COMMODITIES - Morgan Stanley IQ · 1 Everyone thinks that they know what a commodity is until they...

A N I N T R O D U CT I O N FO R I N V ES TO RS

COMMODITIES

This brochure has been prepared solely for informational purposes

and is not an offer (or a solicitation of an offer) to buy or sell any of

the commodities or products mentioned in this document. Structured

Products may not be offered, sold, transferred or delivered directly

or indirectly in the United States to, or for the account or benefi t of,

any U.S. Person (as defi ned in Regulation S under the Securities

Act). This brochure is not a product of Morgan Stanley’s Research

Department and you should not regard it as a research report.

Please refer to the Important Information at the end of this

document. Morgan Stanley IQ is a service mark of Morgan Stanley;

all rights reserved. © Copyright 2007 Morgan Stanley.

Backed by strengths in research, sales and

trading, Morgan Stanley IQ puts the market

knowledge and infrastructure of Morgan Stanley

at your disposal.

Morgan Stanley IQ offers an attractive range of

products to investors, spanning all asset classes:

equities, interest rates, credit, FX, commodities,

real estate and hedge funds. We have committed

substantial resources to ensure the highest

possible levels of service for our clients.

Investors are invited to learn more by visiting

our website: www.MorganStanleyIQ.com

1

Everyone thinks that they know what a commodity is until they try to defi ne it.

Commodities are sometimes raw materials. More generally, they are

usually inputs to the creation of other goods. Commodities are often

physical assets but not always: less tangible commodities include

electricity and carbon emissions.

Tradeable commodities offer exciting and varied opportunities for

investors. For example, an individual may have specific views on a

commodity like oil and want a way to express it. On the other hand,

investors might use commodities to explore a particular investment theme:

those looking for access to industrial growth in China could consider

exposure to dry freight; those who believe that we will see increased water

shortages might take a view that this could lead to increased prices for

agricultural commodities.

By investing in commodities via structured products like Notes and

certificates, investors can benefit from movements in the price of

commodities without ever taking physical delivery of them. Morgan

Stanley IQ offers a wide range of products linked to individual commodities,

commodity indices or customised baskets tailored to capture specifi c

investment themes. Whether an investor has a positive, negative or neutral

outlook on commodity markets, structured products can offer compelling

investment opportunities.

This handbook is intended to introduce investors to the commodity markets

and give a basic overview of some of the most prominent commodities.

It is only a starting point, to help investors work out where their interest

lies, before doing the research needed to truly understand these

markets.

the case for commoditiesCOMMODITY INVESTING:

2

A CONSTANTLY EVOLVING MARKET

THE HISTORY OF COMMODITIES MARKETS

Although relatively new territory for many investors, the commodities

market has existed for centuries, if not millennia.

The roots of today’s commodities markets lie in the trading of agricultural

produce in the nineteenth century. Buyers and sellers wanted to manage

the risks they faced in harvesting and processing crops. Buyers were

seeking protection from a poor harvest and the resulting high prices.

Sellers wanted a guaranteed price at which they could sell their goods,

protecting them in case of over-supply. However, there was little

standardisation in terms of quality and delivery of goods and no

centralised storage.

In 1848, the Chicago Board of Trade opened to facilitate the trading of

grain between farmers and merchants. Procedures were established for

weighing and grading the grain and a central marketplace was created.

Prices were agreed in advance for delivery on future dates, allowing buyers

and sellers of corn to hedge their price risk. This marked the birth of the

modern futures markets, which quickly evolved to trade other commodities

such as metals, rubber, silk and hide.

Trading in commodities has not always been undertaken to reduce risk.

In the late 16th century, an active market for tulips developed in Holland.

Prices began to rise, and investors with limited knowledge of horticulture

piled in. The bubble infl ated and then burst. There is a debate about how

many people the market touched but it is undisputed that tulips achieved

prices far beyond their obvious physical value.

TODAY’S COMMODITY MARKETS

Markets can be used to layoff or put on risk. What was once considered

a hedging tool for raw material suppliers and merchants is now providing

access to commodities for a much wider audience. Over recent decades,

pension funds, hedge funds, investment banks, other institutional investors

and, increasingly, individual investors have become involved.

Today, commodities play an important role in many investment portfolios.

The increase in interest has led to a greater range of tradeable commodities

and a broader choice of ways to invest. The market continues to cover

energy, metals, minerals and agriculture but has evolved further to include

new assets such as carbon emissions and freight.

Although the market has grown, most commodities are nonetheless

restricted in supply. For example, it is estimated that if you poured all the

platinum that has been mined thoughout history into an Olympic size

swimming pool it would just reach the level of one’s ankles1. Many

commodities are also fi nding new uses in the 21st century. For example,

1 Source: Platinum Guild International

3

corn has traditionally been used as food, be it cattle feed or human

consumption. As the world has become more conscious of the

possible negative environmental effects from burning fossil fuels,

soft commodities like corn are increasingly being used in the

production of bio-fuel. Competing uses and contracting supplies

of commodities can create interesting dynamics in supply and

demand thereby affecting the prices at which they trade.

WHAT DOES THE FUTURE HOLD?

As populations grow and standards of living rise, demand for

various commodities can increase. If supply is relatively inelastic

then supply-demand pressures can lead to higher prices. Ongoing

development of trading activity combined with competing uses

of various commodities is shaping the landscape for the asset

class. As the market continues to evolve, will there be enough

opportunities to accommodate this growing interest? Will

increased environmental awareness further drive the development

of new, greener energies? How will the growth of global emerging

markets impact demand for raw materials, especially when many

resources are already scarce? Will new techniques such as

genetic-modifi cation alter the agricultural landscape? Issues and

developments such as these should continue to open new and

exciting opportunities for investors in the commodity markets.

COMMODITIES IN YOUR PORTFOLIO

Over the long term, commodities have displayed returns of

similar magnitude to equities. However, since the late 1990s,

the broad commodities market has outperformed the global

equity market.

Aside from the potential for attractive returns, commodity investing

can offer additional benefi ts within a portfolio:

Portfolio Diversifi cationCommodity returns have historically displayed low correlation with

equities or other asset classes. As equities and other traditional

assets perform well, commodities have tended to underperform

these asset classes. However, as other asset classes decreased

in value, commodities have sometimes provided positive returns

for investors. Commodities are often used to reduce portfolio risk

by adding diversifi cation.

Portfolio ProtectionHistorically, commodities are one of the few asset classes to have

benefi ted from rising infl ation. As demand for goods and services

increases, prices of those goods and services usually also rise,

as do the prices of the commodities used in their production.

Because commodity prices tend to rise in periods of infl ation,

investing in commodities can potentially provide some portfolio

protection against accelerating infl ation.

In addition, commodities have often proved more resilient than

other asset classes to geopolitical and macro-economic shocks.

For example, political crises in emerging markets have sometimes

tripped up stock markets but left the commodity market

relatively unaffected.

INVESTMENT CONSIDERATIONS

While commodities bring many positive attributes to a portfolio,

there are also risks that investors should consider.

VolatilityHistorically, commodities have been one of the more volatile asset

classes. It is important that investors consider their use carefully.

Volatility of commodity investments may be reduced either through

products offering capital protection, or by combining exposure to

commodities with exposure to other asset classes.

A Constantly Changing MarketCommodities markets continue to evolve. Changes in market

participants, traded commodities, and competing uses of

commodities all shape the market. Investors should be aware that

past performance and behaviour is not necessarily indicative of

how commodity markets might perform or behave in the future.

Performance of S&P GSCI vs. MSCI World, Jan 1970 - April 2007 (both rebased to 100 in 1969).

8000

6000

4000

2000

0

S&P GSCI INDEX (TR)MSCI WORLD (TR)

Source: Morgan Stanley / Bloomberg, August 2007. Past performance

is not a guide to future performance.

1970 1980 1990 2000

4

MORGAN STANLEY – YOUR PARTNER IN COMMODITIES

Morgan Stanley is one of the largest players in global commodities. We

have been committed to commodities market for over 23 years. We have

maintained a strong continuous market presence throughout this period

and are widely recognized as an industry leader.

Morgan Stanley’s involvement and understanding of the commodities

business ranges from active trading in numerous commodities to close

involvement with commodity production. For example, Morgan Stanley

owns and operates power plants in the US, Spain and Holland, provides

jet fuel to United Airlines and wholly owns TransMontaigne, a petroleum

products distribution and supply company. The fi rm is also active in the

freight market, chartering a range of freight vessels.

As commodity markets become more sophisticated, market experience is

crucial to successful investing. With a long and successful history in this

market, Morgan Stanley is the partner of choice for investing in the

commodities market. Our depth of experience and broad capability allows

us to offer creative ideas and products to our clients.

About Morgan Stanley IQBacked by strengths in research, sales and trading, Morgan Stanley IQ puts

the market knowledge and infrastructure of Morgan Stanley at your disposal.

Morgan Stanley IQ offers an attractive range of products to investors,

spanning all asset classes: equities, interest rates, credit, FX, commodities,

real estate and hedge funds. We have committed substantial resources to

ensure the highest possible levels of service for our clients.

Investors are invited to learn more by visiting our website:

www.MorganStanleyIQ.com

Alternatively, please contact your private bank, broker or fi nancial advisor.

MORGAN STANLEY & CO INTERNATIONAL PLC

25 CABOT SQUARE

CANARY WHARF

LONDON E14 4QA

TEL: +44 (0) 20 7677 8880

FAX: +44 (0) 20 7056 0404

EMAIL: [email protected]

MORGAN STANLEY RECOGNITION FOR COMMODITIES

Commodity Derivatives House of the Year

(Risk Magazine, 2007)

Energy Risk Manager of the Year, US Natural Gas

House of The Year and U.S. Power House of The Year

(Energy Risk Magazine, 2007)

“20 Year Pioneer in Energy Products”

(Risk Awards, 2007)

Bank of the Year for Commodities

(Investment Banking Awards, 2006)

Gold Award for Energy Trading

(Commodities Now, 2006)

5

HOW TO ACCESS COMMODITIES

Commodity investing should not be mistaken for investing in the

physical commodities themselves. Rather than buying and storing

crude oil or live cattle, investors can use structured products to

gain fi nancial exposure to the asset class. Structured products

may offer a return linked to an underlying commodity itself (a

“spot” price), but more often they are linked to futures contracts

on a commodity or a commodity index.

The Futures MarketFutures are standardised contracts between two parties for

delivery on a future date at a pre-agreed price. These contracts

are used by producers and consumers to manage the risk from

price movements in the underlying commodities. The futures

market also provides a speculative arena for hedge funds and

other professional investors, where they can speculate on future

price movements.

There are two ways to gain exposure via futures. Investors can

hold long-dated futures contracts until they approach expiry. At

this point, the non-commercial investor can take an off-setting

position, to avoid taking physical delivery of the underlying

commodity.

The other approach is to hold short-dated futures contracts, ie

those that are due to expire soon, and keep “rolling” them. The

roll process involves replacing contracts that are close to expiry

with longer-dated contracts.

When investors buy a structured product linked to commodity

futures, this “roll” is managed by the product issuer. In our

experience, products usually track the “near-month” or “prompt”

futures contract – the one closest to expiry – which tends to match

the underlying commodity price most closely.

Commodity IndicesInvestors generally look to indices to provide publicly available

benchmarks of a particular asset class, industry or sector. They

should be rules-based, transparent in their construction and liquid

to trade. Gaining exposure to an index equates to gaining exposure

to all the components of that index, in the proportions directed by

the index provider. For the investor to manage this exposure

themselves, this would mean rolling futures contracts (see above

under “Futures”) in each of the index components. When investing

in a structured product which is based on an index, the rolling of

future contracts is managed within the product itself.

Indices like the S&P GSCI, the Dow Jones-AIG Commodity Index

and the Rogers International Commodity Index have opened up

the commodity markets to investors and have attracted substantial

interest over the past fi ve years.

table of contents

5

PRECIOUS METALS

Platinum Page 10

Gold Page 12

Silver Page 14

BASE METALS

Aluminium Page 18

Copper Page 20

Lead Page 22

Nickel Page 24

Zinc Page 26

ENERGY

Natural Gas Page 30

Crude Oil Page 32

Coal Page 34

Electricity Page 36

Carbon Emissions Page 38

Biofuels Page 40

SOFT COMMODITIES

Cocoa Page 44

Coffee Page 46

Corn Page 48

Cotton Page 50

Rapeseed Page 52

Soybeans Page 54

Sugar Page 56

Wheat Page 58

LIVESTOCKLive Cattle Page 62

Lean Hog Page 64

FREIGHT Baltic Dry Index Page 66

COMMODITY INDICES Page 70

GLOSSARY Terms & Abbreviations Page 76

10

precious metals: platinum, gold, silver

10

Platinum is often referred to as the most precious of the precious metals: in the 18th century, King Louis XV of France declared it ‘the only metal fi t for a king’. Today, platinum also has a number of

more technical uses, owing to its hardness, resistance to corrosion and

effi ciency as a catalyst.

Deposits of platinum are extremely scarce and relatively low quantities

have been produced throughout history. Production is concentrated in very

few regions and among only a few mining companies. South Africa is by

far the largest producer, followed by Russia and North America.

The extraction process for platinum is highly labour-intensive and refi ning is

complex. An enormous amount of raw ore must be mined to produce just

ounces of pure metal. The process to produce pure platinum can include milling,

concentration (separating particles that contain platinum), smelting and refi ning

to remove impurities and other precious metals such as gold and silver.

PRINCIPAL USES

Autocatalyst: Around half the demand for platinum is for use in catalytic

converters for cars. Platinum is the catalyst that prompts hydrocarbons,

nitrogen oxides and carbon monoxide to turn into more environmentally

friendly emissions. Almost all new cars are fi tted with catalytic converters

and demand continues to rise, due to tightening emissions regulations and

increased demand for cars from developing markets.

Petroleum and plastics: Platinum catalysts are used to upgrade low

octane petroleum naphtha to high octane products for automobiles and

piston-engine aircraft. It is also used in the plastics industry.

Other industrial and electronic uses: Platinum has many specialist

applications due to its chemical resistance, ability to withstand high-

temperature and stable electrical properties. Uses range from the

magnetic layers of hard discs, to coatings for missile nose cones, to fuel

nozzles for jet engines.

Jewellery: Platinum is an ideal material for fi ne jewellery – it is hard

wearing, tarnish-resistant and hypoallergenic. Demand for platinum

jewellery is particularly strong in Asia.

Dentistry and medicine: Platinum can be used in electrodes for

pacemakers, guide wires in catheters used to treat heart disease, as well

as for dental equipment and fi llings. Platinum can also inhibit the division

of living cells. This characteristic, discovered in 1962, has led to the

development of drugs to treat cancers.

A fi nancial asset: Platinum has not historically been stored or used as a

reserve asset to the same extent as gold. However, during the 1980s the

rapid increase in the value of precious metals gave rise to the production

of a variety of bars and coins.

platinum

Common Futures contracts

New York Mercantile Exchange Platinum Futures

Quote: USD and US cents / troy ounce

Contract size: 50 troy ounces

Tokyo Commodity Exchange Platinum Futures

Quote: JPY / gram

Contract size: 500 grams

1 troy ounce is around 31.1g or 0.031kg

11

THE PLATINUM MARKET

The main exchanges for platinum trading are the New York Mercantile

Exchange (NYMEX) and the Tokyo Commodity Exchange (TOCOM).

Factors affecting the price of platinum could include the following:

Disruptions to supply: Unlike gold, there is little above-ground

platinum inventory. If supply and demand are not closely matched,

prices can become volatile. Because platinum production is

concentrated in so few countries, the political situation in those

countries can also impact supply. For example, labour market issues

such as strikes in South Africa could lead to supply disruption.

New technologies: Because of platinum’s cost and rarity, many users

of platinum autocatalysts are actively developing alternative technologies

or looking for substitutes. However, other new technologies may lead

to higher demand for platinum. For example, fuel cells, which convert

hydrogen and oxygen to electricity, use platinum as the catalyst.

Substitution with other metals: Rhodium and palladium can now

be substituted for platinum in autocalysts. Both palladium and white

gold are also used as platinum substitutes in jewellery. The prices

of these metals are therefore inter-related and the degree of

substitution can depend on the price differentials between them.

Notable Events

A. 1983-1988: The Isle of Man issues the fi rst platinum

coins, followed by Australia and Canada in 1988.

B. 1997: U.S. launches ‘The Platinum American Eagle’,

doubling investment demands from 1996 levels.

C. 2000: China introduces cleaner air restrictions on

vehicles.

Source: Morgan Stanley / Bloomberg as at July 2007. Price data based on front-month NYMEX futures

contracts. Past performance is not indicative of future performance.

Estimated World Platinum Mine Production 2006

Source: U.S. Geological Survey.

SZ - 77%

RU - 14%

CA - 3%

US - 2%

OTHER - 4%

INDEX

Platinum Price History 1987 - 2007

USD

/ T

RO

Y O

UN

CE

1600

1200

1000

800

600

400

200

0

PLATINUM PRICE

1987 1990 1993 2002 20051996 1999

B

A

C

12

For millennia, gold has been embraced as a valuable commodity, owing to its beauty, its chemical properties and also its role as a monetary asset.

Gold has been an international currency for centuries. As late as 1900-

1933, during the period of the Gold Standard, paper money could be

converted into gold at a fixed price and central banks all held large

reserves. By the mid twentieth century, and the introduction of the Bretton

Woods System, paper currencies were pegged to the US dollar and, in

1971, President Nixon cancelled the convertibility of the dollar into gold.

However, gold is still a major component of central bank reserves and, in

many parts of the world, it retains its use as a form of payment and a

savings vehicle.

Gold has been mined since around 2000 BC. However, some of the largest

discoveries were in the 19th century: in California (sparking the Gold Rush)

and in South Africa. Mining gold, especially in the deep mines of South

Africa, is very capital intensive. As a result, mining activity and exploration

have tended to increase when the price of gold is high and the rewards

are greater. Currently the world’s largest producers of gold are South

Africa, Australia and the USA.

Supply to the gold market also comes from existing “above-ground”

stocks, including jewellery, investor holdings and central bank reserve

accounts. International agreements such as the Washington Accord have

set limits to the sale of gold by participating central banks.

Pure gold is usually hardened by creating an alloy with other metals. The

gold content of alloys is measured in carats (ct k). Pure gold is designated

as 24k – lower carats mean a lower percentage of gold. Historically, in

England, the carat was divisible into four grains, and each grain into four

quarts. Therefore, in 24 carats there are 96 grains or 384 quarts.

The Football World Cup Trophy is made of solid 18-carat gold, so 75%

pure gold.

PRINCIPAL USES

Jewellery: This is estimated to account for around two-thirds of global

demand for gold. The world’s largest market for gold jewellery is India - as

a result, the demand for gold jewellery tends to peak during festive

seasons such as the Indian wedding season, Christmas and the Hindu

festival Diwali.

Electrical products: Gold’s conductivity, malleability and resistance to

corrosion make it a useful metal in the production of a wide range of

electrical products, especially in telecommunications, information

technology and safety-critical applications. Demand for gold has increased

as a result of growth in these sectors.

gold

New York Mercantile Exchange Gold Futures



Chicago Board of Trade Gold Futures



Chicago Board of Trade Mini-Gold Futures


Contract size: 33.2 troy ounces

Tokyo Commodity Exchange Gold Futures

Quote: JPY / gram

Contract size: 1 kilogram

1 troy ounce is around 31.1g or 0.031kg.

13

Dentistry: As a non-toxic and biologically inert metal, gold is often

used in dentistry in the form of alloys with other metals such as

platinum, silver, palladium or copper.

A fi nancial asset: Gold has historically had many attractions for

investors, not least as a “safe-haven” asset, and a hedge against

infl ation and fl uctuations in the US dollar. Its accessibility has

increased recently through the launch of investment vehicles such

as Exchange Traded Funds.

THE GOLD MARKET

The three largest exchanges to trade gold futures are the New

York Mercantile Exchange (NYMEX), the Chicago Board of Trade

(CBOT) and the Tokyo Commodity Exchange (TOCOM). The most

liquid gold contract in the world is traded on NYMEX and is used

by large commercial consumers, producers and fi nancial players.

The TOCOM and CBOT contracts can be traded electronically.

The spot price of gold is fi xed twice daily by members of the

London Bullion Market Association, at 10:30am and 3:00pm

London time. The afternoon fi xing is used as a reference for the

price of gold globally.

Factors that can affect the price of gold include demand for

jewellery, industrial demand and investor interest. Gold’s role as

a “safe haven” asset means that investment demand can increase

in times of uncertainty or instability.

Because a high proportion of gold is held by central banks and

investors as above-ground stocks, increased demand can often

be readily met with above ground supply, rather than by increasing

mining production. This is one reason why gold has tended to be

less volatile than many other commodities.

Notable Events

A. 1975: Gold is no longer used to settle international

accounts - price now determined by market.

B. 1979-1982: War in the Middle East, US recession

and period of”stagfl ation” lead to fl ight to quality.

C. 1987: “Black Monday”.

D. 1996: Belgian central bank and IMF announce

sizeable sales of gold.

Gold Price History 1975 – 2007

USD

/ T

RO

Y O

UN

CE

1000

800

600

400

200

0

1975 1980 1985 1990 1995 2000 2005 2007

GOLD PRICE



INDEX

OTHERRU ID CA US

PE CN AU ZA

3000

2000

1000

0


1997 1999 2001 2003 2005

Annual World Gold Mine Production (tonnes)

C

A

D

B

14

One of the precious metals, silver is characterised by a brilliant white metallic shine with high light reflection and the ability to withstand extremes of temperature. Silver also has good thermal and

electrical conductivity. Importantly, silver’s physical properties make it

desirable for both decorative and industrial uses.

Compared with other precious metals, silver is the least expensive and the

most abundant. It has long been recognised as a precious metal and used

to make jewellery and religious ornaments. Silver is thought to have been

fi rst mined in Anatolia (now Turkey) in around 3000 BC. By the end of the

19th century, many of the world’s high grade silver mines had been depleted.

However, technological advances in both mining and refi ning have increased

production. These advances have included the effi cient extraction of silver

from lower grade base-metal ores (see “Lead”). Much of today’s silver

production is as a by-product of lead, copper and zinc mining. The majority

of the silver supply today comes from mines located in Peru, Mexico, China,

Australia and Chile. Silver supply also comes from secondary sources such

as government sales and scrap recovery. In 2006, these accounted for 9%

and 21% respectively of global supply2. Today the demand for silver is driven

mainly by electronic industries, photography, jewellery and silverware as

well as investor demand.

PRINCIPAL USES

Jewellery and silverware: This malleable metal can be used to create

jewellery, ornaments, medals and even high quality musical instruments

such as fl utes. These items are traditionally made from sterling silver, which

is an alloy of silver and copper that achieves a brilliant polish. Silver’s unique

refl ectivity (it is practically 100% refl ective after polishing) also makes it

useful in items such as mirrors.

Industrial and electronic: Silver is used in many electrical applications, including

switches, contacts and fuses in appliances such as microwave ovens, dishwashers,

television sets and telephones. It is also used in batteries, bearings and circuit

boards. Silver is used in household switch contacts as it is non-corrosive when

combined with other metals, thereby minimising the risk of overheating.

Photography: Silver is used extensively in photography. Photographic

paper is coated in an emulsion of silver halide, which is light sensitive.

A fi nancial asset: Silver has historically been used as a monetary asset as

well as a physical asset, as a store of value and a “safe haven” investment.

Coinage: Historically, silver coins were used as a medium of exchange.

The United Kingdom monetary unit, the ‘Pound’, originally had the value of

one troy pound of sterling silver. According to the World Silver Survey 2007,

coinage still represented around 4% of global demand in 2006.

Medical uses: Silver is thought to have anti-bacterial properties. Bandages

that emit silver ions are sometimes used in the treatment of burns.

silver


New York Mercantile Exchange Silver Futures


Contract size: 5,000 troy ounces

Chicago Board of Trade mini-Silver Futures


Contract size: 1,000 troy ounces

Tokyo Commodity Exchange Silver Futures

Quote: JPY / 10g

Contract size: 60kg

1 troy ounce is around 31.1g or 0.031kg

2 Source: World Silver Survey 2006 / Silver Institute

15

THE SILVER MARKET

The most liquid silver futures contracts are the New York Mercantile

Exchange (NYMEX) silver contract and the Chicago Board of Trade (CBOT)

Mini-Silver contract, which is traded electronically.

Although the majority of paper contracts are traded in the US, London

remains the centre of the physical silver market. The spot price of silver

is still “fi xed” in London at 12:00pm each day.

The price of silver is driven not just by demand as a physical asset but by

investor activity. Indeed, the silver market has seen its share of large

investors. In the 1970s, Nelson Bunker Hunt and William Herbert Hunt fi rst

started investing in silver as a hedge against infl ation, but eventually

attempted to corner the silver market by accumulating a significant

proportion of the world’s deliverable supply. In the end, new margin

requirements, rising interest rates and then falling silver prices forced the

brothers to liquidate their positions and declare bankruptcy.

Changing usage can also be a factor in the silver market. Some industrial

uses of silver have declined as new materials are substituted. For example,

the use of silver in coinage has diminished, and the increased use of digital

prints could impact the use of silver in photography.

Silver Price History 1975 – 2007

USD

/ T

RO

Y O

UN

CE

50

40

30

20

10

0

SILVER PRICE

Notable Events

A. 1980: The price of silver reaches an all time high of US$ 49.45, then plummeted when exchanges

increased margins requirements. Large investors (notably Hunt brothers) forced to liquidate.



1975 1980 1985 1990 1995 20072000 2005

Mined Silver Production by Country

Source: World Silver Survey 2007/Silver Institute.

MX - 15% PL - 6%

PE - 19% CL - 8% CA - 5%

OTHER - 10%

INDEX

KZ - 4%

CN - 12% RU - 6%

AU - 9% US - 6%

Silver Usage

INDUSTRIAL APPLICATIONS - 48%

PHOTOGRAPHY - 16%

INDEX

SILVER WARE - 6%

JEWELLERY - 18%

COINS & MEDALS - 4%

NET GOVT. PURCHASES /

PRODUCER DE-HEDGING - 1%

IMPLIED NET INVESTMENT - 7%

Source: World Silver Survey 2007/Silver Institute.

A

base metals: aluminium, copper, lead, nickel and zinc

18

Aluminium is a lightweight metal with a silvery grey colour, and a very high resistance to corrosion. It is one of the most abundant elements in the earth’s crust. However, it took years of research to

unlock it from its raw form and produce the metal that is so widely used

today. It is a modern metal, both in its short history of commercial

production (less than one hundred and fi fty years) and in its uses.

Aluminium is primarily found in bauxite ore. The pure metal is extracted

through electrolysis, but fi rst the ore must be melted so that electricity

can fl ow through it. Because of the very high melting point (above 2,000

degrees Celsius), this is diffi cult and energy intensive. The melting point

is usually reduced to around 900 degrees Celsius by dissolving the ore in

molten cryolite (a mineral found in Greenland) or synthetic alternatives.

China is the largest producer of aluminium, followed by Russia, Canada

and the USA. Current world production stands at around 30 million metric

tonnes a year. As well as production from primary sources, aluminium

is one of the most commonly recycled metals. Worldwide recycling has

grown from practically zero in the 1950s to over 15 million tones a year

in 20043. Recycling uses far less energy than primary production. For

example, according to the US Aluminum Association, making new

aluminium cans uses 95% less energy than producing a can from primary

production.

Under certain conditions, minute particles of aluminium can ignite, making

it a useful component of rocket fuel for space exploration.

PRINCIPAL USES

Transportation: Aluminium’s use in transportation includes the

construction of cars, aircraft and ships. Aluminium structures are

signifi cantly lighter than equivalent steel structures, resulting in greater

fuel effi ciency and therefore lower environmental cost.

Construction: The corrosion resistant qualities of aluminium, together with

its light weight and high strength make it attractive to the construction

industry. It is widely used in buildings, including as cladding, which increases

the energy effi ciency of structures due to its refl ective nature. One downside

in using aluminium is that it has low fatigue strength. Engineers therefore

tend to design aluminium structures for a fi xed life span.

Packaging: Aluminium can be shaped into ultra-thin, light sheets to

package a range of foodstuffs, providing an absolute barrier to light,

moisture and oxygen. As a result, aluminium foil has become the most

versatile packaging material on the market today.

THE ALUMINIUM MARKET

Aluminium is the largest traded contract on the London Metal Exchange

(LME). There are four open outcry trading sessions daily and offi cial prices

aluminium


London Metal Exchange Aluminium Futures

Contract size: 25 tonnes

Quote: USD / tonne

Aluminium Alloy Futures


Quote: USD / tonne

NASAAC Aluminium Alloy Futures


Quote: USD / tonne

New York Mercantile Exchange

Aluminum Futures

Contract size: 44,000 pounds

Quote: US cents / pound

3 Source: European Aluminium Association

19

are set during aluminium’s second trading session (or “ring”) of

the day, from 12.55 to 13.00. The LME is the primary futures

market for aluminium, although an alternative contract trades on

the New York Mercantile Exchange (NYMEX).

The LME has also introduced two contracts for aluminium alloy:

one standard contract and a North American Special Aluminium

Alloy contract (NASAAC) that meets the specifi cation of North

American manufacturers.

Factors that can affect the price of aluminium include the

following:

Energy costs: Because aluminium extraction is energy intensive,

profi tability of production (and therefore the level of supply to the

market) depends heavily on production costs, including the costs

of the energy consumed.

Carbon taxes: Since the aluminium extraction process is so

energy intensive, carbon taxes could impact production. Smelters

may be relocated to areas where carbon taxes are not imposed,

altering the structure of the global smelting industry.

Source: Morgan Stanley / Bloomberg as at July 2007. Price data based on front-month

futures contracts. Past performance is not indicative of future performance.

Aluminium Price and Inventory, 1998 - 2007

INVE

NTO

RY

(TO

NN

ES)

1800000

1500000

1200000

900000

600000

300000

0

20071998 1999 2000 2001 2002 2003 2004 2005 2006

PR

ICE

(USD

/ T

ON

NE)

6000

5000

4000

3000

2000

1000

0

LME INVENTORYLME ALUMINIUM FUTURES

CN - 26%

RU - 11%

US - 7%

AU - 6%

NO - 4%CA - 9%

BR - 5%

IN - 3%

Estimated World Smelting Production 2006


OTHER - 29%

INDEX

20

This reddish metal was one of the fi rst metals to be mined and used by man. The use of copper, along with gold, marked the shift out

of the Stone Age. It continues to be used extensively today: after iron

and aluminium, copper is the third most widely used metal in the world.

It has excellent heat and electrical conductivity as well as the ability to

resist corrosion.

Copper can be found in its natural state on the earth’s surface but is

usually extracted from mineral ores. Copper is extracted from ore in a

smelting process, thought to have been developed in around 5000 BC.

Ores containing oxidised metals are heated together with a reducing

agent, commonly a carbon fuel, to remove the oxygen from the pure

metal. Other methods of extraction and purifi cation include acid leaching

of oxidized ores.

Although copper is found worldwide, the main producing regions are the

Americas (Chile, USA, Peru and Canada), Australia and Asia (Indonesia and

China). In the nineteenth century, when copper smelting began on an

industrial scale, the UK was the centre of production. However, as the

concentration of copper in ore has declined (requiring greater quantities

of ore), production has moved closer to the main mining regions.

PRINCIPAL USES

Construction: Copper is used in the production of pipes for plumbing,

guttering, heating and ventilation as well as building wire and sheet metal.

Due to its malleability, copper has also been used historically in decorative

construction: the Statue of Liberty is constructed from copper and has

suffered little corrosion during her hundred year history.

Electronics and electrical: The strong conductive quality of copper

makes it the metal of choice in the production of cable, wire and electrical

products. A few examples of copper’s wide usage include copper wire,

printed circuit boards, electromagnets, motors, generators, switches,

cathode ray tubes and magnetrons for microwave ovens.

In alloys: Copper in its pure form is soft and malleable – too soft for some

uses. Alloys of copper with other metals can be harder than pure copper.

Copper is alloyed with tin to produce bronze and with zinc to produce brass.

Coinage: Copper is frequently used in the production of coinage due to

its low corrosion properties.

THE COPPER MARKET

The majority of copper trades on the London Metal Exchange (LME).

Offi cial prices are set during copper’s second “ring” (open outcry trading

session) of the day, from 12.30 to 12.35.

copper


London Metal Exchange Copper Futures


Quote: USD / tonne

New York Mercantile Exchange

Copper Futures



21

Copper is viewed by some economists as a good indicator of growth

– price rises have often preceded periods of economic expansion.

Factors that can affect the price of copper include the following:

Growth in China: Chinese imports for industrial production have

been a major factor in global demand for copper in recent years.

Supply constraints: Supplies of copper depend on raw materials,

smelting and refi ning capacity and, importantly, stock availability.

The LME reports daily on stock levels. Data on US inventories is

released by the US Department of Energy at 10.30 EST every

Thursday. Data on Asian stocks is published by the Shanghai

Futures Exchange on Fridays.

Change of usage: As new technologies develop, uses of raw

materials change.

Political risk: New supplies of copper could come from regions

of high political risk such as Central Africa.



Copper Price and Inventory, 1998 - 2007

INVE

NTO

RY

(TO

NN

ES)

1200000

1000000

800000

600000

400000

200000

0

20071998 1999 2000 2001 2002 2003 2004 2005 2006

PR

ICE

(USD

/ T

ON

NE)

12000

10000

8000

6000

4000

2000

0

LME INVENTORYLME COPPER FUTURES

CL - 35%

US - 8%

ID - 5%

CN - 5%

ZM - 4%

PL - 3%

PE - 7%

RU - 5%

AU - 6%

CA - 4%

2006 World Mine Production for Copper (Estimated)


OTHER - 18%

INDEX

22

Lead is a soft, dense metal. It is blue-white in colour but turns grey when exposed to air. Its availability, easy extraction, softness and low melting point have made it widely used throughout history. However, as lead’s toxic effects were recognised, its usage changed.

Lead is no longer used in paints or as a sweetener in food and wine but

it is still one of the most widely used and versatile metals. Lead has a

particularly high density, which makes it an effective shield against

radiation and sound waves.

Lead is abundant in the form of ore mixed with other metals. It is usually

smelted to produce lead bullion, then refi ned to remove other metals and

impurities. These can include gold, silver, antimony, arsenic, copper, tin

and zinc. Copper is usually the fi rst impurity to be removed. The lead is

heated to just above melting point, when solid copper rises to the surface

and is skimmed off. Other impurities are removed using a variety of

pyrometallurgical techniques in a furnace. Electrolytic methods are also

being used to purify lead and are regarded as cheaper than the

pyrometallurgical methods.

Australia, China and the US are the main producers of lead. Lead supply

comes from a combination of newly mined lead and recycled scrap, in

roughly even proportions.

PRINCIPAL USES

Batteries / auto industry: Lead’s main use today is in lead-acid batteries,

where it is used because of its resistance to chemical erosion. Lead-acid

batteries are used to start cars and other vehicles and also to power

electric vehicles and provide emergency power when electricity supply

fails. As other uses for lead have declined because of concerns about

toxicity, demand for lead in batteries has continued to grow.

Construction: Lead has a high resistance to corrosion and is therefore

ideal for weatherproofi ng buildings. Flexible lead sheets are attached to

the outsides of buildings to create a long-lasting coating.

Radiation shields: Lead’s high density makes it an ideal material in

laboratories, hospitals and the nuclear industry to shield against radiation.

Powdered lead can also be added to plastic and rubber sheets to

manufacture protective clothing.

Glass: Lead can be added to glass to create ‘Lead Crystal’. This provides

a superior shine and also makes the glass softer and easier to cut.

Piping: Although no longer used in the piping for domestic water supplies,

lead is used for pipes to transport corrosive chemicals due to its high

chemical resistance.

Ammunition: Lead is used widely in ammunition. However, other less

toxic substances are being investigated as alternatives.

lead


London Metal Exchange Lead Futures

Quote: USD / tonne


23

THE LEAD MARKET

Lead has been traded on the London Metal Exchange (LME) since

1903. The current lead contract was introduced in 1953.

Demand for car batteries: Increased use of cars, especially in

emerging markets such as China, drives much of the demand for lead.

Scrap metal supply: Lead is distinct from other base metals in

that supplies depend on scrap metal as well as primary production.

When lead prices are low, it may not be profi table to collect and

recycle scrap. Likewise, when prices are high, sourcing and

recycling scrap is more profi table. This can have an impact on

supply, and thereby on price.

Regulation and the environment: Concerns about the toxicity

of lead could lead to tighter controls in both primary production

and recycling facilities. Concerns about lead usage can also lead

to the substitution of lead with other materials such as plastics,

in some applications.

Supply/demand for other base metals: Where two metals are

produced in conjunction with each other, a fall in output of one could

lead to a fall in output of the other. For example, lead and zinc are

often produced together so supply patterns can be linked.

Source: Morgan Stanley / Bloomberg as at July 2007. Price data based on front-month futures


Lead Price and Inventory, 1998 - 2007

INVE

NTO

RY

(TO

NN

ES)

250000

200000

150000

100000

50000

0

20071998 1999 2000 2001 2002 2003 2004 2005 2006

PR

ICE

(USD

/ T

ON

NE)

5000

4000

3000

2000

1000

0

LME INVENTORYLME LEAD FUTURES

CN - 31%

AU - 23%

US - 13%

PE - 10%

MX - 4%

2006 World Mine Production for Lead (Estimated)


OTHER - 19%

INDEX

24

Nickel is a silvery white, hard metal. This abundant, natural element has many useful properties including high corrosion resistance, high melting point and durability. It is not only useful in its pure form

but can also be combined with other metals to form alloys and with other

non-metallic elements to form compounds.

Although only a small fraction of the composition of the earth’s crust,

nickel is much more abundant in the deeper core of the earth. There are

many different nickel ores, which require different extraction processes

depending on the composition of the ore. These processes are similar to

copper smelting, though nickel typically requires higher temperatures.

By-products of the nickel production process include cobalt, copper,

platinum and palladium.

The main producer of nickel is Canada. However, deposits are also found

in Russia, Australia, Cuba and Indonesia.

PRINCIPAL USES

Stainless steel: The biggest use of nickel is as an alloying metal, along

with chromium and other metals, in the production of stainless steel.

Stainless steel is used in transport and chemical processing, as well as

equipment for food processing. Many products in the home, such as sinks,

pots and other utensils are made from stainless steel due to their ease of

cleaning and shiny appearance.

Other alloys and compounds: Nickel can be combined with other

elements to produce plating material. Nickel plating offers strong

resistance to corrosion and high temperature, providing a durable coating

for industrial and electronic equipment.

Coinage: Nickel’s resistance to oxidisation makes it a useful material

in the manufacture of coins. In fact, the US five cents coin is commonly

called a nickel, in reference to the copper-nickel alloy from which it is

made.

THE NICKEL MARKET

Nickel started trading on the London Metal Exchange (LME) in 1979.

Offi cial prices are set during the second trading session (or “ring”) of the

day, from 13.00 to 13.05.

Factors that can affect the price of nickel include the following:

Growth in China: Demand for nickel has been influenced by strong

industrial production growth in China over recent years.

Supply constraints: The LME reports daily on nickel stock levels. Tight

inventories, together with limited smelting capacity, can affect the supply

and price of nickel.

nickel


London Metal Exchange Nickel Futures

Quote: USD / tonne


25

Demand for stainless steel: The majority of nickel is used in the

production of stainless steel. Therefore changes in demand for

stainless steel can potentially affect the nickel market.

Substitution with other metals: Recent high prices of nickel

resulted in a move towards the use of pig iron (raw iron) in

stainless steel production. Pig iron is a high-cost alternative to

nickel, so is only an economically viable alternative when nickel

prices are high.



Nickel Price and Inventory, 1998 - 2007

INVE

NTO

RY

(TO

NN

ES)

70000

60000

50000

40000

30000

20000

10000

0

20071998 1999 2000 2001 2002 2003 2004 2005 2006

PR

ICE

(USD

/ T

ON

NE)

70000

60000

50000

40000

30000

20000

10000

0

LME INVENTORYLME NICKEL FUTURES

RU - 19%

CA - 15%

ID - 8%

NC - 6%

CN - 5%

BR - 4%AU - 12%

CO - 6%

CU - 4%

2006 Estimated Mine Production


OTHER - 10%

INDEX

26

This blue-white metal is the fourth most common metal traded after iron, aluminium and copper. Zinc is usually produced from a mineral

called sphalerite, or zinc sulphide, which is often found in ores containing

other metals such as lead, silver and copper.

Zinc ore must fi rst be processed to remove any sulphur. By heating to

temperatures in excess of 900 degrees Celsius, sphalerite is separated

into sulphur and the more reactive zinc oxide. The sulphur can be converted

into sulphuric acid, a useful by-product. The zinc oxide is then processed

to produce the pure metal, either through electrolysis, where sulphuric

acid is used to dissolve the zinc content, or through pyrometallurgical

processes, where carbon is added into a smelting furnace to produce both

zinc and lead simultaneously.

At normal temperatures the metal is brittle and only becomes malleable

when heated or combined with other metals in alloys. Powdered zinc is

explosive and can ignite if stored in a damp place.

Over seven million tonnes of zinc were produced globally in 20064. The

largest zinc mines are found in China, Australia and Peru. However, zinc

can be recycled indefinitely without loss of its physical or chemical

properties. Consequently, a portion of the world’s annual zinc supply

comes from secondary, recycled sources.

PRINCIPAL USES

To galvanise steel: Nearly half of zinc production is used to galvanise

steel. This process involves dipping a metal object into molten zinc, which

forms a coating. Zinc’s chemical properties mean that it prevents corrosion

and thereby extends the life of steel used in construction.

As an alloy: Brass is an alloy of zinc combined with other metals, most

commonly copper. Brass is malleable and a good electrical conductor so

is used widely in electronic equipment.

Coinage: Zinc is the primary metal used in the production of American

one cent coins.

THE ZINC MARKET

Zinc trades on the London Metal Exchange (LME). Offi cial prices are set

during zinc’s second trading session (or “ring”) of the day, from 12.50 to

12.55.

zinc


London Metal Exchange Zinc Futures


Price Quote: USD / tonne

4 Source: U.S. Geological Survey

27

Factors that infl uence the price of zinc include the following:

Supply/demand for other base metals: As zinc ore contains deposits

of other metals, changes in markets for these metals can potentially affect

the quantities of zinc ore mined. For example, one of the zinc extraction

processes can also be used to extract pure lead from the raw material. If

the price of lead increases, more zinc ore may be processed, with

increased supply of zinc as a consequence.

Primary production: When demand outstrips supply, new production

capacity can emerge, including new mines or smelting plants, or the

reopening of existing plants. For example, high prices in recent years have

led to the reopening of several disused zinc mines worldwide.

Scrap metal supply: Zinc can be recycled from scrap metal. When prices

are low, it may not be cost-effective to collect and recycle scrap zinc. As

prices rise, it may become profi table to do so, resulting in increased

supply to the market.



Zinc Price and Inventory, 1998 - 2007

INVE

NTO

RY

(TO

NN

ES)

1000000

800000

600000

400000

200000

0

0798 99 00 01 02 03 04 05 06

PR

ICE

(USD

/ T

ON

NE)

5000

4000

3000

2000

1000

0

LME INVENTORYLME ZINC FUTURES

CN - 13%

DE - 8%

IT - 6%

BE - 3%

ND - 3%

TW - 6%

IN - 3%US - 14%

HK - 5%

FR - 6%

UK - 3%

CN - 25%

AU - 14%

US - 7%

CA - 7%

MX - 5%

PE - 12% KZ - 5%

2006 Estimated Mine Production


OTHER - 25%

INDEX

Zinc Imports by Country, by value, 2005

Source: United Nations Comtrade database,

DESA/UNSD.

OTHER - 31%

INDEX

energy: natural gas, crude oil, coal, electricity, carbon emissions and bio-fuels

30

Natural gas is a colourless, odourless gas that gives off large amounts of energy when burnt. It is cleaner than other fossil fuels,

emitting fewer greenhouse gases, and accounts for a signifi cant proportion

of worldwide energy use. Global production and consumption of natural

gas doubled between 1980 and 2006, according to estimates from the

U.S. Energy Information Administration.

Natural gas is found in reservoirs under the earth’s crust, often close to oil

fi elds or coal beds. Like oil and coal, it is a fossil fuel formed over millions

of years from decayed organisms. In its unrefi ned form, natural gas is a

mixture of several gaseous fossil fuels - primarily methane but also ethane,

butane, propane, carbon dioxide, nitrogen, helium and hydrogen sulphide.

Once extracted, natural gas is refi ned to remove impurities such as oil, water

and other hydrocarbons. The refi ned natural gas is mostly methane and

must be of a certain purity before it can be transported and used as a fuel.

The refi ning process usually takes place in the same region as extraction.

Once refi ned, natural gas is liquefi ed or compressed for transportation.

Liquefi ed natural gas (LNG) is easier to transport over long distances as

it is around 600 times lower in volume. However, liquefying involves cooling

to around -160ºC, an expensive process. Compressed Natural Gas (CNG)

has a lower cost of production and storage. Residential and smaller users

usually get CNG by pipeline while larger industrial users may receive LNG

by insulated tanker.

The main producers of natural gas are Russia, the United States and

Canada. However, there are also estimated to be signifi cant reserves

elsewhere, particularly in Iran and Qatar5.

An alternative source of methane is ‘landfi ll gas’. Some landfi lls discharge

a methane-rich gas that can be tapped and used to generate electricity.

PRINCIPAL USES

Power generation: Natural gas is used to generate electricity through

gas and steam turbines.

Hydrogen: Hydrogen can be produced from natural gas. Hydrogen is used as

an important ingredient for the chemical industry and increasingly in fuel cells.

Residential, commercial and industrial use: Natural gas is one of the

cheapest and most versatile forms of energy. Its many uses include

cooking, heating and air conditioning.

Vehicle fuel: Both LNG and CNG can be used as vehicle fuel and are

considered quieter and cleaner than diesel. Because of the cost of

converting vehicles and limited availability of natural gas at fi lling stations,

the use of natural gas vehicles is not yet widespread. However, it is

growing steadily as more countries offer tax incentives. CNG cars are

natural gas


NYMEX Natural Gas Futures

Contract Size: 10,000 million British thermal units

Quote: USD / million British thermal units

ICE Natural Gas Futures

Contract Size: 1,000 thermal units

Quote: GB pence / thermal unit

5 Source: U.S. Energy Information Administration / World Oil

31

most widely used in Argentina, Brazil, Pakistan and Italy. LNG tends

to be used by large commercial vehicles as it must be kept in

insulated tanks that require large amounts of space.

THE NATURAL GAS MARKET

Natural gas futures contracts trade on the New York Mercantile

Exchange (NYMEX) and the Intercontinental Exchange (ICE) in

London. NYMEX futures are quoted based on delivery at the Henry

Hub (HH) in Louisiana, the junction of 16 intra- and inter- state

pipelines. Because most natural gas is transported by pipeline,

the North American and European markets tend to be quite

isolated from each other.

There are many factors that drive natural gas prices, including the

following:

Seasonality: The natural gas market is highly seasonal. Inventories

are built during the summer and drawn down during the winter, when

demand peaks. Data on US inventories is released by the Department

of Energy at 10.30 EST every Thursday.

Weather: Extreme weather such as hurricanes can cause severe

disruption to production and delivery.

Economic growth: A strong economy can drive increased

demand for natural gas for industrial and commercial use

Availability of equipment and infrastructure: Exploration and

drilling are costly, meaning that new sources of supply have to be

planned well in advance. In addition, new pipelines are often major

strategic investments - they can take years to build but can

radically alter supply when they come on line.

Prices of other fossil fuels: As natural gas deposits are often

found alongside coal and oil, an increase in supply of other fuels

can lead to higher natural gas inventories. In addition, some high

volume users of natural gas, such as electricity generators, can

switch between natural gas and other fuels as prices become

more or less favourable.

Notable Events

A. December 1996: Cold weather sends price to record

high.

B. December 2000: Cold weather forecast drive price

higher.

C. August 2005: Hurricane Katrina hits Mississippi.

D. September 2005: Hurricane RITA strikes in Gulf of

Mexico. Natural Gas infrastructure is damaged.

Natural Gas Price History 1990 – 2007

USD

/ M

ILLI

ON

BR

ITIS

H T

HER

MA

L U

NIT

S

16

14

12

10

8

6

4

2

0

2007

NATURAL GAS PRICE



1990 1992 1994 1996 1998 2000 2004 20062002

C

A

D

B

32

Crude oil is the world’s most actively traded commodity. This fossil fuel is a mixture of hydrocarbons, formed over millions of years from the remains of organisms. Crude oil ranges in colour from black and dark

brown to pale yellow. It is classifi ed by its source, for example West Texas or

Brent (from the Brent oil fi eld in the North Sea). It is also classifi ed by viscosity

(light, intermediate or heavy) and as either ‘sweet’ or ‘sour’ depending on the

level of sulphur it contains.

The most common method of extracting crude oil is through oil wells

drilled into underground oil deposits. Underground pressure brings around

20% of oil to the surface. As the oil pressure falls, secondary recovery

methods such as re-injecting natural gas can draw another 5 to 10% of

the oil in the well. Finally, injecting steam and carbon dioxide can reduce

the viscosity of oil, allowing more to be drawn to the surface. Crude oil is

then transported to refi neries, where it is converted into petrol, naptha,

kerosene, diesel and other products.

The use of oil as a source of energy raises a number of environmental

issues. Many petroleum products give off carbon dioxide when burnt, while

the burning of sulphur-heavy ‘sour’ oil can cause acid rain. Oil drilling and

exploration can also disturb natural habitats, though modern remote

sensing technologies have lessened the impact. Oil spills from tankers -

such as the Exxon Valdez spill in Alaska in 1989 - have had major

environmental consequences.

The global supply of crude oil is heavily infl uenced by the actions of the

Organisation of the Petroleum Exporting Countries (OPEC). OPEC was founded

in 1960, to unify and coordinate members’ petroleum policies. Its 12 member

countries meet regularly to fi x production quotas and to try to promote stability

in the oil market. Current members are Algeria, Angola, Indonesia, Iran, Iraq,

Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and

Venezuela. The Energy Information Administration (EIA) estimates that OPEC

members account for around 40% of world oil production, and about two-

thirds of the world’s proven oil reserves. Other significant oil producing

countries include Russia, the US, the UK and Norway.

The process of breaking down heavy crude oil into useful fractions such

as petrol is known as “cracking”. The “crack spread” is the difference

between the price of crude oil and the price of refi ned oil products.

PRINCIPAL USES

Energy: Crude oil is used mainly to produce energy. It is converted at

refi neries into a range of energy-rich fuels including petrol and diesel.

Fertilizers: Several of the by-products of crude oil refi ning can be used

in the production of fertilizers.

Plastics: Petrochemical by-products of the refi ning process are used in

the manufacture of many plastics and waxes.

crude oil


ICE Futures Europe Brent Crude Oil

Contract size: 1,000 barrels

Quote: USD / barrel

NYMEX West Texas Intermediate (WTI) Futures

Contract Size: 1,000 barrels

Quote: USD / barrel

33

Bitumen: This is a by-product of the refi ning process and is used

for road surfacing.

THE CRUDE OIL MARKET

The two most common oil futures contracts are Brent Crude and

West Texas Intermediate. These two contracts are used to price

over 65% of the world’s oil. As West Texas Intermediate is focused

primarily on the American market, Brent Crude futures are

considered the international oil price benchmark. Although Brent

has traditionally traded at a discount to West Texas Intermediate,

this is not always the case.

Factors driving the crude oil market can including the following:

Global demand: In recent years, increased demand from fast-

growing and energy intensive emerging economies such as China

have infl uenced oil prices. Coupled with tight inventories, and

limited production and refi ning capacity, this demand has pushed

up (and may continue to push up oil prices).

Weather disruptions: Adverse weather conditions in producing

and refi ning countries can affect supply. Recent examples include

hurricanes Katrina and Rita in 2005, which damaged a number of

processing plants and oil rigs in the US.

Seasonality: Demand for crude oil is somewhat cyclical – for

example, the US “driving season” can lead to increased demand

in summer, while unseasonably warm winter weather can reduce

demand for heating oil.

Geopolitical events: Oil is commonly referred to as ‘black gold’

and is an extremely valuable asset to many oil producing nations.

This can create political tensions as competition grows for an

increasingly scarce resource.

Supply: If demand outstrips supply and processing capacity is

limited, inventories of crude oil may decrease, infl uencing the price.

The decisions of OPEC can significantly impact prices. Every

Wednesday at 10.30am EST, the US Department of Energy releases

data on oil inventories. Increases (“builds”) are bearish whereas

decreases (“draws”) are bullish for the price of oil.

Source: Morgan Stanley / Bloomberg as at July 2007. Price data based on front-month futures contracts.

Past performance is not indicative of future performance.

Notable Events

A. 1990 - 1991: Gulf War.

B. December 1997: OPEC increases quota, despite

decline in Asian consuption.

C. 1999: Series of OPEC quota reductions.

D. March 2003: Start of war in Iraq.

WTI and Brent Crude Price History, 1989 - 2007

USD

/ B

AR

REL

100

80

60

40

20

0

1989 1991 1993 1995 1997 1999 2001 200720052003

WTIBRENT

C

B

D

A

34

Coal is the world’s most abundant fossil fuel and is widely used to generate energy and electricity. It is found naturally, formed from

organic matter in the same way as other fossil fuels and composed mainly

of carbon, hydrogen and oxygen.

Coal varies in composition depending on its age. Over time, coal tends to

develop lower moisture, a higher carbon content and more heat producing

energy – this is referred to as ‘higher rank coal’. The highest ranking coal,

graphite, is diffi cult to ignite and therefore not commonly used as fuel.

Lower ranking coals such as lignite and sub-bituminous coal can be used

for steam-electric power generation, whereas bituminous coal and

anthracite can be used for heating.

Coal has been used throughout history, but it was during the Industrial

Revolution in the 18th and 19th centuries that demand surged. The modern

steam engine, invented by James Watt and patented in 1769, triggered the

use of coal in steamships and trains. In the 1960s, following huge growth

in global transportation, oil overtook coal as the largest source of primary

energy. Even so, coal still plays a vital role, accounting for 40% of global

electricity production, more than double the next largest source6.

Like crude oil, coal is under fi re for its environmental impact, including the

carbon dioxide and sulphur dioxide it produces when burnt. However, there

are ongoing technological developments that could make coal-fi red power

generation cleaner and more effi cient in the future. Some examples of

“clean coal technology” include the following:

Gasifi cation: Coal is transformed through a chemical process into a

synthetic hydrogen gas that can be burnt cleanly to generate power.

Carbon capture: Carbon dioxide produced in power stations is pumped

into disused coal fi elds or oil fi elds.

Coal washing: Washing coal before it is burnt can remove some of the

impurities that cause pollution.

Supercritical boilers: These allow power plants to operate at far higher

temperatures, resulting in greater effi ciency and lower emissions per

unit generated.

Coal is a well-supplied global industry. There are reserves in over 70

countries, although three-quarters of the world’s total reserves are in the

USA, Russia, China, India and Australia. It has been estimated that there

are over 900 billion tonnes of proven coal reserves worldwide, This means

that at the current production levels, there is enough coal to last us over

160 years7.

Compared with some other fossil fuels and many renewable energy sources,

coal is easily stored. Since energy prices can be volatile, the ability to

purchase supplies and keep them in reserve can be advantageous.

coal


NYMEX Central Appalachian (CAPP) Coal Futures

Contract Size: 1,550 tons

Quote: USD per ton

6, 7 Source: Energy Information Administration

35

Coal is the object of many superstitions: carrying a small lump is meant

to bring luck to sailors and standing on the stage of a theatre and throwing

a piece into the gallery is said to bring success to a performance.

PRINCIPAL USES

Generating electricity: Burning coal to generate electricity is a relatively

new usage. Coal was fi rst used to generate electricity in steam turbines

only in the 1880s. Since then, new combustion technologies have improved

the thermal effi ciency of coal power stations, allowing more electricity to

be produced from less coal.

Construction: By-products of coal-fi red power stations such as fl y ash

can by used to make concrete and in road construction.

Production of coke: Lower ranking bituminous coal produces vast

quantities of smoke when burned. However, it can be baked to remove

the smoke-producing elements. The resulting “coke” is used in blast

furnaces for the production of iron and steel. By-products of this process

include coke gas, tars and oils.

Production of steel: Around two-thirds of worldwide steel production is

from coal-powered furnaces8.

Other uses: Products that use coal or its by-products include

pharmaceuticals, solvents, silicone lubricants and materials such as

carbon fi bre, rayon and nylon.

THE COAL MARKET

Coal prices are affected by numerous variables, including but not limited

to the following:

Weather: Weather patterns can impact both coal production and delivery.

Demand can also be seasonal, with coal being used to generate energy

for air conditioning in summer and heating in winter.

Environmental concerns: When coal is burnt, it gives off carbon dioxide

plus pollutants such as sulphur, nitrogen oxide and mercury. Although

technologies are now being developed to reduce these effects (see above),

environmental concerns remain. Legislation on greenhouse gases could

potentially have a signifi cant impact on the price of coal.

Prices of other energy commodities: The price of other energy

commodities such as natural gas and oil as well as other renewable forms

of energy could infl uence the price of coal.

Global demand: As countries like China expand their production capacitiy,

they have an increased need for more raw materials, including coal and

other fossil fuels.

8 Source: World Coal Institute.

World Coal Reserves

US - 27%

RU - 17%

AU - 9%

SA - 5%

RS - 2%

Source: U.S. Energy Information Administration.

OTHER - 8%

INDEX

CN - 13% UA - 4%

IN - 10% KZ - 3%

PL - 2%

World Coal Consumption, 2006 Estimates

CN - 36%

US - 17%

DE - 4%

RU - 4%

ZA - 3%

Source: U.S. Energy Information Administration.

OTHER - 25%

INDEX

IN - 8% JP - 3%

36

Electricity is a controllable and convenient source of energy, of great importance to our everyday lives. Generators at power plants

transform other forms of energy into electrical energy. Renewable sources

of energy used to general electricity include solar energy, wind power,

water power, geothermal energy and biomass. Non-renewable sources

include fossil fuels and nuclear power. The source of energy used in any

particular region will depend on the natural resources and processing

facilities available. While different types of power plant have different levels

of effi ciency levels, most are only around 35% effi cient, meaning that for

every hundred units of energy generated, only 35 are converted into

electricity.

There is currently no known way to store large amounts of electricity. Once

generated, it must be transported straight to where it is needed, as a

‘current’ or ‘fl ow’ of energy through cables. The two main ways to transmit

electricity are as direct current (DC), when the current flows in one

direction, and alternating current (AC), when it switches direction many

times per second.

Until recently, DC had to be transmitted at low voltage, which limited its

use: low voltages require much thicker wire to transmit the same power

so high voltage is more cost effective, especially over long distances.

AC can be transformed readily from low to high voltage and back again.

As a result, most transmitted power is AC, However, HVDC (high voltage

direct current) has now been developed and is used in, for example,

submarine cables.

Electricity is measured in units called ‘Watts’, in reference to James Watt,

the inventor of the modern steam engine. 750 Watts is the same as one

horsepower, and 1,000 watts is referred to as a ‘kiloWatt’. Electricity

usage is measured in terms of kiloWatt hours: for example, a 40 Watt

lightbulb in use for 48 hours constantly would require 2 kiloWatt hours (40

x 48 / 1,000) of electricity.

PRINCIPAL USES

Domestics and industrial use worldwide: Electricity is used in almost every

aspect of modern life, for heating, lighting, and air conditioning, in many every

day tasks and as part of the essential infrastructure of most communities.

Direct currrent: DC is used in many low voltage applications, including

car electrics, computers, some railways. Many household appliances also

work on DC, using adaptors to convert mains AC supply.

Alternating current: AC is the most common mains electricity supplied

by most national grid networks.

THE ELECTRICITY MARKET

Electricity contracts are traded in a similar way to other commodities.

electricity


ICE Futures Electricity (example contracts)

UK Base Electricity Futures

UK Peak Electricity Futures

Quote: GBP / MegaWatt Hour

NYMEX Electricity Futures (example contracts)

ISO New England peak Daily Futures

NYISO A Peak Daily Futures

NYISO G Peak Daily Futures

NYISO J Peak Daily Futures

Cinergy Hub Peak Daily Futures

Quote: USD / MegaWatt Hour

37

However, there is no single commonly used futures contract -

because electricity cannot be stored, futures contracts are often

specifi c to a particular delivery region (eg New England, USA) and

delivery time (eg peak, off-peak).

The cost of electricity will vary in different regions at different

times depending on a number of factors:

Source of electricity: Some sources of electricity are more cost-

effi cient than others. For example, a region with a mild climate,

no geothermic activity and no nuclear facilities may need to rely

on the burning of fossil fuels to generate electricity. Other regions

may have access to an abundance of renewable resources and

may therefore be able to generate electricity from a number of

cheaper sources.

Prices of fossil fuels: For electricity that is generated from fossil

fuel combustion, the price of these fossil fuels may directly

infl uence the price of the resulting electricity.

Demand: As electricity cannot be stored, short-term changes in

demand can infl uence price. In the longer term, demographic

changes and growing economies could result in increased demand

for electricity.

Environmental legislation: As environmental awareness

increases, economies may increasingly look to generate

electricity from greener, renewable sources, such as solar or

nuclear power. Burning fossil fuels not only has an environmental

impact. In countries where governments have implemented green

legislation, it may also result in a direct cost to the polluting

company as they will need to purchase carbon credits for their

carbon dioxide emissions.

38

“Greenhouse gases”, and their potential impact on the environment and climate, are a growing global issue. These gases are mainly a by-product of burning fossil fuels in electricity power plants, industry, aeroplanes and road vehicles.

International treaties such as the Kyoto Protocol set limits on the amount

of greenhouse gases – including carbon dioxide - that countries can

produce. Participating countries can delegate part of achieving their

obligation onto the business community through the creation of cap and

trade schemes. In these schemes, individual businesses are given carbon

credits equal to their respective emissions caps. One credit gives the

owner the right to emit one tonne of carbon dioxide. Those that are over

their caps must buy credits for their additional emissions, while businesses

that are below their caps can sell their unused credits.

Carbon credits are a mechanism to incentivise businesses to reduce

greenhouse emissions by giving a monetary value to the cost of polluting

the air. The existence of a market for these credits allows businesses for

which it would be diffi cult or expensive to cut their emissions to effectively

pay another market participant to make reductions on their behalf. For

example, a seller of carbon credits might be an organisation that

undertakes projects that reduce carbon emissions, such as switching from

coal-generated to biomass-generated electricity.

THE KYOTO PROTOCOL

In 1997, world leaders met in Kyoto, Japan to agree a plan to reduce

global greenhouse gas emissions. The Kyoto Protocol, which came into

force in 2005, sets emission limits and reduction obligations for six gases.

Of these, carbon dioxide is the most prominent, followed by methane and

nitrous oxide. The Protocol requires an overall reduction in greenhouse

gases by 5.2% from the 1990 level, calculated as an average over the

period from 2008 to 2012. Different countries have different targets. For

example, the United Kingdom agreed to reduce emissions by 12.5%,

whereas Spain was actually allowed to increase emissions by 15%.

Some of the largest global economies, notably the US, have not ratifi ed

the protocol. There is also concern amongst climate change specialists

that the targeted reduction of 5.2% is not sufficiently aggressive.

Nevertheless, the Kyoto Protocol has created a systematic framework for

reducing emissions and also led to the creation of a new market in the

trading of carbon credits.

THE CARBON CREDITS MARKET

The EU Emissions Trading Scheme (ETS) is the largest “cap and trade”

scheme in the world. Within the scheme, quotas for permitted emissions

are set at a national level and are typically passed on to industry. Around

10,000 installations across the EU, including power plants, oil refi neries,

combustion plants, iron and steel plants and factories, are required to

carbon emmissions

Common Emissions contracts

ICE Futures Europe ECX Carbon Financial

Instruments Future

Contract size: 1,000 tones of carbon dioxide equivalent gas

Quote: EUR / tonne

39

submit carbon credits for emissions produced and must buy

credits for any additional emissions over their quota limit. In the

same way, businesses that are below their quotas can sell their

unused credits.

The ETS began in 2005, with a fi rst phase running from 2005 to 2007

and a second phase from 2008 to 2012. Credits are not transferable

between the fi rst two phases, but thereafter can be banked between

phases without restriction. Phase III is likely to run from 2012 to 2020

and should also include airlines for the fi rst time.

EU carbon credits and related futures trade on the Intercontinental

Exchange (ICE), in partnership with the European Climate

Exchange. Factors that could impact the price of emissions futures

include the following:

ETS quota levels: The market plunged in May 2006, when it

became apparent that that many businesses were on track to meet

their targets and would not need to purchase credits. For the

second phase (2008 – 2012), the EU has cut the proposed carbon

credit allocations for most participating countries.

Global emission forecasts: If emission forecasts continue to

rise over time, cap and trade schemes may require greater cuts

in emissions, driving demand for credits.

New market participants: Increased interest from outside

participants such as hedge funds, Exchange Traded Funds and

offsetting schemes could impact demand.

Notable Events

A. April 2006: Market responds to news that Phase 1

quotas are too generous.

B. April 2007: 21 EU nations have their Phase II

allowances cut by an average 9.5%.

Emissions Price History 2005 - 200735

30

25

20

15

10

CARBON CREDIT PRICE

Source: Morgan Stanley / Bloomberg as at August 2007. Price data based on ICE Futures Europe

ECX Dec 2009 contract. Past performance is not indicative of future performance.

EUR

/ T

ON

NE

APR 05 OCT 05 APR 06 OCT 06 APR 07

A

B

40

Bio-fuels are combustible gas, liquid or solid fuels derived from biological matter (biomass). They provide an alternative energy source that is generally cleaner than traditional fossil fuels. Biomass

is organic material made from plants, animals and their by-products (e.g.

wood, manure, garden waste, commercial garbage and crop residues).

The automotive, mining and marine industries are the main potential end

users of bio-fuels.

The principal of harnessing biomass for fuel is not new. Manure has been

dried and burnt as fuel for millennia. Early car pioneers such as Henry Ford

and Rudolph Diesel designed cars and engines to run on bio-fuels. Before

World War II, the UK and Germany both sold bio-fuels mixed with petrol or

diesel. However, the availability of cheap oil made it uneconomical.

Concerns about both the environment and the fi nite supply of fossil fuels

have now put the spotlight back on bio-fuels. Governments have been

working to reintroduce bio-fuels, particularly for transport. For example,

the British Government’s Renewable Transport Fuel Obligation requires 5%

of fuels sold at the pump by 2010 to be bio-fuels, while the US 2005

Energy Policy Act aims to double the use of bio-fuels in transport by 2012.

The 2003 EU Bio-fuels Directive also aims to promote the use of biofuels

in transport. According to the US Energy Information Administration, global

biofuel production has tripled between 2000 and 2007.

WHY BIO-FUELS?

Bio-fuels are considered “renewable” as the fuel source can be rapidly

replaced (fossil fuels take millions of years to be regenerated).

Bio-fuels may offer environmental benefi ts, including reduced greenhouse

gas emissions. Although bio-fuels emit carbon dioxide when burnt, this is

generally offset by the carbon dioixide absorbed from the air by the crops

that produce them. The overall impact of bio-fuels on the environment,

compared with fossil fuels, may not yet be fully understood – additional

considerations include the energy required to produce the fuel and the

impact on land use and biodiversity.

Bio-fuels allow governments to diversify their energy supply and reduce

dependency on foreign oil supplies.

WHAT ARE THE MAIN BIO-FUELS?

The most common types of bio-fuels are ethanol, bio-diesel and bio-butanol.

Ethanol is a clear colourless alcohol based fuel made primarily from the

starch found in corn grains and sugar cane. Other crops such as barley,

wheat, rice, sorghum, sunfl ower, potatoes and sugar beets can also be used

to produce ethanol. It is made by fermenting any biomass high in carbohydrates

through a process similar to beer brewing. The US and Brazil account for

most ethanol production and usage. The US produces corn-derived

ethanol whereas ethanol from Brazil comes mainly from sugar cane.

bio-fuels

41

Ethanol can be used as a total or partial replacement for petrol.

Petrol containing up to 10% ethanol can usually be used in ordinary

petrol engines. The use of petrol with a higher concentration of

ethanol, such as E85 (85% ethanol, 15% petrol), requires engine

modifi cations. Using ethanol cuts down carbon monoxide and

other smog-causing emissions. It also increases octane content,

keeping engines running smoothly without the need for lead or

other chemical additives. Although ethanol is cheaper to produce

than many other bio-fuels, there is a trade off with the cost of

modifying machinery if higher concentrations are used.

Bio-diesel is made by fi ltering, heating, reacting and distilling

vegetable oil (for example: soya, cottonseed, rapeseed), animal

fat, or recycled cooking grease. Bio-diesel can be blended with

petroleum diesel in ratios of 2% (B2), 5 % (B5), or most typically

20% (B20). It can also be used in pure form as an alternative fuel

for diesel engines (B100). Blended bio-diesel fuels can generally

be used in traditional diesel vehicles without any modifi cations.

Compared to petroleum diesel, bio-diesel results in lower

emissions of almost every pollutant, including carbon dioxide,

sulphur oxide, particulates, carbon monoxide and unburned

hydrocarbons. The bio-diesel market is centred in Europe, with

Germany as the biggest producer followed by France and Italy9.

Bio-butanol is made through the fermentation of biomass. It uses

similar feedstocks to those used for bio-ethanol, including corn,

wheat, sugar beet, sugar cane, sorghum, cassava and agricultural

by-products such as straw and corn stalks. The US is the biggest

market in terms of consumption and production. Bio-butanol can

be blended into standard grade petrol, petrol-ethanol blends or

diesel. It is compatible with existing vehicle technology and has

the potential to be incorporated into the existing fuel supply

infrastructure. Unlike ethanol, bio-butanol can be shipped through

existing fuel pipelines. However, bio-butanol production is currently

more expensive than ethanol so it has not been commercialised

on a large scale.

Please refer to the “Soft Commodities” section for information on

some of the main bio-fuel feedstocks: corn, soybeans, sugar,

rapeseed and wheat.

9 Source: European Biodiesel Board.

soft commodities: cocoa, coffee, corn, cotton, rapeseed, soybeans, sugar and wheat

44

Cocoa originated in Central and South America and was harvested from as early as 600 AD. During the Mayan civilisation, cocoa was a

valuable commodity, used as a currency and traded in exchange for other

goods. Cocoa pods were also symbols of life and fertility and were used

in religious ceremonies.

Cocoa reached Europe in the 16th century, when Spanish explorers like

Columbus and Cortes encountered the Aztecs, who were partial to a spicy,

unsweetened cocoa drink. Cocoa was consumed only as a drink until the

late 18th century, when techniques were developed for making chocolate.

HOW IS COCOA PRODUCED?

Cocoa is derived from the seeds, or beans, of the cacao tree. The trees

produce large pods that contain beans and a sweet pulp. It is the dried,

fermented beans that are processed and traded as cocoa.

Climate – both rainfall and temperature – is critical for cocoa crops. As a

result, production is concentrated in a very limited zone close to the

equator. The largest producers are Cote d’Ivoire, Ghana and Indonesia.

Much of the world’s cocoa supply is grown by small landholders in

developing countries where cocoa can be a signifi cant factor in the local

economy. For example, data from the World Bank suggests that cocoa

accounts for 22% of GDP in Cote d’Ivoire.

PRINCIPAL USES

Cocoa’s main use is for human consumption. Cocoa butter (the fat

extracted from cocoa) is also used in cosmetics.

THE COCOA MARKET

Cocoa is traded in both London and New York, in bean, butter and powder

form. Cocoa bean futures contracts are traded on ICE Futures U.S. and

on NYSE Euronext LIFFE.

Factors affecting supply and demand of cocoa, and therefore the market

price, include the following:

Weather conditions: The cocoa harvest is highly dependent on weather

conditions. Because the market is so geographically concentrated, poor harvests

in one of the major production zones can have a major impact on supply.

Political environment: Geographical concentration also means that

supply is sensitive to political conditions in the producing countries. For

example, the peaks in cocoa futures prices in late 2002 and early 2003

coincided with civil war in Cote d’Ivoire.

The cocoa growing cycle: The life cycle of cocoa trees has an important

impact on the cocoa market. Falling cocoa prices can lead to a reduction

cocoa


ICE Futures US Cocoa Futures


Quotation: USD / tonne

NYSE Euronext LIFFE Cocoa Futures


Quotation: GBP / tonne

45

in planting, so that demand eventually outstrips supply. As prices increase,

growers plant more cocoa trees. However, it is usually at least three years

before newly planted trees begin to produce. If demand has slumped by

the time the trees mature, oversupply can lead to falling prices. This time

lag is key to some of the cyclical patterns in cocoa prices.

Technology: Fertilisers and chemicals can signifi cantly improve yields

and reduce disease. However, due to the high cost for growers, they are

not always widely employed.

Human consumption patterns: Demand for cocoa depends heavily on

the economies of its main consumers – in particular, the OECD countries.

Regulation and quality control: These can affect both the supply and demand

dynamics. There is increasing quality control at the export point in many cocoa

producing countries. At the same time, consumer countries regulate on permitted

ingredients and quality levels for chocolate. Some consumer countries, including

the UK, France, Russia, and several US states, are also implementing regulation

to limit the availability of chocolate bars in school vending machines.

World Consumption 2004/2005

Source: UNCTAD based on data from the

International Cocoa Association.

MX - 3%

IT - 5%

RU - 8%

CA - 3%

BE - 2%ES - 4%UK - 9%

PL - 3%BR - 4%FR - 10%

JP - 6%

DE - 12%

US - 33%

INDEX

World Production: 2005/2006 Estimates

CI - 38%

GH - 21%

NG - 5%

CM - 4%

EC - 3%

Source: UNCTAD based on data from

International Cocoa Organisation.

OTHER - 10%

INDEX

ID - 13% BR - 4%

MY - 1%

Cocoa Price History 1986 - 2007

USD

/ T

ON

NE

3000

2500

2000

1500

1000

500

0

1986 1991 1996 2001 2006

COCOA PRICE

Notable Events

A. 1999: Mid-season harvest is larger than anticipated.

C. September 2002: Attempted Coup D’Etat in Cote D’Ivoire , followed by several years of

intermittent civil war.

Source: Morgan Stanley / Bloomberg as at July 2007. Price data based on front-month ICE U.S.

Futures contracts. Past performance is not indicative of future performance.

B

A

46

Coffee plants are the source of one of the world’s most popular beverages. The plants produce berries, which must be processed before

they are ready to be consumed. The ripe, bright-red berries are picked

and the fruit removed to reveal two seeds. It is these seeds, or ‘beans’ as

they are more commonly known, from which we get the coffee we drink.

The beans are dried and roasted at high temperatures to caramelise their

sugars – this process gives coffee its distinctive fl avour and colour.

Robusta and Arabica are the two most common varieties of bean. Arabica

is known to provide a better fl avoured bean. However, Robusta is less

susceptible to disease and can therefore be grown more widely than

Arabica. Both types of bean need certain conditions to fl ourish: a tropical

climate, high altitude and an abundance of water.

Coffee is produced across the tropical regions of the globe, including parts

of Latin America, such as Brazil and Columbia, and regions of Africa and

Asia. For many producing countries, coffee accounts for a considerable

component of export income. Fluctuations in the price of coffee can

therefore have a substantial impact on the economies of these countries.

Coffee plays an important role in many societies throughout the world.

From the coffeehouses of the 16th century to modern day cafes, coffee

continues to be consumed widely. Since 1973, global production has

grown by over 80%10.

PRINCIPAL USES

Consumption: Coffee can be purchased in bean, ground or instant format

for preparation as a beverage.

Composting: Used coffee granules are an excellent plant fertilizer due

to their high nitrogen content. Many coffee shops give their used coffee

granules to gardeners for this purpose.

THE COFFEE MARKET

Coffee has traded on ICE Futures U.S. (formerly the New York Board of

Trade) since 1882, when it was created to bring order to a volatile

market. ICE Futures U.S. provides electronic trading systems as well as

a grading facility that compares the quality of Arabica coffee against the

Coffee “C” contract.

Coffee has historically been one of the more volatile commodities. Factors

that can affect its price include the following:

Weather: Like most agricultural commodities, coffee yields are highly dependent

on favourable weather conditions. Negative weather conditions can severely

disrupt crop supply. For example, in 1986, frosts in Brazil decimated coffee

crops and pushed prices to an all time high. Even forecasts of droughts in a

producing region (as well as droughts themselves) can impact coffee prices.

coff ee


ICE Futures U.S. Coffee “C” Futures


Price quote: US cents / pound

NYSE Euronext LIFFE Coffee Robusta Futures


Price quote: USD / tonne

10 Source: U.S. Department of Agriculture, June 2007

47

Regulation: Historically, a series of International Coffee

Agreements have aimed to stabilise coffee prices by creating and

enforcing production quotas on producing countries. This quota

system was suspended in 1989, after which coffee prices

plummeted. Supply outstripped demand, eventually leading to the

start of the “Coffee Crisis” in 2001, when prices hit a 30-year low.

This undermined the economic stability of a number of producing

nations. New mechanisms or regulation to control supply or price

could, if adopted, impact the future price behaviour of coffee.

Political factors: Coffee production is geographically

concentrated in developing countries around the equator and

forms a large part of many of these economies. Supply is therefore

sensitive to political conditions in producing countries.

The retail market for coffee actually tends to be dislocated from the

commodity market. The price you pay for your morning cup bears

little relation to the cost of the beans harvested for its production.

One reason for this is that both retailers and producers can vary

the quality of coffee in response to price changes. If prices are low,

the more highly regarded Arabica bean may be cultivated less widely

due to its higher production cost, meaning coffee blends could

contain a higher proportion of Robusta beans.

Notable Events

A. 1986: Prices peak owing to frosts in Brazil

damaging crops.

B. December 1986: Prices fall below the trigger point

for the reintroduction of quotas and controls under

International Coffee Agreement.

C. October 1987: Quotas and controls were

reintroduced.

D. 4 July 1989: Quota system suspended.

E. October 1994: New International Coffee Agreement

comes into force, which does not set out to regulate prices.

F. 1997: Price surges due to cold weather in Brazil.

G. 2001-2004: Coffee Crisis.

H. October 2001: New International Cofee Agreement

comes into force.

Coffee Price History 1986 - 2007

US

CEN

TS /

PO

UN

D (

LB)

300

250

200

150

100

50

0

1986 1991 1996 2001 2006 2007

COFFEE PRICE

Source: Morgan Stanley / Bloomberg as at July 2007. Price data based on front-month ICE Futures U.S.


PE - 3%

HN - 2%

GU - 3%

ID - 6%

MX - 4%

CO - 10%

IN - 4%

ET - 4%

VT - 12%

BR - 35%

Coffee Exports by Region 2006

Source: International Coffee

Association.

OTHER - 16%

INDEX

C

A

B

D

E

F

H

G

48

Corn, or maize as it is also known, is one of the most widely cultivated crops in the world. It grew in popularity as a farmed

commodity in the 15th century, spreading from central Mexico. Corn has

a distinct appearance, characterized by tall stems sporting many nodes,

casting off fl ag leaves at every node. While there are hundreds of varieties

of corn hybrids, they fall into six broad categories: fl int, fl our, dent, pop,

sweet and waxy. Some varieties can grow up to 7 metres high; sweetcorn

is one of the shorter varieties.

Corn is a cold-intolerant plant and therefore must be planted in spring. It has

a shallow root system so is heavily dependent on soil moisture. Corn is usually

harvested in late autumn, although this varies depending on the subspecies.

Corn is an important food source for people and livestock, but its uses

are becoming increasingly diversifi ed.

PRINCIPAL USES

Livestock feed: In Canada and the US, the primary use for corn is as

feed for livestock. Dent corn is the most common variety, as it tends to

have a higher oil content and thus higher caloric value. Livestock are fed

grain or silage (fermented, chopped corn stalks).

Human consumption: Corn is a staple part of the diet in many regions

and a core ingredient in foods like porridge, breakfast cereal and tortillas.

Grain alcohols, such as bourbon whiskey, are also traditionally derived

from corn.

Bio-fuel: The search for innovative and serious alternatives to petroleum

has led to growing demand for corn to produce bio-fuel, particularly

ethanol. Home-heating furnaces have also been developed that use corn

kernels as a fuel.

Industrial uses: Corn grain is becoming increasingly used to produce

biomaterial as part of the trend to fi nd alternative, “greener” ways of living.

It can be used to produce plastics and fabrics.

THE CORN MARKET

Corn futures trade on the Chicago Board of Trade (CBOT). According to

the CBOT, the earliest forward contract, for 3,000 bushels of corn, was

recorded in 1851.

The price of corn is generally driven by numerous factors, including the following:

Weather: Some of the biggest fl uctuations in the price of corn are caused

by weather. Drought or frost can completely destroy harvests. Even the

expectation of bad weather can impact heavily on price. Corn is particularly

dependent on water. Weather can also explain some of the cyclical trends

in corn prices over the year.

corn


Chicago Board of Trade Corn Futures

Contract size: 5,000 bushels

Quote: US cents / bushel

A bushel or corn is 56 pounds, or approximately 25.4kg.

Corn is weighed after husks and cobs are removed.

49

Pests and disease: These can have a major impact on yields. Their

prevalence can be affected by the weather.

New consumer demand: Demand from emerging markets is a signifi cant

factor in longer term prices trends, as is the increased demand from developing

countries. For example, China is emerging as a net importer of corn, having

been one of the largest exporters.

Ethanol demand: The growing US ethanol industry has become a major driver

of corn demand. Ethanol is used at low concentrations as an additive in petrol

and specially adapted cars can now run on far higher concentrations.

Prices for other agricultural commodities: Corn, soybean and wheat

have many uses in common and can act as substitutes for each other.

Increased demand for one can therefore drive up the price of another.

Seasonality: Demand for corn is highest in winter when cattle most need

feed. Demand then tends to decline steadily and is lowest in the summer

months, when cattle are grazing. The risk of crop failure can also lead to

cyclical patterns as higher risk commands a premium. This risk is highest

in spring, when the crop is just planted but the weather conditions for the

growing season are uncertain.

U.S

. C

ENTS

/ B

USH

EL

Corn Price History 1985 – 2007

800

600

400

200

0

CORN PRICE

A. 1992: Record harvest in the US.

B. 1996: Heavy rain delays US planting.

C. 2005: The US Energy Policy Act (EPACT) creates a national Renewable Fuels Standard.


CBOT futures contracts. Past performance is not indicative of future performance.

1985 1990 1995 2000 2005

US - 33%

CN - 20%

BR - 6%

MX - 4%

IN - 2%

EU - 8% JP - 2%

CA - 2%

Global Consumption by Region 2006/2007

Source: U.S. Department Of Agriculture.

OTHER - 24%

INDEX

US - 38%

CN - 21%

BR - 7%

AR - 3%

MX - 3%

EU - 8% MX - 3%

Global Production by Region 2006/2007


OTHER - 17%

INDEX

C

A

B

50

Cotton is the world’s biggest non-food crop. The plants have soft,

fi brous seed cases called “bolls”. When the seeds, protein and wax are

removed from the bolls, the result is a strong, durable and absorbent

cellulose fi bre, or lint, ideal for spinning into textiles.

Cotton needs specifi c conditions for optimal growth: heavy soil, a long

frost-free period and plenty of sunshine. The plants suck up large quantities

of water from the soil – yields are therefore heavily dependent on rainfall.

Growing cotton without suffi cient water can result in desertifi cation, as

has occurred in large areas of Uzbekistan.

Cotton was being cultivated in India as far back as 3,000 BC. The modern

textile industry took off in Europe, and the UK specifi cally, during the

Industrial Revolution in the late 18th and early 19th century, with invention

of spinning machinery and the emergence of large cotton mills.

Today, cotton is the most widely used natural fi bre cloth. A high proportion

of current production is from genetically modifi ed varieties that are more

resilient to disease and less heavily dependent on pesticides. The main

production areas are China, India and the United States. China is also the

main importer of cotton fi bre, followed by Turkey.

PRINCIPAL USES

Textile products: Cotton is used to make a wide variety of textiles,

including terrycloth, denim, corduroy, seersucker and cotton twill and in

industrial applications including fi shing nets. Cotton can also be blended

with other fi bres, such as rayon and polyester.

Cotton fi bres are usually separated from the cotton seeds early in the

process and packed into bales for sale. Cotton seeds are traded separately

to cotton and have a variety of different uses:

Oil: Cotton seeds can be crushed to produce a vegetable oil used in cooking.

The cottonseed meal that is left over is generally fed to livestock.

Paper and plastics: Cotton linters, which are short, silky fi bres that

adhere to the seeds of the cotton plant during processing, are traditionally

used in the manufacture of paper. The cellulose in linters is also used

for plastics and explosives.

Bio-fuel: Cottonseed oil can be used in the production of bio-diesel.

THE COTTON MARKET

Cotton futures are traded on ICE Futures U.S. The contracts are for bales

of cotton fi bres, after separation from cotton seeds. Futures for cottonseed

oil trade separately.

Some of the main factors affecting the price of cotton include the following:

cotton


ICE Futures U.S. Cotton No.2

Contract size: 50,000 pounds net weight

(approximately 100 bales)


51

Weather: Cotton is one of the most water intensive crops, requiring 7,000

- 29,000 litres of water per kg of crop, several times the requirement of

corn or wheat. Any water supply disruption or drought can have a direct

impact on crop yield and harvest.

Demand from developing countries: Rising income in developing

countries, and the sheer size of the consumer base, can infl uence demand

for cotton. China and India have particularly large textile industries.

Land scarcity: Although cotton production has more than doubled in the

past few decades, this has been attributed more to improved technology

and higher yields than to increased acreage. Competition from other crops

can reduce available acreage and limit supply.

Alternative textiles: Cotton shares many of its uses with synthetic fi bres

such as polyester. The demand for cotton is therefore infl uenced by its price

relative to these alternative fi bres. As most synthetic fi bres are produced

from petroleum products, their costs are highly correlated with oil prices.

Trade policy: Subsidy programmes or government constraints on imports

can impact the price of cotton.

Cotton Price History 1986 to 2007

U.S

. C

ENTS

/ P

OU

ND

140

120

100

80

60

40

20

0

COTTON PRICE

Notable Events

A. March 1995: Strong demand for U.S. cotton, as much of crop in China, Pakistan and India is

destroyed by insects.

B. July 1995: Prices slip as record price curbs demand, and good weather prompts

higher USDA forecast.

C. October 2001: Cotton hits 29 year low, when record forecasts coincide with

consumption concerns following September 11 terrorist attacks.

D. October 2003: Cotton surges after US gets largest export order from China since 1995.


ICE Futures U.S. contracts. Past performance is not indicative of future performance.

1986 1991 1996 2001 2006

CN - 29%

TR - 10%

ID - 6%

TH - 6%

MX - 4%

RU - 4%

BD - 7% PK - 6%

Global Imports by Region 2006/2007


OTHER - 29%

INDEX

CN - 27%

IN - 18%

US - 18%

PK - 8%

BR - 6%

UZ - 5%



OTHER - 18%

INDEX

C

A

B

52

Rapeseed, or oilseed rape, is an annual crop in the Brassica family, related to mustard, broccoli, cabbage, caulifl ower and turnip. The

plants are sown in winter or spring and can grow from three to fi ve feet

tall. They have distinctive yellow fl owers that produce small black seeds.

The seeds are pressed to produce vegetable oil and the left over meal is

usually used for animal feed.

Rapeseed has become an important global crop only in the past few

decades. The original varieties contained high quantities of erucic acid

and glucosinolates – this made the oil toxic, bitter-tasting and unsuitable

for human or animal consumption. Since the 1960s, more palatable strains

have been developed. Much of the rapeseed crop is now “double low” or

“00”, meaning low acid and low glucosinolate. In Canada, low acid

rapeseed is known as “Canola” (Canadian Oilseed, Low Acid). Higher acid

varieties are still grown for some specifi c industrial applications.

Rapeseed has also undergone signifi cant genetic modifi cation, to give, for

example, higher concentrations of Vitamin A or different amounts of fatty

acid. Genetically modifi ed rapeseed is used extensively in Canada but its

use in Europe is restricted to trials.

Leading producers of rapeseed include China, Canada, the EU and India. These

are also the main consumers. Worldwide production of rapeseed has grown

by over 50% over the past 10 years to reach 47 million tonnes in 200611.

PRINCIPAL USES

Human consumption: Rapeseed oil is low in saturated fat and high in

healthier monounsaturated fat. Refi ned rapeseed oil is used for cooking

and to make margarine. Rapeseed leaves and stems are also edible and

sold as greens.

Animal feed: When rapeseed is processed, the products are oil and a

protein-rich meal. This meal can be used to feed cattle, pigs and chickens.

Livestock may also graze on the raw plants during the winter.

Biodiesel: Rapeseed is the main feedstock for biodiesel production in Europe.

Industrial: Traditional and industrial uses of rapeseed have been for lamp

oils, soap making, lubricating oils, hydraulic fl uids and plastics manufacturing.

These applications tend to use higher acid varieties of rapeseed.

THE RAPESEED MARKET

NYSE Euronext LIFFE’s rapeseed futures contract is the main European

benchmark for rapeseed. The contract was launched in 1994 in close

co-operation with ONIDOL (Organisation Nationale Interprofessionnelle des

Oléagineux) and is for “00” variety rapeseed. It is actively traded by

producers, cooperatives, merchants, exporters, importers, trade houses,

and processors such as crushers and bio-diesel manufacturers. Rapeseed

rapeseed


NYSE Euronext LIFFE Rapeseed Futures


Quote: EURO cents / tonne

11 Source: U.S. Department of Agriculture

53

oil futures are also traded, on both NYSE Euronext LIFFE and,

since June 2007, China’s Zhengzhou Commodity Exchange.

Factors affecting the price of rapeseed can include the following:

Weather: This is an important element in the production of

rapeseed. It is susceptible to cold or poorly drained soils, so frost

and water shortages can cause supply concerns.

Bio-diesel demand: Demand for bio-diesel could become an

increasingly important component of demand for rapeseed.

Rapeseed oil tends to be the preferred oil stock for biodiesel

production in Europe.

Alternative crops: Rapeseed shares some of its uses with other

crops. For example, vegetable oil and biodiesel can be sourced

from soybeans and corn. Thus the price and demand for alternative

crops can have a direct impact on the price of rapeseed.

Trade policy: Subsidy programmes, government constraints on

imports and other structural reforms can impact the price of

rapeseed. For example, farmers in the EU are allowed to grow

rapeseed on set-aside land as long as the rapeseed is for non-food

(ie bio-fuel) use.

Disease and pests: Rapeseed is susceptible to both. Production

can require heavy use of pesticides and herbicides.

FR - 9%

DE - 11%

CA - 19%

CN - 28%

IN - 12%


Source: U.S. Department of

Agriculture.

OTHER - 21%

INDEX

Rapeseed Price History 1999 - 2007

US

CEN

TS /

PO

UN

D (

LB)

400

350

300

250

200

150

100

50

0

RAPESEED PRICE

Source: Morgan Stanley / Bloomberg as at July 2007. Price data based on front-month ICE Futures


1999 2000 2003 2004 20072001 2002 2005 2006

Notable Events

The Biodiesel boom has driven the price of rapeseed

to an all time high.

54

The soybean or soya bean is part of the legume family. The beans are found in pods hidden under the green leaves of the soya plant, which grows successfully in climates with hot summers. Soybeans can

be various sizes and colours, including black, brown, blue, yellow and mottled.

Soybeans are usually crushed into dry soymeal or bean oil (liquid).

The soybean was fi rst cultivated in eastern Asia several thousand years

ago, where the bean and products made from the bean were an important

part of the diet. Today it is a major global crop with some diverse uses -

from an alternative protein source for vegetarians to use in the manufacture

of some plastics.

According to data from U.S. Department of Agriculture, the US is the major

producer of soybeans However, Brazil and Argentina have become

increasingly important producers and together account for more than the

US. China has overtaken the European Union to become the main importer

of soybeans, accounting for 42% of global imports in 2006/7.

PRINCIPAL USES

Human consumption: The main use of the soybeans is as a foodstuff.

Soybean oil is widely used in cooking. Tofu (or soya bean curd) is popular

in many Asian cuisines. Soybeans can also be made into fl our, infant formula,

vegetable oil and, as the name suggests, soy sauce. Additionally, due to its

high protein content, soy products provide an important alternative to meat

and dairy products for vegetarians, vegans or those with allergies. There

has been much research into the health benefi ts of soybeans. Potential

benefi ts can include reduced cholesterol and a lower incidence of heart

disease.

Livestock feed: Any surplus from processing soybeans, such as soybean

husks, can be used as animal feed.

Bio-fuel: Soybeans can be made into biodiesel – one bushel of soybeans

makes around one and a half gallons of biodiesel. Biodiesel can be used

to power cars with suitably modifi ed engines and is becoming a major

driver of soybean production.

Industrial products: The soybean is found as an ingredient in many

industrial products including oils, soap, cosmetics, plastics, inks, crayons,

solvents and clothing. In fact Henry Ford promoted the soybean and used

two bushels in the production of every Ford car, demonstrating that auto

body panels can be made from soy-based plastics.

THE SOYBEAN MARKET

The main futures contract for soybeans is for yellow soybeans, traded on

the Chicago Board of Trade (CBOT). There are also separate contracts

traded on soybean oil and soymeal – for example a soybean oil contract

trades on CBOT and soymeal contracts trade in Mumbai and Tokyo.

soybeans


Chicago Board of Trade Soybean Future

Contract size: 5,000 bushels


A bushel of soybeans is 60lb (around 27.2kg)

55

Some of the main factors affecting the price of soybeans include the following:

Weather: This is an important element in soybean production. Harsh

weather conditions can wipe out entire harvests. The soybean is particularly

susceptible to cold and drought, so frost and water shortages can create

major concerns over supply.

Demand from developing countries: Rising per capita income can lead

to growing usage of soybean products such as vegetable oil. China

accounted for almost half global demand in 2006/2007.

Biodiesel demand: As demand for biodiesel grows, it should become an

increasingly important factor in the demand for soybeans.

Alternative crops: Soybeans and corn can be grown in similar climates

and can therefore be in direct competition for land. As a result, demand

for corn and corn prices will influence the area that is available for

soybeans, and vice-versa. In countries like the US, where land use is

already stretched, increased supply may need to come from higher yields.

Vegetable oil (one of the major uses of soybeans) can be sourced from

other oilseed crops, including rape, sunfl ower, cotton seed and palm.

Supply of these alternatives could affect demand for soybeans.

Soybean Price History 1985 - 2007

U.S

. C

ENTS

/ B

USH

EL

1200

1000

800

600

400

200

0

SOYBEAN PRICE

Notable Events

A. May - June 1988: drought reduces US soybean crop.

B. March 2004: US stocks fall to lowest in 15 years.

C. April 2004: Prices soar higher as Brazil and Argentina reduce their crop forecasts.

D. May - July 2004: Hedge funds and speculators sell soybean exposure.



1985 1990 1995 2000 2005

CN - 42%

EU - 23%

JP - 6%

MX - 6%

TW - 3%

Global Imports by Region 2006/2007


OTHER - 20%

INDEX

US - 37%

BR - 25%

AR - 20%

CN - 7%

IN - 3%

PY - 3%



OTHER - 5%

INDEX

CA

B D

56

Sugar is a widely used carbohydrate with a sweet taste. It comes in many different forms, including glucose, fructose, sucrose, lactose, dextrose and maltose. Some of these types of sugar occur

naturally in foods such as fruit, while some are processed and refi ned from

two sources: sugar cane, which can be shredded and crushed to extract

sugar, and sugar beet.

Cane sugar is grown in regions with a tropical or sub-tropical climate. The

largest producers include Brazil, India and China. Sugar beet, which

accounts for around 25% of total sugar production, can be grown in both

warm and colder climates. In warm climates, beets are winter crops. In

the colder climates of the northern hemisphere, the beet-growing season

starts in the spring and ends in the autumn. Top producers of beet sugar

include Europe, Japan and the US. Although they have different sources,

there is little perceptible difference between the sugar produced from beet

and cane.

PRINCIPAL USES

Human consumption: Sugar can be consumed in a number of forms,

including cubed, granulated, caster and syrup. Sugar is also widely used in

cooking. Sugar can be used as a preservative, sweetener, bulking agent

and to speed up the fermentation process caused by yeast in baking.

Bio-fuel: Sugar is also being developed as an energy commodity, for the

production of ethanol. The Brazilian Ministry of Agriculture estimates that,

in 2008, over 60% of the country sugar cane crop will be used for

ethanol.

THE SUGAR MARKET

Both raw and white (refi ned) sugar contracts can be traded. Sugar futures

are the largest market on ICE Futures U.S. (previously the New York Board

of Trade) and began trading there in 1914. In addition, NYSE Euronext

LIFFE trades sugar contracts on its electronic platform.

Some of the factors affecting the price of sugar include the following:

Weather: This is an important factor in the price of sugar as adverse

weather can affect the yield. Frost can destroy a crop of sugar beet. Sugar

cane needs a warm climate with a certain amount of rainfall.

Ethanol Demand: Roughly half the global supply of sugar is used in the

production of ethanol. If demand for bio-fuel continues to grow, this could

become an even more important component of sugar demand.

Technology: In order to extract sugar from either cane or beet, the

sugar

Common Futures Contracts

ICE Futures U.S.

World Sugar No.11(SM)

Contract size: 112,000 lbs

Price quote: US cents / pound

Domestic Sugar No.14 (SM)


Price Quote: US cents / pound

NYSE Euronext LIFFE

White Sugar Futures


Price quote: US / tonne

Raw Sugar Futures


Price Quote: US cents / pound

57

harvested crop needs to be processed in specially designed

processing facilities. Improvements in technology can increase

the capacity and effi ciency of these processing plants.

Health impact: Consumers and governments are becoming more

aware of the possible negative impacts of excessive consumption

of refined sugar products, including obesity and diabetes.

Competition from alternative sweeteners, such as High Fructose

Corn Syrup (HFCS) could impact the demand for sugar for human

consumption.

BR - 20%

IN - 17%

a.f. - 5%

US - 5%

MX - 3%

m.e. - 3%

e.u. - 11%

e.m. EU - 5%

CN - 8%

TH - 4%

Notable Events

A. 1990: US places a fl oor on sugar imports and

introduces the 1990 Farm Act.

B. 2004: India becomes net importer after 2 years of

failed harvests.

C. 2005/2006: Prices soar as Brazil devotes half its crop

to ethanol to meet a goal to eliminate gas-fueled cars.

D. 2006/2007: Bumper crops in Brazil and India.

Sugar Price History 1986 - 2007

U.S

. C

ENTS

/ P

OU

ND

25

20

15

10

5

0

SUGAR PRICE

Source: Morgan Stanley / Bloomberg as at July 2007. Price data based on front-month ICE Futures U.S.


1986 1990 1994 1998 2002 2006

Production of Raw Sugar by Region 2006/2007


Agriculture.

OTHER - 23%

INDEX

A

B

C D

58

Wheat is a grass that is widely cultivated across the globe. It can grow

to two metres in height and turns golden when ripe. Wheat is thought to have

originated in the Middle East several thousand years ago, in an area in modern

day Iraq known as the Fertile Crescent.

The wheat grown today is a mutated form of the original. Intense cultivation

in the past few hundred years has led to the development of many different

variants to suit different climates or to ripen in different seasons.

According to data from the U.S. Department of Agriculture, the main wheat

producers are the European Union, China and India, followed by the US. These

regions are also the main consumers. This is in contrast with corn, where

both production and consumption are heavily concentrated in the US.

PRINCIPAL USES

Human consumption: Whilst wheat is second to corn in terms of overall

production, it is the most important grain for human consumption and is

a staple food in many diets. It is a very versatile food ingredient – it can

be powdered into fl our, germinated and dried to create malt, crushed to

produce cracked wheat or processed into semolina and pasta. Wheat can

be found in bread, breakfast cereals and many other staple foods.

Fermented wheat can also be used to make alcohol.

Livestock feed: The grain, the bran (the residue from milling) and the vegetable

parts of the wheat plant are all used for feed. Dried wheat can also be used as

fodder. Additionally, wheat damaged by poor weather may be less suitable for

human consumption but can often still be used as livestock feed.

Bio-fuel: Wheat has been increasingly used to produce bio-fuel.

THE WHEAT MARKET

Wheat futures are traded on numerous exchanges. The contract traded

on the Chicago Board of Trade covers several grades and varieties.

There are also contracts traded for specifi c wheat varieties. For example,

hard red winter wheat (used in bread) is traded on the Kansas City Board

of Trade. The US Department of Agriculture releases regular production

forecasts and crop ratings.

Factors affecting the price of wheat can include the following:

Weather: Although excessive rainfall can alter some of its properties and

therefore affect its usage, wheat is one of the more resilient crops. This

is because different varieties are planted in different hemispheres and

climatic regions - when there is a production shortfall in one region, other

regions can respond to the demand.

Economic growth: Wheat is a staple or “inferior good” in economic

terms. This suggests that, as income increases, people may favour more

wheat


Chicago Board of Trade Wheat Futures

Contract size: 5000 bushels


A bushel of wheat is 60lb, or around 27.2kg.

59

“luxury” food items. For example, per capita wheat consumption in the US

declined in the early 20th century as wheat flour was increasingly

substituted by sugar in the diet. As income per capita grows in developing

countries, this may impact the demand for wheat.

Cyclicality: As wheat shares many uses with other crops such as corn

or soybean, demand for wheat is related to demand for these other crops.

For example, wheat is usually more expensive than corn. However, in

summer, when winter wheat has been harvested but corn has not, the

price gap can narrow.

Demand for ethanol: As bio-fuel becomes a more important end use for

wheat, it should have a greater impact on price.

Trade policies: These can infl uence exports and imports, even if production

and consumption remain similar. The fl uctuation in China’s wheat imports in

the past two decades can partly be attributed to government policy.

RU - 6%

US - 5%

TR - 3%

IN - 12% PK - 4%

Wheat Price History 1985 – 2007

U.S

CEN

TS /

BU

SHEL

800

600

400

200

0

WHEAT PRICE

Notable Events

A. March/May 1993: Prices slump on news that U.S. food aid package to Russia is in

jeopardy.

B. 1996: Heavy rainfall in the U.S. delays planting of wheat leading to supply concerns.

C. April 1996: U.S inventories at record low.

D. May 1996: Wheat plummets as dry weather fi nally allows planting.

E. October 2006: U.S. forecasts lowest grain investory for 22 years.



1985 1990 1995 2000 2005

EU - 21%

CN - 18%

US - 8%

RU - 8%

PK - 4%

TR - 3%

IN - 12% CA - 4% AR - 3%



OTHER - 20%

INDEX

EU - 20%

CN - 16%

Global Consumption by Region 2006/2007


OTHER - 34%

INDEX

livestock: live cattle and lean hog

62

There are an estimated 1 billion cattle worldwide12 and many different breeds. “Live cattle” as a traded commodity covers cattle of

many different breeds that are market ready, i.e., of slaughter weight. This

is an active market for both industry participants and speculators that is

very focused in the U.S.

Before cows reach market weight, there is a long breeding and maturing

cycle. Female cows do not usually breed until they are 14 to 18 months

old and the gestation period is a further 9 months. New-born calves are

weaned for up to 8 months and, after a grazing period of two to four

months, reach 600 to 800 pounds, ‘feeder weight’.

At this stage, cattle are sold to feedlots. These are typically small

independent operations that fatten up feeder cattle to their market weight

of 1,050 to 1,200 pounds. It usually takes four to eight months before

cattle reach slaughter weight and can be traded as ‘Live Cattle’. The length

of this process means that changes in herd size can take time: a cycle of

expansion and reduction typically takes around 12 years.

There is also an active market for feeder cattle. As feedlot operators

have some fl exibility over how many cattle to buy and when, supply and

demand do not always match so this market tends to be more volatile.

For example, when profi t margins or expected demand are high, feedlot

operators can increase their number of cattle and vice versa. Disease

and parasite problems are more likely to occur in younger cattle. The

market for live cattle tends to be much more closely correlated to the

end market for beef.

PRINCIPAL USES

Cattle have many uses, including the production of dairy products and as

draught animals. However, live cattle are traded simply for slaughter and

the production of beef. The remaining parts can be used in the production

of leather, soaps, animal feed and other products.

THE LIVE CATTLE MARKET

Because of the seasonal aspects of beef production, the futures market

has been important for producers to remove uncertainty and secure

prices. When the Chicago Mercantile Exchange (CME) introduced live cattle

futures in 1964, it was the first futures contract on a non-storable

commodity. Since 1971, feeder cattle futures have also traded on the

CME. In addition, the Brazilian Bolsa de Mercadorias & Futuros (BM&F)

trades both live and feeder cattle futures.

Many factors infl uence the price of live cattle, including the following:

Weather: Uncertain or adverse weather conditions can affect feed costs,

availability of feed and forage, conception rates, survival rates of young

animals and transportation of cattle.

live cattle


CME Live Cattle Future



CME Feeder Cattle Future

Contract Size: 50,000 pounds

Quote: US Cents / pound

12 Source: U.S. Department of Agriculture.

63

Disease: Outbreaks of bovine diseases can result not only in the

immediate slaughter of those animals but also in lower consumer

demand. For example, Bovine Spongiform Encephalopathy (more

commonly known as BSE or ‘Mad Cow Disease’), and suspected

links to Creutzfeldt-Jacob Disease in humans, dented consumer

confi dence in the cattle industry amid fears that the disease could

be passed to humans through consumption of beef.

Import/export restrictions: These are often driven by outbreak

of disease. For example, beef exports from the US to South Korea

were banned following the BSE outbreak in 2003.

Agricultural commodity prices: The price of grain is a major

cost component for feedlots and therefore directly affects the

demand for feeder cattle as well as the future supply of live cattle.

In addition, as agricultural commodity prices increase, more land

is dedicated to the cultivation of these commodities, leaving less

land available for the grazing of feeder cattle. For example, the

expanding ethanol production in the U.S. might have an impact on

cattle prices as land allocated for cattle feed is taken away,

resulting in higher costs for cattle producers.

Notable Events

A. December 2003: Discovery of “Mad Cow Disease”

in the US.

B. October 2005: Outbreak of foot and mouth

disease in Brazil.

Live Cattle Price History 1988- 2007

U.S

. C

ENTS

/ P

OU

ND

(LB

)

140

120

100

80

60

40

20

0

FEEDER CATTLE PRICE



1988 1992 20021996 2000 2006

LIVE CATTLE PRICE

AB

64

Lean hogs are domesticated pigs. There are around 150 breeds and around 870 million lean hogs worldwide, of which approximately 500 million13 are in China. However, the lean hog market, as a traded

commodity, is focused very much in the US.

Female pigs (or sows) do not breed until they are 8 to 18 months old. They

have an average of nine piglets per litter, with a gestation period of 16

weeks. Although hogs can be raised from birth to slaughter at one location

(classifi ed as ‘Farrow to Finish’), they can also start life with specialist

feeder pig producers moving to feeder pig fi nishers when they reach

feeder weight (10 - 60 pounds). Finishers bring feeder pigs to slaughter

weight - this is typically 240 – 270 pounds and is usually achieved at 22-

26 weeks.

Typically, piglets are born around March, making them available for

slaughter six months later in August and September. The availability of

modern environmentally modifi ed facilities has made the lean hog market

less vulnerable to this seasonality by creating confi ned environments

protected from weather changes.

In 1995, as large new producers emerged with year-round processing

capacity, the US became a net exporter of lean hogs. Today, the US is the

world’s third largest producer. The total US hog herd is estimated to be

60 million, of which the majority live in the “Corn Belt” area, near to the

food supply (grains and soymeal).

Hogs will scavenge and eat almost any food. However, farmed hogs are

fed mostly on grains such as corn, barley or wheat, supplemented by

oilseed for protein. The cost of this feed plays an important role in supply

decisions. Feed makes up a signifi cant proportion of total costs and can

be quite volatile.

PRINCIPAL USES

Human consumption: Lean hogs are commonly raised for consumption

as pork. World pork consumption is expected to exceed 100 million tones

in 2007, a 12% increase since 200314.

By-products: Lean hogs, like live cattle can also be used to produce

leather, which is widely used for furnishings, shoes, clothing and

accessories.

THE LEAN HOG MARKET

Lean hog futures and options have traded on the Chicago Mercantile

Exchange (CME) since 1966. The contract size of 40,000 pounds is the

amount of meat produced from around 200 hogs.

There are many factors affecting the market for lean hogs, including the

following:

lean hog


CME Lean Hog Future


Quote: U.S. cents / pound

13, 14 Source: U.S. Department of Agriculture

65

Demand for pork: Changes to preferences and diets, as well

as cost relative to other foodstuffs, can all affect demand.

Consumption of protein rich foods such as pork and beef are

typically linked to growing GDP.

Lean hog supply: The size of the hog ‘crop’ is a key indicator

of the supply pipeline. Because of the gestation period and time

to achieve slaughter weight, supply is already fi xed 9-10 months

prior to slaughter so can lag changes in demand.

Price of feed: The price of grain is a major component of lean

hog production costs. If agricultural commodity prices increase

(for example due to increased demand for bio-fuels) this could

impact lean hog production costs and market price.

Weather: Although lean hog producers can use environmentally

modified conditions to reduce the effect of adverse weather

conditions, changeable weather may still affect feed costs and

supply.

Notable Events

A. 1995/1996: Lower inventories and higher corn

prices.

B. 1996: Increased use of bacon by fast food

restaurants in the US.

C. December 1996: Prices fall amid concern that

hogs held back by bad weather could fl ood the market.

D. December 1998: Prices crash as supply outstrips

meatpackers’ processing capacity.

E. December 2002: Governor of Iowa urges farmers

to cut losses and bring hogs to market early.

Lean Hog Price History 1990 - 2007

US

CEN

TS /

PO

UN

D (

LB)

100

80

60

40

20

0

LEAN HOG PRICE



1990 1992 20021994 1998 20061996 2000 2004

US - 9%

KO - 11%

BR - 19%

RU - 28%

CA - 12%

Lean Hog Production (Pig Crop), 2006


Agriculture.

OTHER - 21%

INDEX

MX - 11%VN - 28%

JP - 11%E.U. 25 - 28%

PH - 11%CN - 28%

CB

D

E

A

freight

68

Sea freight is at the core of global trade. Vast quantities of fuel, agricultural products, fertilisers, construction materials and other raw goods are transported by sea between producers, manufacturers and consumers. There are three main types of sea freight: “dry”, “wet” and “container”.

Dry freight is the transportation of loose, dry material, including

grain, ore, coal and industrial metals.

Wet freight is the transportation of wet material primarily crude oil

and fuel products. Routes are classifi ed as either clean or dirty. Clean

products include kerosene, gasoline and naphtha. Dirty products include

crude and fuel oils.

Container freight includes goods packed in containers, rather than

loose in the hold.

Global demand for freight is strongly linked to industrial growth and, in

particular, the demand for commodities in developing countries such as

China. Seaborne freight has grown from 2.5 billion tons in 1970 to over

7 billion tons in 2005. Much of this growth has been in dry freight, which

has increased by over 300% since 197015.

THE FREIGHT MARKET

World trade fl ow relies heavily on available shipping capacity and the ability

for shipbrokers, shipowners and charterers to agree prices for freight.

London’s Baltic Exchange is the main freight exchange globally. It originated

in the 18th century and now provides a self-regulated market for the chartering,

sale and purchase of ships. The Exchange also provides independent market

information for the trading and settlement of freight contracts, both physical

contracts and derivatives such as forward freight agreements.

Investors can access this market via a series of indices created by the

Baltic Exchange to track shipping rates Index levels are determined by a

panel of shipbrokers, who assess the value of freight on a standardised

set of shipping routes.

Beyond demand for transported goods, the freight market itself is

infl uenced by numerous additional factors:

Fuel prices: Fuel is a signifi cant portion of the cost of running a vessel.

Record oil prices in 2007, are putting pressure on seaborne freight rates.

Availability of ships: The number and size of available ships is key to

global capacity. Longer term considerations include the number of new

vessels being built and the likely longevity of current vessels.

Port congestion: During 2007 there has been major congestion at ports

in both Australia and Brazil. Congestion can tie up valuable capacity and

freight

15 Source: UNCTAD, “Review of Maritime Transport 2006”

69

increase the risks from adverse weather as ships wait outside

port.

Route congestion: Many of the world’s main shipping routes have

physical convergence points – for example, the Panama and Suez

canals. With shipping lanes already crowded, congestion or closure

of these strategic routes, for political or operational reasons,

could quickly impact global shipping movements.

Weather: Adverse weather conditions can have a big impact on

the shipping market. Certain routes carry specifi c weather-related

risks such as ice in ports or river levels.

Seasonality: Demand for freight can be seasonal, especially if

the commodity being transported is also seasonal. For example,

grain freight can be impacted by the timing of harvests and coal

freight by seasonal peaks and troughs.

COMMON FREIGHT INDICES

Baltic Exchange Dry Index

Sub Indices

Baltic Capesize Index

Baltic Panamax Index

Baltic Supramax Index

Baltic Handysize Index

Baltic Exchange Dirty Tanker Index

Baltic Exchange Clean Tanker Index

Baltic International Tanker Routes

Notable Events

A. August - December 2003: Chinese demand for

raw materials began pushing the Baltic Dry Freight Index

to record levels in late 2003.

B. August 2006: Increasing demand for freight

together with an ageing fl eet and port congestion in

Australia and South America push freight rates higher.

Baltic Dry Index Performance 1997 - 2007

IND

EX L

EVEL

(U

SD)

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000

0

BDI PERFORMANCE

Source: Morgan Stanley, Bloomberg, August 2007. Past performance is not indicative of future performance.

AUG1997

AUG1998

AUG2003

AUG1999

AUG2001

AUG2007

AUG2000

AUG2002

AUG2005

AUG2006

AUG2004

B

A

commodity indices

71

Indices are a convenient way to access a group of commodities. Indices can represent the asset class as a whole or a particular sub-sector, such as energy, agriculture or precious metals.

Commodity indices differ in the rules used to gain exposure to the asset

class. Does the index track futures prices or spot prices? How often is the

index rebalanced? Are there minimum and maximum weightings for

different sectors or individual commodities? Investors should be aware of

these rules before investing in structured products linked to indices.

This section describes the components and methodologies of some of the

main commodity indices. Some of the key features are outlined below.

Number of Commodities Covered16

Weighting Recomposition

Dow Jones AIG Commodity Index

19

Liquidity and

production

based

Annual

S&P GSCI Family

24World

productionMonthly

Reuters Jefferies CRB Index

19

Equally

weighted within

broad sectors

Irregular

recomposition, with

monthly reweighting

Rogers International Commodity Index

36

At discretion

of RICI

committee

Annual

recomposition with

monthly reweighting

16 As at November 2007.

Source: Morgan Stanley / Bloomberg, November 2007. Past performance is not indicative of

future performance.

Commodity indices: Historical performance 31st Aug 1998 – 31st Oct 2007

PER

FOR

MA

NC

E (%

)

180

160

120

80

40

0

-40

SEP98

SEP99

SEP00

SEP01

SEP02

SEP07

SEP03

SEP04

SEP06

SEP05

S&P GS COMMODITY INDEX (ER)ROGERS INTNL. COMMODITY INDEX (RICI)

DOW JONES AIG COMMODITY INDEXREUTERS/JEFFERIES CRB INDEX

72

DOW JONES AIG COMMODITY INDEXSM

The Dow Jones-AIG Commodity IndexSM is a liquid and diversifi ed benchmark

for the commodity market. It was created to provide investors with broad

exposure to the commodity market and the diversifi cation benefi ts it can

offer.

The Dow Jones-AIG Commodity IndexSM is a rolling index composed of

futures contracts on 19 physical commodities. It uses dollar-adjusted

production data to determine its individual component weightings. This

means that, rather than offering a family of targeted indices like the S&P

Goldman Sachs Commodity Index, the DJ-AIG Commodity IndexSM offers

one index with broad commodity exposure. The index applies the following

selection rules:

No commodity sub-sector (e.g., energy, precious metals, livestock

and grains) may constitute more than 33% of the Index.

No single commodity may constitute less than 2% of the Index.

OTHER INDEX FACTS

Index Calculator: Dow Jones

Currency: USD, EUR and JPY

Rebalancing Frequency: Annual (January)

Weightings: Production and Liquidity weighted

Futures Listing: Chicago Board of Trade

Precious MetalsGold

Silver

Base Metals

Aluminium

Copper

Nickel

Zinc

Energy

Natural Gas

Crude Oil

Unleaded Gas

Heating Oil

Soft Commodities

Corn

Cotton

Soybeans

Soybean Oil

Wheat

LivestockLive Cattle

Lean Hog

73

S&P GSCI (GOLDMAN SACHS COMMODITY INDEX)

The S&P Goldman Sachs Commodity Indices represent long-only, unleveraged

exposure to commodity futures. The indices include commodities from all

commodity sectors: energy, base metals, precious metals, agriculture and

livestock.

As well as providing a benchmark for commodity performance, the indices

are designed to be ‘tradeable’ indices, accessible to investors wanting to

capture broad commodity exposure in their portfolios.

The S&P GSCI has a relatively high exposure to energy. S&P offers other

indices in the same family that have the same 24 commodities but lower

energy exposure: the S&P GSCI Reduced, S&P GSCI Light and S&P GSCI

UltraLight Energy have ½, ¼ and 1/8, respectively, of the energy weighting

of the S&P GSCI.

OTHER INDEX FACTS:

Index Calculator: S&P

Currency: USD

Rebalancing Frequency: Monthly

Weightings: On a world-production weighting basis

Futures Listing: Chicago Mercantile Exchange

The S&P GSCI family of indices are calculated for three types of returns:

Spot Index: Based on the spot price movements of the relevant

commodities.

Excess Return Index: Adds the returns from rolling the short term futures

from month to month.

Total Return Index: The returns on a fully collateralised investment in

the GSCI Index (i.e., the gains of the ER Index, plus t-bill interest earned

on the capital invested).

Precious MetalsGold

Silver

Base Metals

Aluminium

Copper

Lead

Nickel

Zinc

Energy

Natural Gas

Crude Oil

Brent Crude Oil

Unleaded Gas

Gasoil

Heating Oil

Soft Commodities

Corn

Cotton

Soybeans

Sugar

Coffee

Cocoa

Red Wheat

Wheat

Livestock

Live Cattle and

Feeder Cattle

Lean Hog

The family also includes the following 14

sub-indices:

Energy

Non-Energy

Industrial Metals

Precious Metals

Agriculture

Livestock

Petroleum

Grains

Energy and Metals

Gold

Non-livestock

Live Cattle

Natural Gas

WTI

74

REUTERS JEFFERIES CRB (COMMODITIES RESEARCH BUREAU) INDEX

This is one of the longest running commodity indices, with a history dating

back to 1957. Originally designed to replicate performance of the

commodities markets and provide information on broad trends, the

components and methodology have been periodically adjusted to ensure

that the index has retained this role over time.

Initially comprising 28 commodities, the index now has 17 components,

equally weighted.

The calculation methodology for the index is unique, attempting to capture

a ‘three-dimensional’ view of the commodities markets. It looks at average

prices across different commodities and also across time within each

commodity sub-sector. The calculation process is as follows:

1. The 17 component commodities are arithmetically averaged using

prices for each of the contract months which expire up to 6 months from

the current date.

2. These 17 fi gures are then geometrically averaged.

3. The resulting single figure is multiplied by an adjustment factor

(necessary because of the revisions made to the index since its inception

in 1957) and multiplied by 100 to give a percentage.

OTHER INDEX FACTS

Index Calculator: Bridge Information System, Inc.

Currency: USD

Rebalancing Frequency: Monthly

Weightings: Equal

Futures Listing: ICE Futures U.S.

Precious Metals

Platinum

Gold

Silver

IndustrialsCotton

Copper

Energy

Natural Gas

Crude Oil

Heating Oil

Soft Commodities

Cocoa

Coffee

Orange Juice

Sugar

Grains And Oil Seeds

Corn

Soybeans

Wheat

LivestockLive Cattle

Lean Hog

75

ROGERS INTERNATIONAL COMMODITY INDEX (RICI)

This index was developed in 1998 by Jim Rogers, one of the world’s

leading authorities on commodity investing, in order to meet the need for

a broad based international commodities vehicle for investment. The index

represents the value of a basket of 36 commodity future contracts from

11 different exchanges globally. This overall index is supplemented by

individual indices on different commodity sub-sectors.

Only contracts that meet the following criteria are eligible for inclusion in

the index:

Must be on one of 15 recognised international exchanges.

Must have played a significant role in worldwide consumption,

measured via tracking international imports and exports and domestic

consumption of the worlds prime commodity consumers.

Must have suffi cient liquidity to be tradeable.

An investment committee chaired by Jim Rogers meets each December

to determine whether index components and weights should change.

Component weights are set according to their importance in international

commerce.

OTHER INDEX FACTS

Index Calculator: RICI Committee

Currency: USD

Rebalancing Frequency: Annual

Weightings: Set by methodology

Current Index Compostition

Crude Oil

IPE Brent

Wheat

Aluminium

Copper

Corn

Heating Oil

IPE Gasoil

RBOB Gasoline

Natural Gas

Cotton

Soybeans

Gold

Live Cattle

Coffee

Zinc

Silver

Lead

Rice

Soybean Oil

Platinum

Lean Hog

Sugar

Azuki Beans

Cocoa

Nickel

Tin

Greasy Wool

Rubber

Lumber

Barley

Canola

Orange Juice

Oats

Palladium

Soybean Meal

76

A

Actuals: Physical or cash commodities, as distinguished

from commodity futures contracts.

Afl oat: Commodities in transit in vessels or in harbour.

Ask: The price at which a market participant is willing to sell

(also called the “offer”).

B

Back Months: The futures or options being traded that are

furthest from expiration.

Backwardation: A market where prices are lower in the

back month futures contracts than in the nearby month

contracts.

Basis: The difference between the cash price for a

commodity and the price of a particular futures contract.

The futures price plus the basis is the cash price.

Bear: An individual who believes prices will move lower.

Bear Market: A market in which prices are falling

Beta: A measure of the sensitivity of an asset’s price to a

group of assets or index.

Bid: The price at which a market participant is willing to

buy.

Board of Trade: See Contract Market.

Bull: An individual who expects prices to rise.

Bull Market: A market in which prices are rising.

Buying Hedge (or Long Hedge): Buying contracts, such

as futures, to protect against price increases in commodities

that will be needed in the future. See also Hedging.

C

Carry: The cost of fi nancing (borrowing to buy) a position in

fi nancial instruments. A position is said to have “positive”

carry if the cost of fi nancing is less than the return on the

instrument, and “negative” carry if the cost of fi nancing is

higher than the return.

Carrying Cost: Those costs incurred in warehousing the

physical commodity, generally including interest, insurance

and storage.

Carry-Over: Commodity supplies that are left over from the

previous production or marketing season.

Cash Commodity: The actual physical commodity as

distinguished from a futures contract (see Actuals).

Cash Market: A market for the purchase and sale of physical

commodities, as opposed to futures. Cash markets for

commodities can include cash sections of commodity

exchanges (where there may also be futures conracts trading)

or, for example, central stockyards in the livestock industry.

Certifi ed Stock: Stocks of a commodity that are stored at

a designated delivery point and that have been inspected

and found to meet the quality standards specifi ed by futures

contracts and are stored at a designated delivery point.

CIF (Cost, Insurance and Freight): A selling price that

includes all shipping and other carriage charges, plus

insurance, to a named destination port.

Close: The period at the end of the trading session.

CME: The Chicago Mercantile Exchange.

Commodity Credit Corporation (CCC): A corporation

established in 1933 by the US government to help stabilise

and protect US farm income and agricultural commodity

prices. The CCC is wholly government-owned.

CFTC (Commodity Futures Trading Commission): The

glossary

77

government agency responsible for regulating the commodity

futures industry in the United States.

Commodity Pool: A fund that pools contributions from

numerous investors to trade commodity futures or options

contracts, particularly in the United States.

Commodity Pool Operator (CPO): An individual or organisation

responsible for the assets in a Commodity Pool. In the United

States, CPOs usually need to be registered with the Commodity

Futures Trading Commission.

Commodity Trading Advisor (CTA): An individual or

organisation that trades or advises on commodity futures and

options on behalf of a customer account. For example, a

Commodity Pool Operator may hire a Commodity Trading

Advisor to manage and trade a pool of assets. In the United

States, CTAs usually need to be registered with the Commodity

Futures Trading Commission.

Contango: A market where prices are higher in the back

month futures contracts than in the nearby month

contracts.

Contract: The unit of trading in commodity futures. A futures

contract specifi es the exact grade, amount and month of

delivery of the commodity.

Contract Grades: Standards or grades of cash

commodities deliverable against futures contracts. There

may be discounts and premiums for delivery of commodities

of lower or higher quality than the contract grade.

Contract Month: The month specifi ed in a futures contract

when delivery is to be made.

Contract Unit: The actual amount of a commodity stipulated

for delivery against a given futures contract.

Convergence: The tendency of futures prices to approach

cash market values as contracts near expiration.

Cover: To offset a previous futures transaction with an equal

and opposite transaction. “Short-Covering” is the purchase

of futures contracts to cover an earlier sale of an equal

number of the same delivery month. “Liquidation” is the sale

of futures contracts to offset the obligation to take delivery

of an equal number of futures contracts of the same delivery

month purchased earlier.

Crack Spread: A type of commodity trade involving the

purchase of crude oil futures and the sale of petrol and

heating oil futures.

Crush Spread: A type of commodity trade involving the

purchase of soybean futures and the sale of soybean meal

and soybean oil futures.

Current Delivery (Month): The futures contract due to

expire and become deliverable during the current month;

also called a Spot Month.

D

Day Order: An order that expires at the close of a day’s

trading. If not fi lled during that day, it is withdrawn.

Day Trading: Establishing and liquidating the same position

or positions within one day’s trading, thus ending the day

with no established position in the market.

Dealer: An individual or organisation that acts as principal

in transactions.

Dealer Option: A put or call on a physical commodity that

is not subject to the rules of an exchange but is written by

a dealer fi rm.

Default: In futures markets, the theoretical failure of a party

to a futures contract to either make or take delivery of the

physical commodity.

Deferred Delivery: The more distant months in which

futures trading is taking place, as distinguished from the

Nearby futures delivery months.

78

Delivery: This word has a very specific meaning in

connection with futures contracts. Delivery refers to the

changing of ownership or control of a commodity under the

terms and procedures established by the exchange upon

which the contract is traded. The commodity must usually

be delivered to an approved storage facility and inspected.

The storage facility then issues a transferable receipt or

certifi cate. After receipt of this receipt or certifi cate, the

new owner can arrange with the storage facility to take

possession of the physical commodity.

Delivery Points: The locations specifi ed by a commodity

exchange where stocks of a commodity may be delivered to

fulfi l a future contract.

Differentials: Price differences between classes, grades

and locations of different stocks of the same commodity.

Discount: specifi cally for futures contracts, a downward

adjustment in price allowed for delivery of a lower grade of

commodity than specifi ed in the futures contract.

E

Expiration Date: The last day of trading for a futures

contract, or the last day that an option may be exercised

into its underlying futures contract.

F

Flat: When a trader has no open positions.

Floor Broker: An exchange member who executes orders on

behalf of clearing members of an exchange or their customers.

Floor Trader: An exchange member who generally trades

only for his/her own account. Also referred to as a “local.”

Full Carrying Charge Market: When the difference in

futures prices between delivery months refl ects the full costs

of interest, insurance and storage.

Futures: Contracts agreed on an exchange for the future

purchase and sale of financial instruments or physical

commodities.

H

Hedge: The purchase or sale of a futures contract as a

temporary substitute for a cash market transaction to be

made at a later date, or to reduce the risk of that transaction.

A “Long” hedge is the purchase of a future contract in

anticipation of an actual purchase in the cash market and is

used by processors or exporters to protect themselves from

rising prices. A “Short” hedge involves the sale of a futures

contract in anticipation of the sale of a commodity so is

usually used by producers to lock in current prices or protect

against falling prices.

L

Limit Order: An order given to a broker by a customer that

specifies a price; the order can be executed only if the

market reaches or betters that price.

Limit Price: (See Maximum Price Fluctuation).

Liquidation: Any transaction that offsets or closes out a

long or short futures position.

Liquidity: The ability for market participants to quickly enter

or exit positions at a price close to the last traded price. A

liquid market usually requires a large number of traders

willing to buy and sell in a particular commodity market.

Long: Buying a futures contract without an offsetting

position; the opposite of short.

M

Margin (or Performance Bond): Funds that a customer

must deposit with a broker ( or a broker with a clearing

member, or a clearing member with the Clearing House)

before trading futures. Customers may need to make

additional payments (maintenance margin) depending on their

futures positions.

79

Mark-To-Market: The daily adjustment of margin accounts

to refl ect profi ts and losses.

Maximum Price Fluctuation: The maximum amount that

contract price can move up or down during one trading

session, as stipulated by an exchange’s rules.

Minimum Price Fluctuation: The smallest allowable

price movement for a given contract, often referred to as

a “tick.”

N

Nearby Month: The nearest active trading month of a futures or

options on futures contract. Also referred to as “lead month.”

O

Offer: Also called “ask”, the price at which a market

participant is willing to sell.

Offsetting: Taking out a futures contract opposite to one’s

current position, ie selling if one has bought, or buying if one

has sold.

Open Interest: The total number of futures contracts that

have not yet been offset or fulfi lled by delivery. The level of

Open Interest can indicate the depth or liquidity of a market

and the use of a market.

Open Order: An order to a broker that is good until it is

cancelled or executed.

Open Outcry: Method of public auction for making verbal

of fers in the trading pi ts or r ings of commodity

exchanges.

P

Premium: Specifi cally for commodity futures contracts, an

updward adjustment in price allowed for delivery of a higher

grade of commodity than specifi ed in the contract.

R

Rally: An upward movement of prices following a decline;

the opposite of a reaction.

Reaction: A decline in prices following a rise (the opposite of rally).

S

Scalping: Trading for small gains. Scalping usually involves

establishing and quickly liquidating a position.

Short: Selling a futures contract without an offsetting

position; the opposite of long.

Speculator: Someone who attempts to profi t from buying

and selling futures contracts by anticipating prices changes.

Speculators usually have no connection with the production

or processing of a commodity and do not usually take

physical delivery.

Spot: The cash market price of a commodity; or a commodity

that is available for immediate delivery.

T

Tick: Refers to a change in price by a specifi ed increment,

either up or down.

80

AR: Argentina

AU: Australia

BD: Bangladesh

BE: Belgium

BR: Brazil

CA: Canada

CL: Chile

CM: Cameroon

CN: China

CO: Colombia

CU: Cuba

DE: Germany

EC: Ecuador

ET: Ethiopia

FR: France

GH: Ghana

GU: Guam

HK: Hong Kong

HN: Honduras

ID: Indonesia

IN: India

IT: Italy

JP: Japan

KR: Korea

KZ: Kazakhstan

MX: Mexico

MY: Malaysia

NC: New Caledonia

NL: Netherlands

NG: Nigeria

PE: Peru

PH: Phillipines

PK: Pakistan

PL: Poland

PY: Paraguay

RS: Serbia

RU: Russian Federation

SZ: Swaziland

TH: Thailand

TR: Turkey

TW: Taiwan

UA: Ukraine

UK: United Kingdom

US: United States

VT: Vietnam

ZA: South Africa

ZM: Zambia

Abbreviations

a.f: Africa

e.u: European Union

country code index

ISO 3166 two letter country codes used in this document.

IMPORTANT INFORMATION

Approved for issue by Morgan Stanley & Co. International plc (25

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has been prepared by sales, trading, banking or other non-research

personnel of Morgan Stanley & Co. International plc (together with

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is not an offer or a solicitation to buy or sell any commodity,

commodity investment, structured product or other investment or

trading strategy (“Products”). Certain assumptions may have been

made in the analysis that resulted in any information and returns/

results detailed herein. No representation is made that any returns/

results indicated would be achieved or that all assumptions in

achieving these returns/results have been considered. Past

performance is not necessarily indicative of future results. We

make no representation or warranty with respect to the accuracy

or completeness of this brochure nor are we obliged to update

information in respect of the Products mentioned herein.

Any investment decision should be made only upon receiving all

relevant information, including the prospectus for the relevant

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82

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COMMODITIES - Morgan Stanley IQ · 1 Everyone thinks that they know what a commodity is until they...

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