-Value Trades bca.ces_wr_2016_12_22_c11 bca.ces_wr_2016_12_22_c11 Our calculations indicate the global sugar market is likely to have a supply surplus next year, which will be a big shift from this year's supply deficit. This likely will pressure sugar prices lower. Upside Risks To Our Softs View Both the cotton and sugar markets are still in supply deficits, which means any unfavorable weather in the major producing countries could send prices sharply higher. For sugar, Brazilian sugarcane mills could favor ethanol production instead of sugar in 2017 if the country keeps hiking gasoline prices and promotes ethanol consumption. So far, the sugar/ethanol price ratio in Brazil still favors sugar production. This can change quickly if ethanol prices in Brazil rise faster than sugar prices in 2017. We will monitor this risk closely. Investment Strategy Our Ag strategies continue to focus on relative-value investments. As such, we look to go long wheat versus cotton, long corn versus sugar, and long rice versus soybeans through the following recommendations: Long July/17 wheat vs. short July/17 cotton: We recommend putting this relative trade on if the wheat-to-cotton ratio drops to 5.75 (current: 6.14) (Chart 11, panel 1). Long July/17 corn vs. short July/17 sugar: We put a limit-buy order at 17 on this position on November 3, 2016. Since then, this ratio rose 12.8% and only declined to 17.47 on November 9. Now, we suggest initiating this position if the ratio falls back to 18.5 (Chart 11, panel 2). Long November/17 rice vs. short November/17 soybeans: We recommend putting this relative-value trade on if the ratio drops to 0.95 (current: 1.01) (Chart 11, panel 3). Ellen JingYuan He, Editor/Strategist ellenj@bcaresearch.com Investment Views and Themes Recommendations Tactical Trades Commodity Prices and Plays Reference Table Closed Trades 2017 Commodity Outlook: Grains & Softs 2017 Commodity Outlook: Grains & Softs