Commodities, inflation and interest rates

Commodities, inflation and interest rates
Part 1: Where will the commodity markets go from here?
News from the financial markets | February 11, 2011

Commodities, inflation and interest rates
Part 1: Where will the commodity markets go from here?
Bernhard Allgäuer, Senior Investment Strategist, and Rolf Kuster, Investment Strategist
Prices for agricultural commodities have risen almost
70% within the space of a year. Foodstuffs are
becoming more expensive throughout the world.
Recently, the price of oil breached the 100 dollar
mark once again – albeit only for Brent crude and
not WTI. People in the emerging and developing
nations are being particularly hard-hit by this
situation. In those countries, food represents up to
50% of the statistical shopping cart versus 14% in
Europe.
Various causes are behind the price increases in the
individual commodities. Weather-related crop
failures last year were the main reason for higher
food prices, so if production normalizes this year,
the agricultural (“soft”) commodity markets are
likely to calm down. The lofty price of oil is high
mainly attributable to strong demand. For the time
being, we expect to see both markets trending
sideways at high levels.
In several days’ time, we will discuss the effects
these developments should have on inflation in Part
2 of our report series «Commodities, inflation and
interest rates». We will then offer our summarized
considerations for bond investors immediately after
this three-part series is concluded.
Supply shortage and agricultural produce prices
500
450
400
350
300
250
200
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11
Forest fires Russia/export ban Drought China
Flood Australlia DJ UBS Agriculture (SP)
Source: VP Bank, Bloomberg
High prices due to lack of supply
Prices for agricultural produce have been on the rise
since last summer. The cost of wheat and corn has
almost doubled. According to UN statistics, global
foodstuff prices at present are roughly 8% above the
highs reached in the summer of 2008 and
approximately 80% higher than the average for the past
ten years. This rapid price increase becomes all the
more problematic the lower the per capita income is of
a given populace: the proportion of their disposable
income that has to be spent on food of course
increases.
Rising incomes and positive population growth spur the
demand for foodstuffs. Moreover, higher incomes lead
to increased meat consumption, which in turn
necessitates a larger supply of grain for feeding
livestock. In the past, this demand was
overcompensated through higher yields per cultivated
land area. Over the years, the relative prices for
foodstuffs in the industrialized nations have been falling
continuously. We are going on the assumption that the
same trend will evolve also in the emerging and
developing countries. However, in the case of certain
products such as bioethanol, state-sponsored
production boosting measures have led to distortions.
The major reason for the recent price increases lies in
the weather-related shortage of supply. According to
US Department of Agriculture estimates, roughly 2.2
billion tons of wheat, corn and rice will be harvested
worldwide this year – that would be 2 to 3% less than
last year.
Corn price and inventories (in days)
2/5 | Commodities, inflation and interest rates: Part 1 – Where will the commodity markets go from here?| February, 2011 | Economics & Investment Office
Corn price (Cents/Bushel)
800
700
600
500
400
300
200
100
0
current
10 30 50 70 90 110 130
Inventory (in days)
Source: VP Bank, Bloomberg

The supply situation with wheat appears to be
particularly dramatic. Here, a decline of close to 6% is
anticipated. Simultaneously, global demand for wheat
is increasing and as a result inventories are being
depleted even more. In terms of corn, the US reported
this past week that inventories are currently at their
lowest level in 15 years.
For now, however, we consider this situation to be a
temporary one. The droughts or forest fires in Russia,
the USA and China are causing merely a short-term
supply shortage. The high prices for agricultural
produce will also lead to an expansion of production in
other places, thereby limiting the potential for further
price increases. China has already announced that it
will make available the equivalent of USD 2 billion for
the expansion of farm production.
Agricultural produce prices and consensus forecasts
1'800
1'600
1'400
1'200
1'000
800
600
400
200
-
2006 2007 2008 2009 2010 2011 2012
Wheat (USd/bu.) Soybeans (USd/bu.) Corn (USd/bu.)
Source: VP Bank, Bloomberg
Most analysts concur that the recent price
developments in the soft commodity markets represent
a short-term phenomenon. For the year ahead, they are
looking for price declines in corn (down 13%), wheat
(down18%) and soybeans (down 12%).
Agricultural produce prices
3/5 | Commodities, inflation and interest rates: Part 1 – Where will the commodity markets go from here?| February, 2011 | Economics & Investment Office
260
240
220
200
180
160
140
120
100
2006 2007 2008 2009 2010 2011
Source: VP Bank, Bloomberg
UNO Food Price Iindex VP Bank Forecast
We expect to see a volatile sideways trend evolve in the
coming months. A buildup of strategic reserves or
enactment of new rules governing futures trading could
lead to market distortions, but for the medium to long
term, we anticipate that prices will ease. Natural
disasters, of course, can always trigger temporary price
spikes also in future years.
Economic growth is boosting the price of oil
In the crude oil market, there is a completely different
situation. On the supply side, full storage tanks and free
production capacity are being reported. Strong
demand, especially from the booming emerging
nations, has been the cause of the anticipated price
increases in recent months. According to OPEC, global
demand as of last December stood at 90 million barrels
per day (bpd), approximately 2% higher than the precrisis
level.
Global crude oil demand and price trend (benchmark, WTI)
160
140
120
100
80
60
40
20
0
2006 2007 2008 2009 2010
Global oil demand (mio bbl/day, rhs) Oil price (USD)
Source: VP Bank, Bloomberg
91
90
89
88
87
86
85
84
83
82

The upside price potential for crude oil is severely
limited:
• Since the last reduction of its daily production quota
in December 2008, OPEC has kept its daily output
unchanged at 25 million bpd. In the meantime, the
heightened demand has been satisfied by non-
OPEC countries such as Russia and Brazil. Because
many OPEC members are already exceeding their
quotas, it is likely that an official quota increase will
be announced in June.
• Given America’s reasonably buoyant economy, it is
improbable that the Fed will inject even more dollar
liquidity into the system. That will also drain fuel
from the commodity markets.
• The dollar is stable.
• Inventories are high.
• Monetary policy tightening in Asia is preventing a
further acceleration of growth in the commodityintensive
economies.
• For year’s end, we are currently reckoning with a
crude oil price of between USD 85 and105.
VP Bank crude oil forecast (WTI)
160
140
120
100
80
60
40
20
0
Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Feb-11
Source: VP Bank, Bloomberg
VP Bank (Min & Max) Oil price (USD)
The bottom line:
The price of oil has adapted to the economic
conditions. Over the medium term, we expect to see
sideways trading in a range of USD 85–105. In terms of
the soft commodities, the upcoming harvest season will
dictate further price developments. The recent
increases have mainly been the result of special factors.
The related effects on inflation and inflation
expectations will be addressed in our next issue of
«News from the financial markets».
4/5 | Commodities, inflation and interest rates: Part 1 – Where will the commodity markets go from here?| February, 2011 | Economics & Investment Office

Contact
Economics & Investment Office
Tel +423 235 65 44
investment@vpbank.com
www.vpbank.com
Disclaimer
This publication has been prepared by our employees using sources that we regard as reliable. We have exercised the utmost care in the
production of this publication, which is intended solely for your information. However, we can offer no guarantee or assurance regarding the
completeness, accuracy or current correctness of its contents.
In particular, the information contained in this publication does not constitute an offer, an invitation to make an offer or a public advertisement
inviting participation in transactions or other business activities involving the products and/or services described herein.
Regarding the risks that you should be aware of when availing yourself of products and/or services described in this publication, we refer you to
the relevant descriptions of the risks involved, e.g. the booklet entitled "Risks in Securities Trading” published by the Liechtenstein Bankers’
Association, and recommend that you seek the advice of a qualified specialist (client advisor). We expressly refuse to accept any liability for any
losses or detriment which are claimed to have been incurred on the basis of information contained in this publication regarding products and/or
services.
The contents of this publication are protected by copyright. Any utilization other than private use requires our prior authorization.
© Verwaltungs- und Privat-Bank Aktiengesellschaft - Tel +423 235 66 55 - Fax +423 235 65 00
LI-9490 Vaduz - Aeulestrasse 6 - Liechtenstein - MwSt.-Nr. 51.263 - Reg. No. FL-0001.007.080 info@vpbank.com - www.vpbank.com
5/5 | Commodities, inflation and interest rates: Part 1 – Where will the commodity markets go from here?| February, 2011 | Economics & Investment Office