29 July 2020, 10:59AM UTC Chief Investment Office GWM Investment Research

Commodity markets: Next leg higher Commodity markets

Authors: Dominic Schnider, CFA, CAIA, Analyst, UBS AG Hong Kong Branch; Giovanni Staunovo, Analyst, UBS Switzerland AG; Wayne Gordon, Analyst, UBS AG Singapore Branch

• Macroeconomic dynamics and a well-behaved supply side should push commodity prices higher. We expect broadly diversified commodity indices to appreciate by about 15% over the next 12 months.

• While all sectors are expected to rise, albeit at varying degrees, we think cyclical commodities are poised for the greatest gains, especially crude oil.

• We recommend investors to be long broadly diversified commodity indices, base metals, gold and livestock. For yield-oriented investors, we suggest selling the volatility of precious metals, crude oil and nickel.

Our view

Our forecast for higher commodity prices is coming to fruition. Broad commodity indices are already up by around 5% in 3Q20, following a 12%–14% rise on a spot basis and a 5%–11% total return in 2Q20. Once again, precious metals are leading the performance table—up by around 12% this quarter—followed by base metals and energy. Gains in agriculture and livestock have been more modest, ranging from 1% to 4% on a sector level.

As ample liquidity finds its way into the real economy, we think the conditions are set for a solid and synchronized growth recovery across the world. This should pave the way for a pick-up in commodity demand, particularly in the developed world, while Chinese demand for commodities stays buoyant. The result should be reflected in tighter market balances and lower visible inventories across cyclical commodities like energy and base metals.

Source: Gettyimages

Solid performance of commodity markets Total return values standardized to 100

Source: Bloomberg, UBS, as of 28 July 2020

This report has been prepared by UBS AG Hong Kong Branch and UBS Switzerland AG and UBS AG Singapore Branch. Please see important disclaimers and disclosures at the end of the document.

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A weaker USD and negative real interest rates should provide additional price support across the asset class, mainly for precious metals. More sector-specific factors, such as drought and excess rain conditions in various crop-producing areas, favor well-bid agricultural prices as well. Livestock prices, too, are finding support from strong Chinese demand for animal protein and supply-side constraints in major exporting countries outside the US.

Looking for the next leg higher

We believe macroeconomic and supply-side conditions are favorable for another leg up in commodity prices over the next 6–12 months. This view is not new; we have been guiding for a 10%–15% appreciation of the asset class in 2H20 for a while now. What surprised us was that broadly diversified commodity indices recovered so quickly in the second quarter, providing investors with positive total returns of around 5% for the Bloomberg Commodity Index and close to 11% for the UBS Bloomberg CMCI Composite index.

Commodity volatility has risen less than equities this year 3-month rolling window, daily data

the BCOM Index and the UBS Bloomberg CMCI Composite Index on a total return basis.The BCOM index has been live since 1998 and the CMCI index started in 2009, but the respective index providers have calculated historical index values backward to 1991 and 1998, respectively, based on the same methodology.

GDP growth of advanced economies, incl. our forecasts Year-on-year values, quarterly

Source: UBS, as of 28 July 2020

Global equities recovered by almost 20% in 2Q20. But the underperformance of commodities should be seen in the context of the considerably higher volatility of equities versus broad commodity indices this year and the lower sensitivity of commodities to market expectations about the future in relation to the actual economic backdrop. To understand this better, we looked at quarterly commodity returns over the last 30 years during different economic growth stages. Based on quarterly year-on-year GDP growth

numbers and the respective changes in GDP growth (growth momentum), we are left with four different economic backdrops:

GDP expanding - Accelerating (second derivative of GDP is positive) - Decelerating (second derivative of GDP is negative) GDP contracting - Accelerating (second derivative of GDP is negative) - Decelerating (second derivative of GDP is positive)

We could have sliced the absolute growth levels further into different periods as well—when activity is above or below trend growth. However, we thought it would only add an unnecessary layer of complexity and it would be more arbitrary. After all, there are different ways to calculate trend growth.

For our activity numbers, we used the GDP of advanced economies from 1985 onwards. These economies accounted for around 55% of global GDP in the late 1980s compared to about 36% today. Given the reduced importance of advanced economies globally over time, we also looked at commodity returns in relation to the GDP dynamics of emerging economies. This time series only starts in 2000. The performance of commodities is represented by

Source: UBS, as of 28 July 2020

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What are the key takeaways for investors? As one would expect, quarterly commodity returns tend to be higher when economic growth accelerates. In our case, they were more than double when the GDP of advanced economies gained speed during the full 30-plus-year sample window. The commodity performance when economic activity is accelerating versus decelerating does change a fair bit over time, from being modest in the 1990s, to high in the 2000s and lower in the last decade.

The key message for us here is that we should not wait until GDP growth in the developed world is back above trend to chase the asset class. That does not mean commodities don’t perform in the later stages of an economic cycle—they do perform strongly. But good returns can also be found when economic activity accelerates, even from negative territory.

Commodity returns during different economic growth conditions in advanced economies Quarterly GDP growth, commodity performance based on total returns

Source: Bloomberg, UBS, as of 28 July 2020

Unfortunately, the performance correlation between commodities and GDP activity in advanced economies became less clear in the last decade. We attribute this to ample supply capacity at lower costs, very stable GDP growth and structural factors. We thus looked at the performance differences of commodity returns when activity in emerging/developing economics gathers momentum or cools. The good news is that there is still a decent performance gap compared to the 2000s. This is not surprising considering that emerging economies (mainly China) account for the bulk of today's commodity demand and incremental commodity offtake.

Commodity returns during different economic growth conditions in emerging economies Quarterly GDP growth, commodity performance based on total returns

Source: Bloomberg, UBS, as of 28 July 2020

A better return profile during accelerating economic growth also comes with less volatility. The average and median volatility of broadly diversified commodity indices dropped in the last 30 years by 2ppt when activity improved compared to times of decelerating economic activity. In the last 10 years, this gap even widened to almost 3ppt. While volatility is high at an individual commodity level, we are confident that the expected volatility profile for broad commodity indices, like the UBS CMCI Composite Index, will only be around 12% over the next 6–12 months.

Volatility of commodities when growth accelerates or decelerates x-axis: values in % (commodity volatility) and y-axis: number of quarters, since 1990

Source: Bloomberg, UBS, as of 28 July 2020

On a sector level, base metal returns (average and median) show the largest and most consistent performance dispersion during different growth stages (accelerating vs. decelerating), followed by energy. Given the cyclical nature of both sectors, this is clearly not a surprise.

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Commodity returns during different economic growth conditions Quarterly GDP of advanced economies and quarterly average commodity returns, since 1990

Source: Bloomberg, UBS, as of 28 July 2020

Precious metal returns are the highest when GDP contracts, unlike for other sectors. However, precious metal returns also stayed positive even when economic growth returned. Accelerating or decelerating growth conditions hardly make a difference in the performance of precious metals. This very favorable performance profile, driven by gold, compared to many other assets is quite unique and speaks for the metal's diversification characteristics.

In the case of agriculture and livestock, the performance difference when growth speeds up or slows is rather marginal. We therefore believe agricultural commodities offer investors exposure to alternative risk sources like weather. From a broad index perspective, this provides valuable diversification benefits and helps to reduce the overall index volatility. Still, outright GDP contraction at an accelerated pace does hurt agriculture and livestock prices, particularly for livestock as meat demand is adversely affected.

The above-mentioned performance numbers are not new, as we have been highlighting them in different ways in recent years. But it's worth reflecting on them given our very favorable economic growth trajectory over the next six to 12 months for both advanced and emerging economies. We believe year-on-year growth will accelerate over the coming quarter and peak in 2Q21. On a sequential basis, economic growth should remain robust beyond the 2H20 bounce. For 1H21, we expect global GDP growth to be around 4% q/ q annualized.

With all the support given to economic growth, both monetary and fiscal, we also expect the commodity intensity of the economic recovery to gear up, mainly with regard to metals. In that context, we are tracking closely China's demand pull and the push in the developed world for more government-led investments. To be clear, as the liquidity- and debt-induced growth story rolls over at some point, most likely in 2H21, the outlook for commodities will change too, unlikely for the better. But markets are not expected to look around two corners yet, given the impending improvement in activity and that the negative growth payback may not take place for 18 to 24 months.

With a lag, commodities tend to benefit from ample liquidity Year-on-year values, monthly data

Source: Bloomberg, UBS, as of 28 July 2020

Beyond the top-down story The top-down macro (demand) view and our expectations of a weaker USD are not the only reasons why we are calling for broad exposure to commodities. We also believe that the bottom-up picture, where the focus is on a well-behaved supply side and low inventory levels for some commodities, remains conducive for higher prices as well.

First, in oil markets, OPEC and its allies (OPEC+) have showed a great deal of unity. With discipline to keep the production cut deal expected to stay strong, as well as oil demand continuing to recover, oil inventories starting to drop due to an undersupplied market, and prices too low to incentivize strong production growth in the US, the world is dependent on crude oil from OPEC+. This increased pricing power, with US shale supply only coming back strongly when WTI crude prices rise above USD 50/bbl, sets the tone for Brent crude oil prices to reach USD 55/bbl in 1H21.

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Global oil production has fallen to 9-year low Values are in mbpd, left-scale y/y change for OPEC and non-OPEC, right-scale absolute global production

Source: IEA, UBS as of 28 July 2020

Second, copper supply is likely to drop this year by more than 3% due to COVID-19. This supply decline, mainly due to mining issues, and a smaller bounce in supply growth next year as new mine capacity is being pushed out call for copper prices to overshoot to USD 6,900/mt over the next six months, in our view. To a smaller degree, the pandemic has also hurt nickel, zinc and lead supply (mainly on the raw product side), with visible inventories of refined metal staying low.

Source: Bloomberg, UBS as of 28 July 2020

Also, rising inflation expectations have pushed the yield of 10-year Treasury inflation protected securities (TIPs) to a record low of –0.93%. With other insurance assets less attractive currently, investor interest in gold should stay high as an alternative diversifier.

Fourth, we see weather risks for key grains due to drought conditions in Argentina and parts of Europe, and flooding in China. This should keep prices well bid.

And fifth, as economies reopen further, we anticipate a building recovery in demand for key soft commodities such as coffee, cocoa and sugar. Furthermore, greater food service activity should lift demand for animal protein and push up livestock prices.

We think this mix of drivers speaks for our almost 15% appreciation forecast for commodities over the coming quarters.

We guide for a solid increase in commodity prices over the coming quarters Expected spot moves for the UBS BB CMCI Composite Index

Third, the monetary and fiscal backdrop, with long-dated US yields converging almost to zero, adds a very favorable backdrop for precious metals, in our view. During the last three US recessions, longer-dated yields offered investors a spread of 300–400 basis points over money market rates. But now, the term spread is largely gone for 10-year Treasuries and is only around a third for 30-year Treasuries.

Compared with other crises, the yield curve is currently very flat, favoring real assets Weekly data

Source: Bloomberg, UBS as of 28 July 2020

Sector considerations:

Energy: To take another step higher On a spot basis, we expect the energy sector to rise by a tad more than 10% by the year-end and by around 30% over the next 6–12 months. This might look a lot, but investors need to consider that prices dropped steeply in 1H20 and that energy has the highest volatility among all the commodity sectors (about 40%). Crude oil and seasonally stronger US natural gas account for the bulk of the expected price move higher.

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Global crude oil supply contracted to a 9-year low of nearly 87mbpd in June 2020. The reduction in supply is being driven by voluntary production cuts by OPEC and its allies (OPEC+), involuntary production curtailments due to political conditions or US sanctions on OPEC countries (Libya, Venezuela, Iran), and price-induced production shut-ins in North America. While OPEC+ is set to increase production modestly in August (see “OPEC+ agrees to taper production cuts” on 17 July), the sharp decline in capital expenditures by oil companies outside OPEC+ should cause a structural decline in production, most notably in the US. To entice stronger production beyond OPEC+, we think WTI crude prices need to trade above USD 50/bbl.

We expect the oil market to be undersupplied in 2H20 and 2021 Values are in million barrels per day

Source: IEA, UBS as of 28 July 2020

On the demand side, we continue to envision a gradual recovery through the year-end and into 2021. However, end-2020 demand will likely fall well short of end-2019 levels given that people will take some time to return to their old habits after restrictions are lifted. For now, we estimate an oil demand decline of 3–4mbpd y/y in 4Q20, weighed down by less economic growth (lower incomes) and changes in behavioral patterns (home working, fewer business flights). Oil demand linked to the aviation sector is only expected to recover more strongly when a coronavirus vaccine has been developed. The increase in people driving to work or parks with their private cars, instead of using public transport, should somewhat offset the demand crunch.

Overall, given our demand and supply estimates, we expect the oil market to be undersupplied in 2H20 and 2021. This backdrop should trigger the Brent price to rise to USD 45/ bbl at the end of this year and to USD 55/bbl at mid-2021.

US natural gas prices, on the other hand, are likely to stay subdued in the near term, which should help to tighten fundamentals. To prevent storage capacity limits from being reached by the end of the injection season in late October, lower prices are needed to trigger a rebalancing of the natural gas market. This is best visible in the power sector in the US, where coal-to-gas switching is picking up. According to the Energy Information Administration, natural-gas-fired generation in the Lower 48 states rose nearly 55,000 gigawatt hours (GWh) (+9% y/y) in 1H20. This came at the cost of coal-fired power generation, which fell by 138,000 GWh (–30% y/y) during the same time period.

Meanwhile, low prices are weighing on natural gas production as well. We expect dry gas production to decline by 3% y/y, or nearly 3 billion cubic feet per day, this year. Improving economic activity in the second part of the year as lockdown measures ease should support industrial activity and help US liquefied natural gas (LNG) exports. This backdrop should result in US natural gas inventories climbing to around 3.9 trillion cubic feet (tcf) at the end of October, which would be above the five-year average of 3.7tcf. But as winter begins, we expect tighter fundamentals to support prices. We expect US natural gas prices to trade at USD 3/mmbtu at the end of this year and at USD 2.9/ mmbtu at mid-2021.

US dry gas production is set to decline further Values are in billion cubic feet per day

Source: EIA, UBS as of 28 July 2020

Base metals: Not just a copper story The rise in base metals indices has been driven mostly by copper. But the next move higher toward the year-end and into the early part of 1H21 should be broader based. Underlying support for this next leg up comes from a pick-up in metal demand ex-China while the market in China stays tight. Supply losses on the mining side in select metals (copper, zinc and nickel) further add to the picture

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of tightening market balances ahead. Some markets could even flip into a market deficit next year. Our metals of choice are copper and nickel, while aluminum prices at the London Metal Exchange (LME) could catch up with Chinese prices to some degree.

The recovery in commodity prices stands out Values standardized to 100

Source: Bloomberg, UBS as of 28 July 2020

Despite rallying since the March 2020 lows and speculative investment positions having geared up sharply, we see room for copper prices to reach USD 6,900/mt at the end of December. Ongoing supply challenges, both mining and scrap related, suggest that supply will contract this year. We expect global refined supply to decline by 3.4% this year. And as we expect demand to contract by 4.3% in 2020, this leaves us with a moderately balanced market of +0.4% of annual demand in 2020.

Our S&D revisions for copper in perspective % changes

Source: Wood Mackenzie, UBS as of 28 July 2020

But we anticipate a deficit market of –0.5% of annual demand in 2021. A tightening copper market with visible inventories at structurally low levels calls for prices to overshoot, in our view.

Our other favored metal is nickel. We expect stainless steel demand to pick up in 2H20 and into 2021, while mining challenges could adversely affect supply in the coming months. We expect nickel supply to decline by around 1% for the full year, suggesting that the ample stainless steel inventory story is likely to take a backseat. We forecast a 4.8% drop in demand in 2020, but expect demand to pick up next year and flip the market into a marginal deficit of 16,000 tons in 2021. A tighter market should lift prices, although we think the longer-term availability of low-cost nickel pig iron will cap the rally at USD 15,000/mt in the coming months.

As for aluminum, we expect supply to expand by 1% this year and demand to contract by 4.2%. While demand has clearly taken a hit, it should rebound swiftly in tandem with the automobile and construction sectors’ recoveries. The market surplus, which we currently forecast at 2.4% of annual demand, may be smaller than anticipated. A less oversupplied aluminum market, with limited supply from Chinese aluminum product exports, would likely help aluminum prices at the London exchange to narrow versus prices in China (at around USD 2,070/mt). If supply stays more disciplined, aluminum prices should close in on USD 1,850/mt at end-2020 and then to level off into mid-2021.

Weak aluminum demand ex China and unfavorable prices trigger a firm decline in Chinese exports of aluminum products Monthly data in thousand tons

Source: Bloomberg, UBS as of 28 July 2020

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Zinc prices are being driven by mine supply challenges, but ample concentrate stocks are mitigating the supply shortfall. For both zinc and lead, supply is likely to drop by around 2.5% this year. This stands in contrast to the 5%–6% drop in demand forecasted for both in 2020. Since most of this decline relates to the first half of the year, improving demand dynamics due to stronger construction activity and recovering vehicle sales should help their surpluses fade into 2021. Visible inventories at depleted levels should also help lift the prices of both metals by high single digits.

Precious metals: Gold and silver surge Gold has been one of the best-performing assets this year (up by around 28% YTD) and is doing even better than it did during the Global Financial Crisis in 2009, surging past its previous record high of USD 1,921/oz set in 2011. Silver has also rebounded sharply to reach its highest level in six years, while the platinum group metals (PGMs) have largely followed the leaders.

Importantly, the move up has occurred despite the sharp reversal in risk-off sentiment and the more than 40% rally in global equities since the March lows. This highlights the yellow metal's dual function as a safe-haven and as a hedge against broad US dollar weakness and mispriced inflation expectations. We have advised investors to be long gold since May 2019 when prices were below USD 1,300/oz. Yet, as gold approaches USD 2,000/oz—our near-term forecast —where to next for the yellow metal?

Figure 1 - ETF holdings in gold and silver have surged in 2020 Values in % of 2019 mine supply

Source: Bloomberg, UBS as of 28 July 2020

First, let’s dissect the rally. Exchange-traded fund (ETF) inflows are primarily behind the surge in demand although central banks have made modest net purchases despite the absence of key EM central banks lately. Total inflows into gold ETFs so far this year have amounted to 864.4 tons, according to the World Gold Council (WGC), or USD 46.9bn

worth, substantially exceeding the highest level of annual inflows in volume terms in 2009 (646 tons) and value terms in 2016 (USD 23bn). Total global ETF holdings were at an all-time high of about 3,750 tons as of 24 July.

While we think rising geopolitical tensions, a further decline in real interest rates and a weakening US dollar can drive further inflows to gold over the next six months, our view for a robust recovery in 2021 should support risk assets and bring the Federal Reserve closer to the peak in policy easing during 2021. Such a shift could then begin to weigh on gold. Hence, we expect gold prices to peak in about six months at around USD 2,000/oz, before easing in 2H21.

In our risk case (of a rebound in equity market volatility due to US-China tensions and/or further COVID-19 outbreaks alongside even greater Fed easing), we would expect gold to forge higher toward USD 2,200–2,300/oz and not peak at USD 2,000/oz.

Figure 2 - Gold in 2020 is outperforming 2009 In index terms, 2 January=100

Source: Bloomberg, UBS as of 28 July 2020

The key driver of silver purchases, like gold, remains a steady expansion of ETF holdings linked to silver. Also, managed money holdings of silver futures have started to turn less negative. Given the run-up in the silver price and prospects of even higher prices, we believe managed-money-held short positions will be squeezed further in the coming weeks. Looking at the gold/silver ratio, silver was cheap by historical comparisons in 1H20, with the ratio rising to a record high of 125x. This has largely corrected in recent weeks; the ratio is back in a range of 75–85x (about the 5–10-year average). So with silver no longer being cheap versus gold, we expect the price to move in lockstep with the yellow metal into the year-end.

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We have raised our silver forecasts to reflect a gold/silver ratio in the 75–85x range, supported by our expectation for a pick-up in industrial demand as economic growth recovers (around 60% of silver demand is from industrial applications) and in view of the metal's greater volatility given its smaller market size versus gold.

The collapse in the gold silver ratio is likely to run further, but levels close to 70x are for us rather extreme Weekly data

Source: Bloomberg, UBS as of 28 July 2020

In other areas like the US and Australia, risks actually eased. Hence, we lift our forecast for Australia's crop to 28.5mn tons from 26.5mn due to improving conditions in Western Australia. The USDA also took the market by surprise at the end of June, slashing its US corn area estimate by 2.0mn hectares to 37.2mn. Soybean areas increased to 33.9mn hectares—well below market expectations. Early industry estimates of Brazil's soybeans output are aligned with our forecast of 131mn tons in 2020–21, which is 8% higher than in 2019–20.

Figure 3 - USDA surprised by slicing US corn areas for 2020-21 In % change, from previous estimate

For the PGMs, although platinum's fundamentals remain weak, higher gold prices have lifted the price of the white metal as well. Narrowing of the wide spread versus gold on recovering economic activity in 2021 should, in our view, push platinum up to USD 1,050/oz by mid-2021. Meanwhile, palladium should shift into a deficit market in 2H20. Market tightness in 2H20, thanks to monetary and fiscal stimulus measures, should support palladium prices over the next 12 months. We expect palladium to reach USD 2,500/oz by mid-2021.

Agriculture: Support from Chinese buying and weather Agriculture and livestock indices recovered modestly in July, rising 4%–6% from June. Chinese purchases from the US were one reason for the rebound; political tensions were put aside temporarily, particularly as severe flooding in the southern parts of the country puts upward pressure on animal protein prices. Another reason was weather-related uncertainties in key grain exporters, namely Russia and Argentina, which have reduced wheat crop expectations in affected regions. As a result, we cut our forecast for wheat production in Russia for 2020–21 by 5.0mn tons to 75.0mn.

Source: USDA, UBS as of 28 July 2020

Data on Chinese agricultural purchases continues to dominate headlines, particularly in corn and wheat. The country has historically been self-sufficient in producing both crops. Yet Chinese purchases of US corn for the 2020– 21 marketing year (August–July) already totals nearly 4.0mn tons, the largest commitment since it procured 5.2mn tons back in 2011–12. China also imported a record 11.2mn tons of soybeans in June, which took 1H20 imports to 45.1mn tons (up 18% y/y).

Brazil has been the main origin of purchases this year, though China has purchased around 4.2mn tons of US soybeans for delivery in the next marketing year (September–August), which is the highest level since 2014– 15 and well above the 126,000 tons bought this time last year. We expect China to buy 100–105mn tons of soybeans in 2020–21 (22mn tons in 4Q20 alone from the US). China has ways to go in meeting the total commitment under the Phase 1 trade agreement. While it insists it can meet its obligations, we think China will import USD 26.8bn worth of agricultural products in 2020, which would be around USD 6.5bn short of the agreed amount.

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Figure 4 - China is buying more US farm products, but there is a long way to go In USD billions

Source: China Customs, UBS as of 28 July 2020

In soft commodities, after spot prices touched the lowest level in a year in 2Q20, coffee has led the recovery with the UBS CMCI Coffee Index surging 12% in July. Certified coffee inventories dipped below 1.6mn bags—their lowest level in nearly three years—as the pace of harvest in Brazil lagged the previous two years. We expect price setbacks in the coming months, given post-pandemic consumption remains sluggish and as we forecast a record crop in Brazil. Conversely, we expect cocoa, cotton and sugar prices to rise into the year-end.

In livestock, the UBS CMCI Index rose around 5.5% in July. China's agricultural ministry data highlights sow and hog numbers continue to climb as the country recovers from the African swine fever (ASF). However, recent flooding in the Yangtze River region (about 40% of China's hog production) could slow this recovery, with reports of increased incidence of ASF due to contaminated water. This, reduced freshwater fish availability and lost vegetable production could put further upward pressure on food prices in the coming months. Pork imports to China continue to rise at a rapid pace; we expect imports of 4.0mn tons in 2020 (up from 2mn tons in 2019). We keep livestock as most preferred.

Investment recommendations:

New positions Long commodities– 16 July 2020 (with the release of the global asset class preferences in the UBS House View Monthly Extended) (10% target return, stop-loss at –5%, 12 months)

Accelerating economic growth has historically gone hand-in-hand with very attractive commodity returns. A pick-up in demand and a well-behaved supply side set the tone for cyclical commodity markets to tighten. This should push commodity prices closer to incentive price levels and trigger a price appreciation of broadly diversified commodity indices of almost 15% over 12 months. Broad commodity exposure is likely to come with roll yield costs of around 3%–4% over the same time period and an expected volatility of around 12%. In terms of strategies, we favor second-generation index exposure.

Unlike the CMCI index, the gap between spot and total returns can be materially higher Values standardized to 100, CMCI Index

Source: Bloomberg, UBS, as of 28 July 2020

Long base metals – 29 June 2020 (9% return target, stop-loss at –4.5%, six months) Following China's strong shipments of base metals in recent months, we expect demand to recover further as the industrial recovery broadens, particularly in the developed world. The lack of material increases in visible inventories while metal supply still struggles with residual effects from the COVID-19 pandemic sets the stage for higher prices ahead, in our view, beyond the strong performance of copper. Our recommendation to go long the sector via second-generation commodity indices comes with an expected volatility of 15%.

Yield pick-up strategy in Brent crude oil (8% p.a. targeted return, six months) With an undersupplied oil market expected in 2H20 and throughout 2021, we recommend investors with a high risk tolerance to sell the downside price risks in Brent with a tenor of six months. We advise targetting a yield of 8% p.a. and a strike at or below USD 35/bbl.

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As we expect Brent prices to step higher into 2021, we think selling downside risks is attractive Values in USD/bbl

Source: Bloomberg, UBS, as of 28 July 2020

Open positions Long livestock – 20 May 2020 (15% targeted return, stop loss at – 7%, six months) We maintain our long livestock recommendation for a few reasons. First, the backlog of US hogs should begin to ease as processing continues, which should see overall supplies tighten into the year-end from current elevated levels. Second, floods in China, which are hampering the post-ASF herd rebuilding phase, recent bans on imports from select global processors and recovering domestic consumption should keep available pork supplies in high demand.

Livestock prices have yet to bounce Index values CMCI TR

Source: Wood Mackenzie, UBS as of 28 July 2020

Third, tightening supplies of beef from key exports outside the US, like Australia, should also support cattle prices in the coming months. We forecast a 15% return over six months. Key risks include a breakdown of the Phase 1

US-China trade agreement and new waves of the virus, which could disrupt the supply chain further. Exposure to livestock should be taken via second-generation commodity indices, with exposure across the futures curve.

Long gold – 15 May 2019 (investment theme, target USD 2,000/oz) We believe that gold should continue to benefit from falling real interest rate expectations (TIPS yield going more negative), additional USD weakness and renewed tensions between China and the US. In that context, strong investment demand for gold should push prices even higher. In a broad investment portfolio, we think gold remains an attractive diversifier, particularly for equity-oriented investors.

Yield pick-up strategy in nickel (10% p.a. targeted return, six months) Although the nickel market moved into surplus this year due to COVID-19, recovering demand linked to greater stainless steel output and ongoing supply side risks suggest to us that the nickel market should rebalance into next year. With a marginal deficit emerging next year, nickel prices are likely to be well bid. Moreover, the metal offers an attractive option volatility backdrop versus other base metals. We favor strike levels at USD 12,750/mt.

Option market volatility in nickel remains elevated 6-month ATM option market volatility

Source: Bloomberg, UBS, as of 28 July 2020

Yield pick-up strategy in precious metals (5%–7% p.a. targeted return, three and six months) With the sharp move higher in prices across precious metals, our expected return has diminished somewhat. However, given our positive view on precious metals and the recent

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pick-up in option volatility, investors can continue to sell the downside price risks. For gold, we target a yield of around 5% p.a, strike levels at USD 1,850/oz, and tenors of three months. For silver, we target a yield of 7% p.a., strike levels at or below USD 21/oz, and tenors of six months. For platinum, we target a yield of 6% p.a., strike levels at USD 875/oz, and tenors of six months.

There is still some value left in option volatility across the sector 3-month ATM option volatility

Source: Bloomberg, UBS, as of 28 July 2020

Closed recommendations – follow-up guidance We expect lead prices to recover further as vehicle sales recover into 2021 Values in USD/mt

Source: Bloomberg, UBS, as of 28 July 2020

Lead: Investors who sold the downside price risks in lead from USD 1,795/mt to USD 1,885/mt should hold their positions until maturity and target a price reversal toward

their initial strike levels, in case lead prices trade below their respective strike level.

Brent crude oil: We reiterate our guidance for investors that followed our recommendation and sold the downside risks in Brent crude oil for a yield pick-up at USD 50/bbl. We advise investors to hold on to their positions until expiry and target an oil price above USD 50/bbl over the next 12 months.

Forecast changes

Our main changes relate to base and precious metals, while we have only selectively adjusted our guidance for agriculture and livestock.

In base metals, we have added a bit more upside to aluminum prices: new price top set at USD 1,875/mt, versus USD 1,750/mt previously. This move lends greater weight to LME prices catching up with Chinese prices. It also considers the possibility of a more muted supply response next year (mainly ex-China) and demand coming back firmly. For nickel, we have rolled forward our end-December forecast to end-September and gave the metal a bit more upside in 1H21 to USD 15,000/mt from USD 14,500/mt. With this move, we wanted to indicate that potential mine supply challenges can give the metal more upside. Moreover, we seek greater alignment with our economic growth outlook over the next 12 months (growth to peak in 2Q21).

We have also lifted the guidance for zinc and lead to reflect our expected economic trajectory better. For lead, given our expectation for better vehicle sales, we have raised our guidance further and set the price peak at USD 1,975/mt versus USD 1,925/mt previously. For zinc, given tightness in the raw material market and infrastructure investment likely to gear up and the associated positive knock-on effects, we have shifted our forecasts up across all tenors to USD 2,400/ mt from USD 2,200/mt in 2H20 and USD 2,300/mt in 1H21.

Our forecast changes for base metals

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Source: Bloomberg, UBS as of 28 July 2020

For precious metals, we have lifted our gold forecasts to USD 2,000/oz at end-September and end-December (from USD 1,900/oz), USD 1,950/oz at end-March 2021 (USD 1,850/ oz) and USD 1,900/oz at end-June 2021 (USD 1,800/oz) (see “Gold: Calling for 2,000” on 23 July). As such, we have lifted our silver forecast to USD 26/oz at end-September, end-December and end-March (from USD 20/oz, 21/oz and USD 21/oz, respectively), and USD 24/oz at end-June 2021 (USD 20.5/oz). We expect the gold-silver ratio to range between 75–85x over the next six and 12 months. While silver prices have outperformed gold lately, silver is no longer cheap compared to gold, so we expect prices to move more in lockstep with the yellow metal from here.

To align with the gold view, we have also increased our platinum forecasts to USD 975/oz at end-September and end-December this year (from USD 850/oz), USD 1,025/oz at end-March 2021 (USD 950/oz), and USD 1,050/oz at end-June 2021 (USD 950/oz). For palladium, we have marked-to-market our near-term forecasts—end-September to USD 2,300/oz (vs. USD 2,000/oz) and end-December to USD 2,400/oz (USD 2,200/oz)—and reiterate our long-term bullish forecasts (2021 targets unchanged).

Our forecast changes for precious metals

Source: Bloomberg, UBS as of 28 July 2020

In agriculture, we have made minimal changes to our forecasts overall. We have trimmed the corn forecast by USD 0.25/bu for end-September, end-December and end-March 2021 to USD 3.25/bu (from USD 3.50/bu), but left the

end-June 2021 view unchanged at USD 3.50/bu. While US weather remains a risk in this year's US corn crop, moisture conditions have improved of late. We expect a lift in prices around mid-next year on lower planted areas and a recovery in ethanol demand.

We have lifted our wheat forecasts by USD 0.25/bu to USD 5.0/bu at end-September to account for downgrades to Russian and Argentinean production. We have raised the palm oil price to MYR 2,750/ton at end-September (from MYR 2,250/ton) and to MYR 2,500/ton at end-December (MYR 2,250/ton). Pandemic-related labor shortages in Malaysia and Indonesia, as well as disruptions due to heavy rainfall and strengthening exports, could see inventories drop further in the coming weeks.

Our forecast changes for agriculture

Source: Bloomberg, UBS as of 28 July 2020

In livestock, we have moved up our live cattle forecasts by USD 0.05/lb to USD 1.05/lb at end-September and USD 1.10/lb at end-December. This increase accounts for a faster recovery in US processing than we had expected and stronger seasonal demand patterns into the year-end.

Our forecast changes for livestock

Source: Bloomberg, UBS as of 28 July 2020

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Forecast table

Source: Bloomberg, UBS, as of 29 July 2020; Forecasts refer to end of period; Abbreviations: Hist. Vol. = Historical volatility, Act Fut. = Active Futures, ESM = Expected spot return in %,

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Commodity markets

Appendix

UBS Chief Investment Office's ("CIO") investment views are prepared and published by the Global Wealth Management business of UBS Switzerland AG (regulated by FINMA in Switzerland) or its affiliates ("UBS"). The investment views have been prepared in accordance with legal requirements designed to promote the independence of investment research. Generic investment research – Risk information: This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein does not constitute a personal recommendation or take into account the particular investment objectives, investment strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions. Different assumptions could result in materially different results. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness (other than disclosures relating to UBS). All information and opinions as well as any forecasts, estimates and market prices indicated are current as of the date of this report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of using different assumptions and/or criteria. In no circumstances may this document or any of the information (including any forecast, value, index or other calculated amount ("Values")) be used for any of the following purposes (i) valuation or accounting purposes; (ii) to determine the amounts due or payable, the price or the value of any financial instrument or financial contract; or (iii) to measure the performance of any financial instrument including, without limitation, for the purpose of tracking the return or performance of any Value or of defining the asset allocation of portfolio or of computing performance fees. By receiving this document and the information you will be deemed to represent and warrant to UBS that you will not use this document or otherwise rely on any of the information for any of the above purposes. UBS and any of its directors or employees may be entitled at any time to hold long or short positions in investment instruments referred to herein, carry out transactions involving relevant investment instruments in the capacity of principal or agent, or provide any other services or have officers, who serve as directors, either to/for the issuer, the investment instrument itself or to/for any company commercially or financially affiliated to such issuers. At any time, investment decisions (including whether to buy, sell or hold securities) made by UBS and its employees may differ from or be contrary to the opinions expressed in UBS research publications. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. 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