Global Metals Playbook, 3Q 2011 by al ng

MORGANSTANLEYRESEARCH

Global Metals and Mining Team July 26, 2011 Preferred commodity exposures by sector: Research Research Global Global

Global Metals Playbook: 3Q11 Navigating heightened risk aversion  Policy tightening measures in emerging markets, natural disasters

in Japan, a below trend recovery in the US, a persistent sovereign debt crisis in the Eurozone, and surging oil prices have provided major challenges to investors in commodities in 2Q 2011.  Despite a marked reduction in investor positioning in this sector,

continuing developed market growth concerns, and a lack of resolution to the debt crisis in Europe, we believe the resilience of commodity prices in 2Q has been fundamentally supported by evidence of real physical buying at the lower end of trading ranges, an end to destocking in China, a range of supply constraints, and continued weakness in the US currency. We expect this resilience to continue in 2H 2011 and 2012.  We retain our conviction that underlying growth and challenges in

the supply chain will deliver rising prices into 2012. However, we have become more selective in our recommended exposure across the metals and bulk commodity space in response to this complex set of developments. In base metals, copper remains our most favoured exposure, followed by tin and aluminium. In bulk commodities, our liking for iron ore is undiminished, and we have upgraded our outlook on the thermal coal market.

Our favoured exposures by sector are • Base metals – copper, tin and aluminium • Precious metals – gold and silver • Bulks – iron ore and hard coking coal • Mined energy – thermal coal The impact of the Japanese nuclear crisis and unexpectedly strong production in China have reduced our liking for uranium and nickel. Highest-conviction Overweight equities: • Mechel • AngloGold Ashanti • Alcoa Inc • Vale • Newcrest Mining • Freeport McMoRan

Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision.

 In precious metals we have made major upward revisions to

For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.

our forecasts for gold and silver as enhanced risk from the contagion effects of the debt crisis in Europe, continued uncertainty over US debt ceiling negotiations and the possibility of renewed QE, drive investor demand.

+= Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Table of Contents Top Picks Summary Economic Outlook Key Sector Themes Key Changes Commodities Outlook

4 5 13 15 18 Steel and Bulk Commodities

Base Metals Aluminium & Alumina

Steel

Copper

Iron Ore

Lead

Met Coal

Nickel

Manganese Ore

Tin

Zinc

Precious Metals Gold

Silver

Platinum Group Metals 50

Mined Energy Thermal Coal

Uranium

Other Metals Rare Earths

- Platinum

Zircon

- Palladium

Titanium Dioxide

- Rhodium

Top Equity Ideas Mechel Dmitriy Kolomytsyn AngloGold Ashanti Simon Kendall Alcoa Inc Paretosh Misra Vale Carlos de Alba Newcrest Mining Brendan Fitzpatrick Freeport McMoRan Paretosh Misra

86 87 88 89 91 92

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Global Commodities Team Global Metals & Mining (Australia)

Latin America Steel, Metals & Mining, Pulp & Paper (New York/S達o Paulo/Mexico)

Peter Richardson 6+

61 3 9256 8934

Carlos de Alba 1

1 212 761 4927

Joel Crane 6+

61 3 9256 8961

Bruno Montanari 2+

55 11 3048 6225

Alfonso Salazar 2+

52 55 5282 6745

EMEA Metals & Mining, Steel (London) Alain Gabriel 3+

44 (0)20 7425 8959

Asia Oil & Gas Coal (Hong Kong) Wee-Kiat Tan 5+

EMEA Metals & Mining, Steel (Moscow) Dmitriy Kolomytsyn 9+

7 (495) 287 2309

Kirill Prudnikov 9+

7 (495) 287 2314

852 2848 7488

Sara Chan 5+

852 2848 5292

Josh Du 5+

852 2239 7593

Japan Metals & Mining, Steel (Tokyo) EMEA Metals & Mining, Steel (Johannesburg)

Harunobu Goroh 7+

81 3 5424 5343

Simon G. Kendall 10+

27 11 282 4932

Akira Morimoto 7+

81 3 6422 8650

Leigh Bregman 10+

27 11 282 8969

Leigha Miyata 7+

81 3 6422 8671

Christopher Nicholson 10+

27 11 282 1154

Li Luo 5+

86 21 2326 0032

Australia Metals & Mining, Steel (Melbourne/Sydney)

Global Commodities (New York)

Cameron Judd 6+

61 3 9256 8904

Hussein Allidina 1

1 212 761 4150

Brendan Fitzpatrick 6+

61 2 9770 1148

Adam Longson 1

1 212 761 4061

Sarah Lester 6+

61 3 9256 8436

Christopher Corda 1

1 212 761 6005

Tai Liu 1

1 212 761 3585

Bennett Meier 1

1 212 761 4967

India Metals & Mining, Steel (Mumbai) Vipul Prasad 4+

91 22 6118 2238

Ketaki Kulkarni 4+

91 22 6118 2239

Ritish Rangwalla 4+

91 22 6118 2258

Non-Japan Asia Metals & Mining (Singapore/Hong Kong) Charles Spencer (team leader) 11+

65 6834 6825

Mean Phil Chong 11+

65 6834 6194

John Lam 5+

852 2848 5412

Aishwarya Narayanan 5+

852 2239 7810

1 Morgan Stanley & Co. Incorporated 5 Morgan Stanley Asia Limited 9 OOO Morgan Stanley Bank

2 Morgan Stanley C.T.V.M. S.A.

North America Metals & Mining, Steel (New York) Evan L. Kurtz 1

1 212 761 7583

Paretosh Misra 1

1 212 761 3590

Wes Sconce 1

1 212 761 6004

3 Morgan Stanley & Co. International plc

6 Morgan Stanley Australia Ltd

7 Morgan Stanley MUFG Securities

4 Morgan Stanley India Company Private Limited 8 Morgan Stanley Taiwan Ltd

10 RMB Morgan Stanley (Proprietary) Ltd

+ Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.

11 Morgan Stanley Asia (Singapore) Pte.

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Stock Picks

Global Highest Conviction Equity Overweights

Mechel

Highest upside potential

AngloGold Ashanti

Compelling internally funded broad-based project portfolio to grow by 1moz pa by 2014 (to 5.5moz), grow reserves, and move down the cost curve into the second quartile.

Alcoa Inc

Leverage to aluminium / alumina and economic recovery

Vale

Cheap leverage to iron ore and growing exposure to other preferred commodities

Newcrest Mining

Provides the first quartile mine life, growth rates, and cash costs among large-cap gold companies

Freeport-McMoRan

Exposure to copper and under-appreciated brownfield growth at attractive cost

200% 150% 100%

81%

BULL 46%

50%

40%

29%

20%

17%

BASE

current price

-50% B EAR

-100% M echel

AngloG old Ashanti

Prices as of July 21, 2011. Source: FactSet, Morgan Stanley Research

Alcoa

Vale

Newcrest

Freeport M cM oRan

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Economic Outlook

Industrial production growth rates have moderated, not collapsed



Global outlook: The global purchasing managers’ index (PMI), a leading indicator of industrial production (IP), fell to a 23-month low of 52.3 in June 2011, but the index has remained above the neutral 50 level for 24 consecutive months, indicating resilience in the key demand proxy for industrial metals.



Key index components, such as manufacturing, new domestic orders, and export orders, also eased to their lowest levels since the post-crisis expansion began in June 2009, but the rate of input price inflation fell to a ten-month low in June 2011 to 60.8, some 15 points below the two-and-a-half year high recorded in February 2011.



While this moderation in leading indicators of IP reflects, in our view, the combined impact of Chinese policy tightening measures, higher oil prices because of political unrest in the Middle East and North Africa (MENA), and the initial severe disruption to industrial output caused by the Tohoku earthquake and tsunami in Japan, the fall in input pricing pressures indicates to us an increased scope for easing policy constraints, with the prospect of a modest rebound in PMI indicators in 4Q 2011 and 2012.



After absorbing these growth shocks, at current levels the Global Manufacturing PMI is still consistent with global industrial production expanding at an above trend rate of growth of 5-6% saar. We see this as consistent with a successful but volatile transition to an above trend mid-cycle growth phase that is positive for the demand outlook for metals and bulk commodities. This view is represented by our projected real global IP growth of 5.5% pa in 2011 and 2012.

Global Industrial Production, 2001-16e China India Japan South Korea Russia Canada US Germany UK Global

2001 9.7 2.7 -6.6 0.3 2.9 -4.0 -3.4 -0.2 -1.5 1.0

2002 12.7 4.9 -1.3 8.2 3.2 1.6 -0.1 -1.3 -1.6 2.9

2003 16.7 6.6 3.0 5.4 9.5 0.1 1.3 0.2 -0.7 4.6

2004 16.3 8.5 4.8 10.1 8.1 1.6 2.5 2.5 1.1 5.7

2005 15.9 7.9 1.5 5.9 5.1 2.0 3.2 2.9 -1.3 5.3

2006 16.4 10.6 4.2 9.2 6.4 -0.6 2.2 5.8 0.0 5.8

2007 17.5 9.9 2.9 7.0 6.9 -0.8 2.7 5.9 0.1 5.5

2008 12.9 4.9 -3.4 3.3 0.6 -5.6 -3.3 0.0 -3.1 2.2

2009 11.0 6.7 -21.9 -0.8 -9.3 -10.7 -11.2 -15.5 -10.1 -2.6

2010e 15.3 11.1 16.5 16.6 8.3 6.2 5.3 10.1 3.6 7.3

2011e 14.0 8.5 -0.6 7.5 4.6 4.4 4.7 5.0 3.5 5.5

2012e 12.8 8.8 8.6 6.4 6.2 4.4 4.4 4.0 2.6 5.5

2013e 12.5 8.5 2.3 6.4 6.2 2.7 4.5 2.9 1.8 5.2

2014e 12.5 9.0 2.5 6.2 6.9 2.8 3.0 2.3 1.2 4.9

2015e 11.4 6.8 2.6 5.3 4.8 2.5 2.5 2.8 0.7 4.5

2016e 11.2 6.3 2.1 5.2 4.1 2.5 2.3 2.5 0.6 3.6

e = Morgan Stanley Research estimates. Source: IMF, Wood Mackenzie Brook Hunt, Morgan Stanley Research 5

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Economic Outlook

2Q 2011 growth headwinds are abating…

• In our view, growth and associated demand prospects for industrial commodities have moderated but not collapsed in the face of some significant headwinds, notably: • China, India, and Brazil have focused on demand management in response to a strong cyclical rise in food and energy prices. • Higher oil and food prices and fiscal consolidation have also constrained demand for consumer goods in developed economies, while a softer export environment in the periphery of Europe and Emerging Markets has reduced the rate of export growth from major developed economies. • The major earthquake and tsunami in Japan in March disrupted the global manufacturing supply chain, especially in autos, electrical, and information technology, and strongly impacted domestic power generation. • US output has also been impacted by a sluggish and disappointing labour market, continued weakness in the residential construction market, adverse weather in the Midwest and the second-order effects of disruption to the Japanese supply chain. • In the face of these developments, we are forecasting IP growth rates of 5.5% in 2011 and 5.5% in 2012, down from 7.3% in 2010.

MG Metals Index vs. global manufacturing PMI 65.0

500

60.0

450

55.0

400

50.0

350

45.0

300

40.0

250

35.0

200

30.0 Jan-06

150 Jan-07

Jan-08

Jan-09

Global Manufacturing PMI (LHS)

Jan-10

Jan-11

MG Metal Index (RHS)

Global and regional manufacturing PMIs 65.00 60.00 55.00 50.00 45.00 40.00 35.00 30.00 25.00 Jan-04 Global Japan

Jan-05

Jan-06

Jan-07

US ISM Germany

Jan-08 China Brazil

Jan-09

Jan-10

Jan-11

Eurozone

Source: Thomson Reuters, Markit Economics, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Economic Outlook

…lifting demand prospects into 2012

• In developed markets, signs of normalisation in Japanese output are increasing (see page 10), German exports are continuing to benefit from a weaker euro against the backdrop of the sovereign debt crisis, and US manufacturing production and exports improved again in June after the sharp and unexpected drop in May, as oneoff weather and Japanese supply chain effects abated and lower oil prices increased consumer spending. • In key emerging markets, we are close to the peak of the policy tightening cycle in our view, despite inflationary pressures in the Asian region remaining persistently strong, as higher base effects in 2H 2010 are expected to result in reduced inflation readings going forward. •This is reducing the risk of a policy induced hard landing and raising the prospect of moderately higher rates of consumption in 2H 2011, in our view, especially as the destocking cycle in China also comes to an end. • For example, bonded warehouse stocks of copper in Shanghai are estimated to have fallen from around 650Kt at the peak of the destocking cycle to 300Kt in mid-July, while duty paid stocks of copper and aluminium have both fallen by 50% from their 2011 peaks. • This development is already triggering renewed physical buying of these metals by fabricators and other consumers, and resulted in June in the first rise in refined copper imports in China for more than six months.

Developed market industrial production and the US ISM 40.0

yoy % chg

Index

30.0

65.0 60.0

20.0

55.0

10.0 50.0 0.0 45.0 -10.0 40.0

-20.0

35.0

-30.0 -40.0 Jan-97

30.0 Jan-99

Jan-01

US IP

Jan-03

Jan-05

Japan IP

Jan-07

Jan-09

EU IP

Jan-11

US ISM (RHS)

AXJ short-term interest rates and policy rates 7.5

Nominal interest rates (%)

Real interest rates (%)

5 4

6.5

3 5.5

2 1

4.5

3.5

-1 2.5

-2

1.5 Jan-03

-3 Jan-04

Jan-05

Jan-06

Jan-07

AXJ Nominal Interest Rates (LHS)

Jan-08

Jan-09

Jan-10

Jan-11

AXJ Policy Rates (LHS)

AXJ Real Interest Rates (RHS)

Source: CEIC, Thomson Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Economic Outlook

China – a soft landing but not the beginning of policy easing

• The signs of a soft landing in China are increasing, with June IP at 15.1% and 2Q 2011 GDP at 9.5%, a greater emphasis on input cost management also highlighted by the decision in June 2011 to reduce import tariffs on a number of key commodities, and monetary conditions continuing to be growth supportive. • New loan creation in June at Rmb634bn was consistent with an undisclosed loan growth target for 2011 of Rmb7trn, a figure that is simultaneously growth supportive but inflation restrictive. Deposit growth also rebounded in June, to 17.6% from 17.1% in May, on the back of a notable jump in household deposits. As a result, M2 money supply growth unexpectedly jumped to 15.9% in June from 15.1% in May • Furthermore, the widely expected 25bps rate hike to 6.56% on 6 July 2011 was not enough to reverse the expansive real interest rate environment following the headline CPI rate of 6.4% reported in June. • The CPI may have peaked in June and will likely soften during the remainder of 2011 as a more favourable base effect from 2010 becomes apparent. This should provide the basis for nominal interest rate stability in the context of a prudent monetary policy designed to deliver “stability, accuracy and flexibility.” • Importantly for commodity markets, an analogous interest rate pause between October 2004 and April 2006 saw global manufacturing PMIs (a leading indicator of industrial production) exhibit material improvement, helping lift commodity prices.

Chinese leading indicators, 2005-2011 yoy % chg

yoy % chg

10.0

40.0

8.0

35.0 30.0

6.0 25.0 4.0 20.0 2.0 15.0 0.0 -2.0 Dec-05

10.0 5.0 Dec-06 CPI (LHS)

Dec-07

Dec-08

FAI (RHS)

Dec-09

Dec-10

New Loans (RHS)

Global PMIs vs. Chinese interest rate, 2004-2011

Source: Markit Economics, Thomson Reuters, Bloomberg, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Economic Outlook

IEA intervention has eased growth risks from high oil prices…

• The rise in oil prices because of political unrest in MENA since February has posed a major threat to the US and European recoveries, and represented a significant policy challenge and growth risk in Emerging Markets (EM). • This is because supply-driven increases in oil prices act as a rationing device on demand for oil and related energy products, which in turn can inflict collateral damage on economic activity. • Similarly, supply- or demand-driven increases in oil prices also pose an inflation risk, which can have second-order growth effects through policy tightening responses to CPI increases. • The growth risk from higher oil prices appears greater in developed markets, where consumers and companies are still recovering from the impact of the Global Financial Crisis and governments are burdened by a significant increase in public sector debt, while a number of EM governments have put in place measures designed to cushion the impact of higher prices. • Seen in this context, the decision by the International Energy Agency (IEA) to release 60Mbbls of oil from strategic stocks, which acted as a circuit breaker to the trend of rising oil prices and a widening Brent premium over WTI, is significant. • While replacing only a portion of lost Libyan oil production (estimated at 132Mbbls between February and late June), its timing in conjunction with increased output from the members of the Gulf Cooperation Council (GCC), was designed to not only replace lost production from Libya but explicitly address growth risks from high prices in both developed and developing economies.

WTI vs. Brent oil prices, 2011 130

IEA releases 60m barrels

US$/bbl

120

Libya unrest begins

110 100 90 80 Jan-11

Feb-11

Mar-11

Apr-11

May-11

WTI

Jun-11

Jul-11

Brent oil

IEA announces 60m barrel oil release, June 2011 Japan / South Korea 20% US 50%

Europe 30%

Source: IEA, Bloomberg, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Economic Outlook

…and eased market fears on US growth as QE2 ends

• The timing of the release of strategic oil stocks from the IEA and higher production from the GCC is also an important clue regarding the broader strategic significance of these actions. • In the first instance, these developments were directly designed to confront the economic consequences of the failure of the 8 June 2011 meeting of OPEC to agree on measures to increase output at a time when leading indicators of economic growth in developed markets were slowing rapidly. • At the same time, the IEA decision on 23rd June came in the same week that the US Federal Reserve all but ruled out another round of Quantitative Easing (QE) after the expiry of QE2 at the end of June. • Directly, the prospect of increased supplies of oil, especially much scarcer light sweet crude, provided the prospect of immediate relief to consumers at a time of uncertainty over growth prospects in the absence of the Fed’s active stimulatory measures. • Indirectly, the combined effect of lower oil prices (WTI fell more 6% and Brent by 8% on the news of the IEA move) and the withdrawal of an incentive to commodity investors to take on additional risk as a result of access to cheap money holds out the prospect of a reduced speculative element in the crude oil price as well as an upside cap on prices. • Consequently, we view the IEA/GCC intervention as an important positive in sustaining the outlook for global and US growth at a time of considerable uncertainty and anxiety in global financial markets. IEA Strategic Stock Releases and Crude Oil Price History, 1973-2011 US$ per barrel

140 120

Gulf War: 2.5m barrels/day made available

100

140

Hurricane Katrina: 60m barrels made available

120 100

IEA releases 2m barrels/day over 30 days, following Libyan uprising

20 0 1973

1977

1981

1985

1989 WTI (Real)

Source: Thomson Reuters, Financial Times, Morgan Stanley Research

1993

1997

2001

2005

40 20 0

2009

WTI Crude Oil (Nominal)

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Economic Outlook

Japanese “revival demand” likely to appear from 2012 as well

PMI (LHS)

metals

Fabricated

General

machinery

Electrical

machinery

Transport

equipment

Pulp & paper

Iron & steel

(Overall

Manufacturing)

Chemicals

metals

Non-ferrous

electronics

communication

& devices

Information &

Electronic parts

Significant inventory build-up across industries • According to recent industrial production and manufacturing PMI ( S . D . ) 3 .0 readings, Japan’s industrial sector has rebounded strongly 2 .5 following the March earthquake and tsunami. Output is now 2 .0 growing at the fastest rate since February, largely due to a sharp 1 .5 moderation in supply-side pressures. 1 .0 0 .5 • Despite this encouraging development, “revival demand” will 0 .0 appear predominantly in 2012, in our view, not earlier. This is because domestic and export demand remains subdued, resulting - 0 . 5 -1 .0 in high and increasing inventory levels. Short-term downward pressure on industrial production will occur unless shipments recover quickly. • At the present time, power shortages continue to impact Source: METI, Morgan Stanley Japan Economic Research production. Only a third of Japan’s nuclear reactors are in Note: Deviation from Sector's Historical Mean of Inventory Ratio (Inventories/Shipments) operation, which is likely to further test the summer electricity Japan’s manufacturing PMI vs. export growth demand peak, while coal-fired generation is still recovering. yoy % chg 60.0 65.0 • Morgan Stanley’s Japan Autos team anticipates normal auto production will resume only from 4Q 2011. Production started to 60.0 40.0 recover in May, earlier than initial market expectations, but 55.0 production has still not returned to pre-quake levels. 20.0 50.0 • The Japan Economics team has revised IP forecasts upward for 0.0 45.0 Japan in 2011 to -0.6% (from -10.4% following the earthquake) to reflect this recovery profile, but have moderated their 2012 40.0 -20.0 forecasts to + 8.6% (from +17.6% previously). 35.0 • Despite these timing changes, these developments support our -40.0 30.0 view that solid and sustainable demand for commodities in Japan is returning and that the negative global supply chain effects of the -60.0 25.0 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 March earthquake and tsunami are fading. Export growth (RHS)

Source: Markit Economics, Thomson Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Economic Outlook

Currencies will again be a major issue for commodities markets

• The prospects for continuation of a weaker euro as a result of the difficulties facing EU authorities in producing a comprehensive solution to the sovereign debt crisis would ordinarily be problematic for commodities, as it would imply a strengthening US dollar. • However, we expect anticipated euro weakness will be less positive for the US dollar compared with previous episodes of euro weakness, as concerns about the sustainability of the US recovery after the expiry of QE2 and risks of a sovereign debt downgrade in the event that a credible long-term debt reduction plan is not agreed by the US Congress, may limit upside to the US currency. • These rating and growth concerns are also likely to sustain flows into other perceived safe-haven currencies such as the Swiss franc and the Japanese yen (the so-called surplus currencies) rather than encourage a flight to safety in the US dollar in the event of heightened risk aversion in financial markets. • If risk aversion declines, we expect currency strength to be reflected also in high-yielding commodity currencies, such as the Canadian and Australian dollar. In this case, continued strength in producer currencies will sustain strong upward cost pressures already evident in these jurisdictions and enhance negative currency translation effects on producer margins. • Any renewal of QE in the US would also put renewed downward pressure on the trade-weighted index (TWI) of the US dollar due to the lowering effects of Federal Reserve bond purchases on long-term interest rates. • Any return to QE would also encourage greater risk taking through a revival in the US dollar carry trade, with upside implications for US dollar priced commodities.

USD/EUR cross rate, 2006-2011 1.70 1.60 1.50 1.40 1.30 1.20 1.10 1.00 Jan-2006

Jan-2007

Jan-2008

Jan-2009

Jan-2010

Jan-2011

USD TWI vs. USD/CHF, 2006-2011 90

1.30 1.20

1.10 80 1.00 75 0.90 70

0.80

65 Jan-2006 Jan-2007 Jan-2008 Jan-2009 USD Trade weighted index (LHS)

0.70 Jan-2010 Jan-2011 CHF/USD (RHS)

Source: Bloomberg, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Sovereign debt issues will be good for safe-haven commodities

• The likelihood of continued uncertainty in financial markets regarding the resolution of European and US sovereign debt issues, while a potential negative for growth assets such as industrial metals, is expected to be an ongoing benefit to perceived safehaven commodity assets such as gold, silver and the PGMs.

Eurozone 10-year bond rates 19

IRELAND 15

SPAIN

ITALY

FRANCE GERMANY

EURO INTRODUCED

10 9 8 7 6 5 4

2011

2009

2007

2005

2003

2001

PERCENT

1999

• In the week ending 15 July 2011, US$ gold prices rose to a new record of US$1,589/oz following warnings from ratings agencies S&P and Moody’s indicating the potential for a US credit downgrade and the reduction in Ireland’s debt status to junk. Simultaneously, ETF Securities’ physically backed gold ETCs experienced the largest inflows in almost a year, with receipts of over US$220m.

PORTUGAL

1997

• The fear of systemic financial and currency market risk has also been substantially increased in recent weeks by political brinkmanship in the US regarding the negotiation of a new government debt ceiling and plans for a long-term credible debt reduction scheme to avoid the danger of a debt rating downgrade.

GREECE*

• Such benefits are expected to come in part from the complex and protracted nature of the European sovereign debt crisis, despite the recent Greek parliamentary votes in favour of further austerity measures in return for further EU/IMF debt funding to avoid an imminent default. • Recently conducted bank stress tests have done little to reassure markets regarding contagion risks to European banks arising from exposure to Greek or other peripheral Eurozone economies, while recent turbulence in the Italian bond market has been a worrying reminder of the potentially increased scale of the next iteration of this long-running drama.

* DRACHMA/EURO RATE SET 19 JUNE 2000, GREECE JOINED EURO 2001

1995

Key Sector Themes

Source: Thomson Reuters Datastream, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Key Sector Themes

Mining taxes/royalties – governments want a bigger slice

• Elevated commodity prices have seen countries globally introduce, or consider imposing, mining taxes and/or royalties. This pickup in resource nationalism in its various forms has undoubtedly increased the uncertainty surrounding the viability of mining projects, with positive implications for future commodity prices due to the potential for a delayed supply response. • In the near term, following the announcement of such policies, the attractiveness of new projects and expansions in these jurisdictions has decreased. This was evident in the Democratic Republic of the Congo (DRC) following a review of mining taxation and equity participation arrangements in that country in 2009, and also in Australia following the announcement of a Mining Super Profits Tax in 2010. • In our view, over time the needs of developing countries to develop mineral projects and the prospect of higher revenue flows in a strong commodity price environment will see companies push forward with projects once they are comfortable with changed tax environments. However, the protracted delays that can result and have already resulted from such changes to resource taxation, royalty and equity participation regimes are reinforcing the effects of other supply constraining elements in the current cycle.

Countries globally are seeking a share of future mining profitability Recent Mining Taxes and Royalties News Flow India Tanzania Mozambique Brazil Peru South Africa Australia

2011 2011 2011 2011 2011 2010 2010

Approved draft mining bill Proposal to study a mining super tax Proposal to revise mining tax regime Proposal of a "special participation tax" Proposal of a mining tax Introduced mining revenue royalty Proposed a Mineral Resources Rent Tax (MRRT)

Mining industry has grown historically despite changes in mining royalties

• Commodities where such delays could be material for the sustainability of elevated prices are, in our view, copper, tin, iron ore and platinum. Source: India Ministry of Mines, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Key Changes

Recent price volatility has had a limited impact on our forecasts

• Base metals: While the underlying fundamentals remain supportive across the complex, the weighted average impact of marking to market for our 2011 forecasts has been modestly negative at -1.9% for the complex as a whole. • Copper, tin and aluminium are our preferred base metal exposures, with our copper and tin view based on resilient Chinese demand, constrained supply, and signs that destocking is coming to an end. • The improvement in aluminium demand that we highlighted earlier this year has continued, with inventory financing and delivery bottlenecks reinforcing resilient prices. However, negative supply-side developments in nickel have led us to downgrade our forecasts in 2011 and 2012. • Precious metals: We have made significant upgrades to our gold and silver price profiles to reflect our conviction that heightened demand for safe-haven commodities will be sustained by lingering investor concerns over sovereign debt issues in the US and Europe. • We have made a significant upgrade to the palladium price forecast, but have downgraded platinum and rhodium.

Aluminium

Period New

Old

US$/lb US$/lb

Copper Chg %

New

Old

US$/lb US$/lb

Nickel Chg %

3.42

New

Old US$/lb US$/lb

Chg %

2010

0.99

2011e

1.20

1.19

4.40

4.45

-1%

11.13

12.25

-9%

2012e

1.26

1.23

4.60

11.00

11.58

-5%

2013e

1.35

1.31

3.80

10.80

2014e

1.22

3.10

10.25

9.25

11%

2015e

1.20

2.80

10.00

9.75

2016e

1.15

2.50

9.90

10.00

-1%

1.31

2.71

9.82

New

Old

Chg

New

Lead

Period

Tin

New

Old

Chg

US$/t

US$/lb

2010 2011e

0.98 1.19

2012e

1.24

2013e 2014e 2015e

9.92

1.21

-1%

1.17 1.05

1.24 1.17

0% 0%

1.05

1.00

US$/t US$/lb 9.24 12.88

Zinc %

13.97

-8%

13.50

14.40 14.75

-9% -8%

13.00

12.50

11.50

13.14

Old

US$/lb US$/lb 0.99 1.07

Alumina (spot) Chg

New

Old

Chg

US$/t

340 414

1.11

-4%

1.15

1.15 1.15

-2% 0%

485

1.10

441

1.02

437

1.13

450

411

438 471

3% 3%

2016e

0.96

11.00

10.00

10%

1.00

421

0.95

8.04

1.13

472

New

Gold Old

Chg

New

Silver Old

Chg

New

Platinum Old Chg

New

Period

US$/oz US$/oz 2010

1,226

US$/oz US$/oz

20.11

US$/oz US$/oz

1,607

Palladium Old Chg

US$/oz US$/oz

522

New

Rhodium Old Chg

US$/oz US$/oz

2,454

2011e

1,511

1,401

36.21

31.39

15%

1,784

1,747

788

751

2,175

2,439

-11%

2012e

1,624

1,330

22%

36.90

28.30

30%

1,911

1,915

956

823

16%

2,293

3,205

-28%

2013e

1,550

1,250 1,200

24% 21%

32.98

25.00 23.08

32% 26%

1,952

2,057 2,270

-5% -7%

976 1,058

885 907

10% 17%

2,927

2014e

4,264 5,140

-31% -38%

29.00

2,115

3,173

2015e

1,450 1,300

1,150

13%

25.00

20.91

20%

2,325

2,458

-5%

1,393

1,133

23%

3,745

5,886

-36%

2016e

1,150

1,050

10%

20.91

18.42

14%

2,413

2,667

-10%

1,942

1,336

45%

4,826

6,727

-28%

1,031

17.48

2,165

1,082

721

50%

4,330

5,412

-20%

Source: Thomson Reuters, Morgan Stanley Research. e = Morgan Stanley Research estimates

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Key Changes

Bulk commodities – seaborne markets remain strong

• Steel-making raw materials: Supply disruptions will remain the key theme in the iron ore and coking coal markets. In metallurgical coal, the normalisation of the supply chain after the major floods in Queensland in 1Q 2011 is putting modest but anticipated downward pressure on prices. However, the expected revival of Japanese crude steel production toward year-end is expected to narrow current discounts to premium hard coking coals in the semi-soft and pci markets. We have left our above consensus iron ore price forecasts for fines for 2011 and 2012 unchanged but modestly increased our forecasts for 2013 and 2014 to reflect our estimate of continuing tightness in the seaborne market as a result of strong Chinese import demand and risks to the timetable of project expansion and the level of Indian exports. • Mined energy: Thermal coal is expected to benefit from a revival in Japanese demand as coal-fired facilities are restored after the March earthquake, a seasonal lift in Chinese imports, and continued supply constraints in South Africa, Indonesia, Australia, and Columbia. Near-term uranium forecasts have again been downgraded as a result of the anticipated fallout from the damage to the Fukushima reactor in Japan, but our confidence in the longer-term role of nuclear power in the global cleaner energy mix remains undiminished. Period

Iron Ore Contract

LV PCI Coal

Semi Soft Coal

Thermal Coal

Old

Chg

New

Old

Chg

New

Old

Chg

New

Old

Chg

New

Old

Chg

US$/t

2010

122

2011e

170

171

-1%

293

224

237

-5%

223

228

-2%

130

2012e

176

275

220

226

-2%

217

135

125

2013e

160

150

260

205

210

-2%

198

202

-2%

140

130

2014e

140

135

235

186

190

-2%

179

183

-2%

125

120

2015e

125

120

215

170

173

-2%

163

167

-2%

110

100

10%

2016e

110

210

166

169

-2%

160

163

-2%

141

112

107

Global HRC

Period

HCC Contract

New

191

US HRC

147

China HRC

141

Japan HRC

Europe HRC

Russia HRC

Brazil HRC

New

Old

Chg

New

Old

Chg

New

Old

Chg

New

Old

Chg

New

Old

Chg

New

Old

Chg

New

Old

Chg

US$/t

2010

665

606

723

688

640

1,212

2011e

800

810

-1%

850

845

713

745

-4%

850

870

-2%

844

828

1,360

1,359

2012e

780

790

-1%

850

830

705

750

-6%

880

900

-2%

783

820

1,394

1,401

-1%

2013e

790

780

870

810

720

700

870

787

794

1,345

1,365

-1%

2014e

735

750

700

655

840

761

759

1,324

1,343

-1%

2015e

685

690

650

620

800

715

733

1,281

1,305

-2%

2016e

650

655

-1%

660

500

640

-22%

780

689

720

1,212

1,224

-1%

600

620

550

650

1,180

1,401

-16%

Source: Thomson Reuters, Morgan Stanley Research. e = Morgan Stanley Research estimates

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Key Changes

Morgan Stanley forecasts compared with consensus Calandar Year Base Metals Aluminium Copper Zinc Lead Nickel Tin Precious Metals Gold Silver Platinum Palladium Bulks Iron Ore (Spot) Coking Coal Thermal Coal Other Alumina Uranium

Unit

MS 2011e

Market 2011e

% Diff

MS 2012e

Market 2012e

% Diff

MS LT (Nominal)

Market LT

% Diff

US$/lb US$/lb US$/lb US$/lb US$/lb US$/lb

1.20 4.40 1.07 1.19 11.13 12.88

1.15 4.36 1.08 1.16 11.55 13.59

4% 1% -1% 3% -4% -5%

1.26 4.60 1.13 1.24 11.00 13.14

1.19 4.54 1.11 1.20 10.43 14.06

6% 1% 1% 3% 5% -7%

1.31 2.71 1.13 0.95 9.82 8.04

1.21 2.96 1.06 0.97 9.52 7.95

8% -8% 6% -2% 3% 1%

US$/oz US$/oz US$/oz US$/oz

1,511 36.21 1,784 788

1,468 32.78 1,825 808

3% 10% -2% -2%

1,624 36.90 1,911 956

1,450 32.81 1,939 909

12% 12% -1% 5%

1,031 17.48 2,165 1,082

1,085 18.67 1,776 689

-5% -6% 22% 57%

US$/t US$/t US$/t

178 293 130

160 271 118

11% 8% 10%

173 275 135

150 241 121

15% 14% 12%

95 141 93

87 172 93

9% -18% 1%

US$/t US$/lb

414 58.51

380 64.50

9% -9%

450 62.75

401 63.25

12% -1%

472 74.07

375 69.30

26% 7%

Morgan Stanley versus Consensus, 2011e

Morgan Stanley versus Consensus, 2012e 20%

15% 11% 10% 10% 10%

15%

8% 4%

15% 14%

12% 12% 12% 12%

10%

1% 0%

5% -1%

-5%

-2% -2%

-4% -5%

-10%

-1% -1% -9%

-7%

-15%

Ti n

um at in

ni um

Zi nc

U ra

Le ad Co pp er

oa l in iu m Ni ck e Pa lla l di um

ol d G

m al Th er

Iro n C o k Or e in g C oa l Si lv er Al um in a

Ti n U ra ni um

Zi nc Pl at in Pa um lla di um N ic ke l

G ol d Le ad C op pe r

re Si Th lv er er m al C oa l Al um C in ok a in g C o Al um al in iu m

-10%

O Iro n

-5%

e = Morgan Stanley Research estimates and Bloomberg for market consensus estimates. Source: Bloomberg, Consensus Economics, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Commodities Outlook

Key macro risks to our view

• Policy risks in China: Ongoing food price inflation and the risk of a renewal in energy price inflation against the backdrop of already tight policy settings in China are still highlighting the potential for a hard landing in China with subsequent negative impacts on growth and commodity consumption compared to our base-case view. • Renewed oil price strength: Despite our positive view of IEA oil market intervention on growth prospects and inflation risks, either a resurgence in political unrest in MENA countries or a revival in speculative demand as a result of the introduction of QE3 could reignite oil prices, with negative growth implications. • An intensification in the European sovereign debt crisis: Recent downgrades to Irish sovereign debt status and turbulence in the Italian bond market have again highlighted the potential for contagion risk to re-emerge, with negative implications for a broad range of risk assets. • US growth risks: Renewed weakness in the US jobs market could herald the onset of recession or a weaker growth outcome than we are currently forecasting.

Aluminium

Period Bull

Base

Copper Bear

Bull

US$/lb

Base

Nickel Bear

Bull

US$/lb

Base

Zinc Bear

Bull

US$/lb

Base

Bear

US$/lb

2011e

1.29

1.20

1.11

4.73

4.40

4.07

11.96

11.13

10.29

1.13

1.07

0.96

2012e

1.51

1.26

1.11

5.52

4.60

4.05

12.65

11.00

9.35

1.29

1.13

0.96

2013e

1.62

1.15

4.56

12.96

1.38

3.57

2.73

11.79

9.02

1.27

1.15 1.10

0.98

1.07

10.80 10.25

9.18

1.40

3.80 3.10

3.23

2014e

1.35 1.22

2015e

1.32

1.20

1.08

3.08

2.80

2.52

11.00

10.00

9.00

1.12

1.02

0.92

2016e

1.27

1.15

1.04

2.75

2.50

2.25

10.89

9.90

8.91

1.10

1.00

0.90

1.44

1.31

1.18

2.98

2.71

2.44

10.80

9.82

8.84

1.24

1.13

1.02

Gold

Period Bull

Base

Silver Bear

Bull

US$/oz

Base

Palladium

Platinum Bear

Bull

US$/oz

Base

0.97

Bear

Bull

US$/oz

Base

Bear

US$/oz

2011e

1,625

1,511

1,436

38.92

36.21

34.40

1,917

1,784

1,694

847

788

749

2012e

1,819

1,624

1,543

41.33

36.90

35.06

2,102

1,911

1,529

1,051

956

764 829

2013e

1,736

1,550

1,434

36.94

32.98

30.51

2,147

1,952

1,659

1,073

976

2014e

1,595

1,450

1,305

31.90

29.00

26.10

2,327

2,115

1,798

1,163

1,058

899

2015e

1,430

1,170

27.50

22.50

2,558

1,532

18.82

2,654

2,051

2,136

1,393 1,942

1,184

23.00

2,325 2,413

1,976

1,035

25.00 20.91

1,651

928

19.23

17.48

15.73

2,381

2,165

1,948

1,191

1,082

974

2016e

1,265

1,300 1,150

1,134

1,031

Period

Iron Ore Contract

Coking Coal Contract

Global HRC

Thermal Coal

Bull

Base US$/t

Bear

Bull

Base US$/t

Bear

Bull

Base US$/t

Bear

Bull

Base US$/t

Bear

2011e

187

170

157

322

293

271

895

800

740

143

130

117

2012e

203

176

150

316

275

234

860

780

720

155

135

115

2013e

176

136

286

835

154

247

200

775

675

131

140 125

119

790 735

715

147

260 235

221

2014e

160 140

2015e

131

125

106

226

215

183

725

685

625

116

110

2016e

116

110

221

210

179

695

650

600

100

148

141

120

630

600

550

106

e = Morgan Stanley Research estimates. Source: Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Price Forecasts â&#x20AC;&#x201C; Quarterly & Annual Profile Base Metals Aluminium Copper Nickel Zinc Lead Tin

Unit

Q1 11

Q2 11

Q3 11e

Q4 11e

Q1 12e

Q2 12e

Q3 12e

Q4 12e

2011e

2012e

2013e

2014e

2015e

2016e

LT Nominal

US$/lb

1.15

1.19

1.22

1.24

1.26

1.28

1.24

1.26

1.20

1.26

1.35

1.22

1.20

1.15

1.31

US$/t

2,530

2,627

2,690

2,734

2,778

2,822

2,734

2,778

2,645

2,778

2,976

2,690

2,646

2,535

2,889

US$/lb

4.37

4.17

4.45

4.60

4.70

4.50

4.60

4.40

4.60

3.80

3.10

2.80

2.50

2.71

US$/t

9,629

9,185

9,811

10,141

10,362

9,921

10,141

9,692

10,141

8,378

6,834

6,173

5,512

5,979

US$/lb

12.21

11.04

10.50

10.75

11.00

11.10

11.05

10.85

11.13

11.00

10.80

10.25

10.00

9.90

9.82

US$/t

26,925

24,339

23,149

23,700

24,251

24,471

24,361

23,920

24,528

24,251

23,810

22,597

22,046

21,826

21,654

US$/lb

1.09

1.03

1.06

1.08

1.10

1.15

1.10

1.15

1.07

1.13

1.15

1.10

1.02

1.00

1.13

US$/t

2,413

2,273

2,337

2,381

2,425

2,535

2,425

2,535

2,351

2,480

2,535

2,425

2,249

2,205

2,487

US$/lb

1.17

1.15

1.22

1.24

1.26

1.23

1.20

1.26

1.19

1.24

1.17

1.05

1.00

0.96

0.95

US$/t

2,575

2,532

2,690

2,734

2,778

2,712

2,646

2,778

2,633

2,728

2,579

2,315

2,205

2,116

2,085

US$/lb

13.57

13.09

12.35

12.50

12.80

13.00

13.25

13.50

12.88

13.14

13.50

13.00

12.50

11.00

8.04

US$/t

29,917

28,848

27,227

27,558

28,219

28,660

29,211

29,762

28,387

28,963

29,762

28,660

27,560

24,251

17,735

Q1 11

Q2 11e

Q3 11e

Q4 11e

Q1 12e

Q2 12e

Q3 12e

Q4 12e

2011e

2012e

2013e

2014e

2015e

2016e

LT Nominal

Precious Metals Gold

US$/oz

1,387

1,508

1,565

1,585

1,605

1,615

1,625

1,650

1,511

1,624

1,550

1,450

1,300

1,150

1,031

Silver

US$/oz

31.91

38.43

36.50

38.00

36.48

36.70

36.93

37.50

36.21

36.90

32.98

29.00

25.00

20.91

17.48

Platinum

US$/oz

1,796

1,787

1,750

1,800

1,911

1,784

1,911

1,952

2,115

2,325

2,413

2,165

Palladium

US$/oz

791

760

800

850

956

788

956

976

1,058

1,393

1,942

1,082

Q1 11

Q2 11e

Q3 11e

Q4 11e

Q1 12e

Q2 12e

Q3 12e

Q4 12e

2011e

2012e

2013e

2014e

2015e

2016e

LT Nominal

US$/t

179

176

180

175

170

165

178

173

160

140

125

110

US$/t

225

330

315

300

285

280

275

260

293

275

260

235

215

210

141

Q1 11

Q2 11e

Q3 11e

Q4 11e

Q1 12e

Q2 12e

Q3 12e

Q4 12e

2011e

2012e

2013e

2014e

2015e

2016e

LT Nominal

Steel Making Raw Materials Spot Iron Ore Fines 62% Equivalent, CFR N China Contract Premium Hard Coking Coal

Mined Energy Thermal Coal - Japanese Guide Price (JFY)

US$/t

130

135

130

135

140

125

110

U3O8 Spot Price

US$/lb

Source: Thomson Reuters, Morgan Stanley Research. e = Morgan Stanley Research estimates

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Commodity Commentary â&#x20AC;&#x201C; Base Metals

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Aluminium

Supply tightness has helped underpin relative outperformance…

• In 1H 2011, aluminium was the top-performing LME metal, primarily as a result of a lingering supply tightness evident since mid-2009. This year’s price performance is a somewhat surprising outcome given global exchange inventories of primary aluminium close to record highs in 1H 2011. • However, inventory financing deals, first appearing in Europe and more recently in the US, have kept metal availability low, a phenomenon that has been reflected in record high spot premia on both continents. • We see little chance of near-term respite to this market tightness, despite the recent attempt by the LME to ease the supply bottleneck in US warehouses. In mid-July the Exchange proposed to change the daily minimum load-out rate from 1,500tpd to 3,000tpd, but only for warehouses containing more than 900Kt of stock. This means, in effect, that this change will impact only the Detroit location. However, the change only becomes effective from April 2012, an outcome of little practical use to those wishing to secure metal for prompt delivery. • We think the existing financing deals are likely to remain in place for some time, a view predicated on the Morgan Stanley house view that the Federal Funds rate is likely to remain unchanged until late 2012 and our expectation that the term-structure for aluminium will remain in contango once short-term load-out effects on the front end of the curve have eased. Spot regional premia for primary aluminium, 1999-2011 Estimated yield on aluminium inventory financing deals 25%

250

20% 15%

200

10% 5%

150

0% -5% 100

-10% -15%

-20% -25%

0 Jan-99

Jan-01

Jan-03

Jan-05

Europe

Jan-07 US

Jan-09 Japan

Jan-11

-30% Jan-02

Jan-03

Jan-04

Jan-05

3-month

Source: CRU, Morgan Stanley Research

Jan-06

Jan-07

Jan-08

15-month

Jan-09

Jan-10

Jan-11

27-month

Source: Thomson Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Aluminium

…with solid demand growth keeping the outlook bright

• We continue to look for a rebound in US growth during 2H 2011, in part driven by a rebound in auto production. Our US Autos team expects a sharp recovery due to improved vehicle availability as Japan auto supply chain issues ease and the negative impact of auto credit issues starts to fade. • Trends in global auto production are also supportive, with Volkswagen recently stating it expects to use increasingly more aluminium to cut carbon dioxide emissions, as more of the lightweight metal is used instead of heavier steel in engine blocks, some protective sheets, and wheels. • Positive momentum in the aerospace industry was recently highlighted at the Paris Air Show, which saw Airbus and Boeing receive total orders valued at ~US$90bn, adding to their backlog of over 7,000 aircraft orders globally. • Weakness in the DM building and construction sector has been offset this year by EM demand, especially from South America, India, and Southeast Asia, where, according to Wood Mackenzie Brook Hunt, the consumer electronics market is driving solid consumption growth. Aluminium stock-to-consumption ratio – improving despite high visible inventories 8000

Day s

Cu:Al ratio – aluminium looks increasingly cheap compared to copper 90 80

7000

4.00 3.50

6000

5000

3.00

2.50

2.00

1.50

4000 3000 2000

1000

Average Ratio

1.00

0 Jan-95

0 Jan-97

Jan-99

Jan-01

Total commercial stocks (LHS)

Jan-03

Jan-05

Jan-07

Jan-09

Stock to consumption ratio (RHS)

Source: WBMS, Morgan Stanley Research

Jan-11 Avg ratio

0.50 0.00 Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

Source: Thomson Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Aluminium

China to run a domestic deficit despite recent strong output growth

• Meanwhile, trends in China remain at the forefront of the primary aluminium market outlook. Although China’s most recent power shortage crisis did not result in reduced aluminium production, as expected by the market, price signals evident during the period suggested domestic demand was strong enough to absorb record high output levels. • We are forecasting China’s domestic output growth to slow significantly over 2011-16. After growing at a CAGR of 17.3% between 2000 and 2010, we expect primary production growth to see only a 6.5% CAGR over 2011-2016, implying a domestic market deficit in China for the first time since 2001. • On the demand side, the transportation industry in China remains the key growth driver, with support from urbanisation, infrastructure, and development projects. Production of air conditioners in January-April rose 44% YoY and the State Grid plans to purchase 1.6Mt of aluminium this year. We expect Chinese consumption to grow from 18.7Mt in 2011 to 26.0Mt by 2016, an increase of 40%. • We have made modest upward revisions to our price forecasts and are now expecting an average of US$1.20/lb (US$2,645/t) this year and US$1.26/lb (US$2,778/t) in 2012. China’s domestic aluminium market balance: SHFE inventories have fallen quickly to a 2-year low Deficit forecast from 2011-2014 1000

883

Kt 646

500

687

934

766

710

500

369

145.0

314

241

400

125.0

300

105.0

200

85.0

100

65.0

-2 0 -59

-149

-321

-500

-1000

-1500

-1430

-2000 2003

2004 2005

2006

2007

2008

2009 2010e 2011e 2012e 2013e 2014e 2015e 2016e

0 Jan-05

45.0 Jan-06

Jan-07

Jan-08

SHFE stocks

e = Morgan Stanley Research estimates Source: CRU, WBMS, Morgan Stanley Research

Jan-09

Jan-10

Jan-11

LME price, USc/lb (RHS)

Source: Thomson Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Alumina

China’s imports dropping fast, but the market is already adjusting

 After a strong run in 1Q, the Pacific alumina spot price has weakened since May, primarily as a result of greater

availability on the back of a 56% YTD drop in Chinese imports. This development reflects China’s increasing selfsufficiency in refined alumina and a growing reliance on imports of bauxite. Although there is potential for the country to source 100% of its SGA (smelter grade alumina) requirement by 2013, we believe China will continue to import Australian alumina as price differentials often make imports attractive and quality considerations argue in favour of continued imports for a share of smelter feedstock.  Meanwhile, the transition to a spot-priced market continues. Vertical integration in the aluminium industry is declining, creating a more liquid alumina market. As supply contracts expire, they are being converted to spot-based or spot-linked structures. Alcoa noted in May that it is not signing any new contracts that are not linked to a spot-based alumina price index.

Spot Australian vs. domestic Chinese alumina price, 2007-2011

Chinese self-sufficiency: Imports as a percentage of apparent consumption vs. price 60

700

600

500

400

300

200

700

US$/t

600 500 400 300 200 100

0 Jan-04

100 Jan-05

Jan-06

Jan-07

Jan-08

Imports as % of apparent consumption (LHS)

Jan-09

Jan-10

Jan-11

Pacific spot alumina, US$/t (RHS)

Source: CRU, Thomson Reuters, Morgan Stanley Research

0 Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

China domestic price

Jan-10

Jul-10

Jan-11

Australian price (FOB)

Source: CRU, Bloomberg, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Aluminium and Alumina Global supply / demand World IP growth (Adjusted PPP Weights) World Bauxite Production World Smelter Grade Alumina Production World Chemical Grade Alumina Production Total World Alumina Production World Production Growth Alumina Refinery Capacity Capacity Utilisation World Metallurgical Alumina Consumption World Alumina Consumption Growth Apparent Alumina Surplus/(Deficit) Average Spot Alumina Prices Average Australian Contract Alumina Prices World Primary Aluminium Production World Primary Smelting Capacity Capacity Utilisation China Primary Production Non-China Primary Production World Primary Aluminium Usage Regional Usage Breakdown China BRI (Brazil, Russia, India) USA W Europe Japan ROW Primary Aluminium Market Balance Reported Stocks Change in reported stocks Apparent change in off-warrant stocks Stock-to-Consumption Ratio Average LME Cash Aluminium Price Average LME Cash Aluminium Price

Unit % Mt Mt Mt Mt % Mt % Mt % Mt US$/t US$/t Mt Mt % Mt Mt Mt

2003 4.57 148 54.54 4.8 59.3 6.3 61.3 96.7 54.9 7.4 -0.40 275 177 28.0 31.5 89.0 5.5 22.5 27.59

2004 5.71 157 58.10 5.2 63.3 6.7 63.8 99.2 58.6 6.6 -0.46 393 235 29.9 34.3 87.2 6.7 23.2 29.80

2005 5.26 148 61.02 5.5 66.5 5.1 68.4 97.3 63.7 8.8 -2.69 448 273 32.0 36.7 87.3 7.8 24.2 31.43

2006 5.80 192 68.31 5.6 74.0 11.2 76.6 96.5 67.6 6.1 0.70 430 384 34.0 38.5 88.3 9.4 24.6 33.99

2007 5.54 209 74.61 5.9 80.5 8.9 86.9 92.6 76.0 12.4 -1.38 369 387 38.2 41.4 92.2 12.6 25.6 37.25

2008 2.20 217 79.11 6.1 85.2 5.8 95.6 89.1 78.4 3.2 0.69 354 360 39.7 48.6 81.6 13.2 26.5 37.02

2009 -2.61 193 73.83 5.3 79.1 -7.1 100.5 78.8 73.6 -6.1 0.20 244 228 37.0 48.6 76.1 12.8 24.1 34.81

2010e 7.31 202 81.84 6.1 87.9 11.1 104.1 82.6 82.2 11.6 -0.31 340 322 40.7 52.7 77.2 16.1 24.6 39.72

2011e 5.49 242 89.02 6.6 95.6 8.8 112.4 85.1 89.0 8.4 0.00 414 391 44.7 56.0 79.9 18.4 26.3 44.83

2012e 5.54 263 96.90 7.2 104.1 8.8 120.7 86.2 96.9 8.9 -0.02 450 411 48.7 59.8 81.4 20.8 27.9 48.73

2013e 5.20 277 101.96 7.6 109.5 5.2 129.4 84.6 102.0 5.3 -0.07 485 444 51.3 63.0 81.4 22.5 28.7 51.37

2014e 4.92 293 107.77 8.0 115.8 5.7 134.9 85.8 107.7 5.5 0.10 441 414 54.1 65.6 82.5 24.2 29.9 53.89

2015e 4.47 309 113.62 8.4 122.0 5.4 135.7 89.9 113.6 5.5 0.04 437 407 57.1 69.3 82.4 26.4 30.7 56.70

2016e 3.60 316 116.18 8.6 124.8 2.2 142.0 87.9 116.0 2.2 0.13 421 390 58.3 72.9 80.0 27.0 31.3 57.85

Mt Mt Mt Mt Mt Mt Mt Mt Mt Mt Wks US$/t USc/lb

5.2 2.2 5.7 7.1 2.2 5.2 0.42 3.56 0.21 0.21 6.71 1431 0.65

6.0 2.5 5.8 7.4 2.3 5.7 0.13 2.99 -0.57 0.69 5.22 1717 0.78

7.1 2.7 6.1 7.4 2.3 5.8 0.59 2.94 -0.06 0.64 4.86 1899 0.86

8.6 2.9 6.2 7.7 2.3 6.2 -0.02 2.73 -0.21 0.19 4.18 2570 1.17

12.3 2.9 5.6 8.1 2.2 6.1 0.94 2.89 0.16 0.78 4.04 2639 1.20

12.4 3.2 4.9 7.8 2.2 6.4 2.65 4.68 1.78 0.87 6.57 2618 1.19

14.3 3.0 3.9 5.7 1.5 6.4 2.18 6.42 1.74 0.44 9.59 1644 0.75

15.8 3.2 4.4 7.4 2.0 6.7 0.95 6.45 0.03 0.93 8.44 2191 0.99

18.8 3.8 4.8 6.6 2.3 8.7 -0.09 6.35 -0.09 0.00 7.37 2645 1.20

20.8 4.2 5.2 6.8 2.4 9.3 -0.03 6.32 -0.03 0.00 6.75 2778 1.26

22.6 4.4 5.3 7.0 2.4 9.7 -0.10 6.22 -0.10 0.00 6.30 2976 1.35

24.4 4.7 5.4 7.1 2.4 10.0 0.21 6.44 0.21 0.00 6.21 2690 1.22

25.5 4.9 5.6 7.3 2.5 10.8 0.38 6.82 0.38 0.00 6.25 2646 1.20

26.0 5.0 5.8 7.4 2.6 11.1 0.46 7.27 0.46 0.00 6.54 2535 1.15

Note: Total exchange stocks, unwrought producer, consumer, port, and merchant stocks at period-end as reported by IAI and WBMS e = Morgan Stanley Research estimates Source: IAI, WBMS, CRU, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Copper

Poor 1H 2011 relative price performance set to reverse

 The LME copper price largely underperformed its peers in 1H 2011, primarily as a result of the combination of

persistent global growth concerns and an easing in the supply/demand balance. In the latest ICSG data relating to April 2011, the refined copper market was in a seasonally adjusted surplus of 46Kt, while spot TC/RCs at US$75/t and 7.5USc/lb were 34% above the levels prevailing for term contracts.  We believe there are two factors behind this trend treatment charges, both of which we expect to reverse in 2H:

1) A sizeable portion of Japanese smelting capacity has been offline since the earthquake; 2) the final stage of Chinese destocking in copper led to a significant drawdown in domestic supplies of refined metal.  The latter factor will likely have the most profound impact in 2H, as there are already a number of signs that China has

entered into a copper restocking phase, most particularly a reversal of the declining trend in refined copper imports in June. We also understand there has been a substantial reduction in copper stocks located outside of the exchanges, particularly in bonded warehouses, where inventory levels have reportedly dropped from 650Kt to around 300Kt. Copper TC/RCs reflecting greater concentrate availability following Fukushima

Copper stock-to-consumption ratio vs. total stocks

50.0

5.00

40.0

4.00

2500

Days

60 50

2000

40 30.0

3.00

1500 30 1000

20.0

2.00

10.0

1.00

20 500

0.0 Jan-02 Jan-03

0.00 Jan-04 Jan-05

Jan-06 Jan-07

Combined TC/RC, USc/lb

Jan-08

Jan-09 Jan-10

Jan-11

0 Jan-95

0 Jan-97

Jan-99

Jan-01

Total commercial stocks (LHS)

Jan-03

Jan-05

Jan-07

Jan-09

Stock to consumption ratio (RHS)

Jan-11 Avg ratio

Month-end cash price, US$/lb (RHS)

Source: Wood Mackenzie Brook Hunt, Morgan Stanley Research

Source: ICSG, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Copper

Supply challenges continue to confront the industry

 Collectively, weather-related disruptions (e.g. heavy rains and snowstorms in Chile), strikes (Codelco and Grasberg), lower

ore grades and output industry-wide (e.g. Rio Tinto’s 2Q11 mined Cu down 24% vs pcp), power shortages (Zambia), and possible policy changes (Peru) impacted production levels in 1H11. For example, Freeport-McMoRan have stated that the Grasberg worker disruption in June has resulted in 15.8Kt of lost production. This highlights our view that supply risks remain one of the key elements the positive outlook for copper.  The success of a key number of new projects and expansions will largely determine the global copper market balance through 2016. We estimate that as much as 10% of global mine production in 2016 will be located in frontier markets, further underscoring project risk.  Consumption growth (4.5% pa) should outpace mine production (2.9% pa) in 2011-16. Longer term (2015-25), Brook Hunt is forecasting a 3.6% pa fall in mine production, largely due to significant output declines from mine closures and attrition (-11% pa), while greenfield/brownfield volumes remain broadly unchanged. Monthly copper global supply/demand balance, 2007-2011 300.0

Key projects will determine copper market tightness

200.0 100.0 0.0 -100.0 -200.0 -300.0 -400.0 Jan

Feb

Mar

Apr

2011

May

Jun

2010

Source: ICSG, Morgan Stanley Research

2009

Jul

Aug

2008

Sep

Oct

Nov

Dec

2007

Source: Wood Mackenzie Brook Hunt, Morgan Stanley Research Italicised projects = Located in frontier markets (higher risk) e = Wood Mackenzie Brook Hunt estimates

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Copper

Demand exposed to global growth risk, but regional patterns remain robust

 China remains the key to the global copper demand outlook – this year alone accounting for 38% (Morgan Stanley

forecast) of global consumption of refined copper. While the market was shaken by the large fall in Chinese imports in 1H 2011 to their lowest level since 2008, we are unwavering in our view that the economy requires enormous amounts of copper to meet its long-term industrialization goals. The recent bout of weather-related power losses will prompt China to accelerate construction of additional power generation and grid distribution capacity, in our view, boosting demand for copper.  According to the journal Shanghai Metals Market, the National Energy Administration and the National Development and Reform Commission will in the near term approve a number of large-scale generation and transmission projects in an effort to ease power and grid shortages.  Despite sovereign debt concerns, European growth in copper consumption has also been strong this year. Germany, which is driving the European manufacturing sector, posted a 6.9% YoY increase in copper consumption in January-April 2011, according to the ICSG. Elsewhere in Europe, wire rod production has kept consumption growth sound.  In the US, continued weakness in the building construction sector remains, although similar to Europe, wire rod production is driving copper consumption. We expect a 5.3% YoY increase in global copper usage in 2011. China refined copper apparent consumption vs. Global copper consumption by market sector, 2009 LME copper price, 2007-2011 Consumer Products 8% Transport 13%

700 Construction 33%

US$/lb

5.00

650 600

4.00

550 500 Industrial Machinery 13%

3.00

450 400

2.00

350 Electrical & Electronic products 33%

Source: ICSG, Morgan Stanley Research

300 Jan-07

1.00 Jan-08

LME copper price (RHS)

Jan-09

Jan-10

Jan-11

China's copper apparent consumption (3mma)

Source: Thomson Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Copper

Global supply / demand Unit

World IP growth (Adjusted PPP Weights) World Mine Production Concentrates SX/EW Total Mine Production World Smelter Production Primary Secondary Total Smelter Production Capacity Smelter Capacity Utilisation Rate Primary/Secondary Ratio Imputed concentrate balance World Refinery Production Electrowon Primary Secondary Total Refinery Production Capacity Refinery Capacity Utilisation Rate World Copper Usage World usage growth China usagegrowth Non-China usagegrowth Regional Usage Breakdown China BRI (Brazil, Russia, India) USA W Europe Japan ROW Refined Market Balance Refined Stocks End of Period Refined Stock Change Apparent change in off-warrant stocks Stock to Usage Rate TC (US$/t conc.) RC (USc/lb Cu) LME Copper Price LME Copper Price

Mt Mt Mt

Mt Mt Mt Mt % % Kt

Mt Mt Mt Mt Mt % Mt % % %

Mt Mt Mt Mt Mt Mt Mt Kt Kt Kt Weeks US$ US$ US$/t USc/lb

2003 4.57

2004 5.71

2005 5.26

2006 5.80

2007 5.54

2008 2.20

2009 -2.61

2010e 7.31

2011e 5.49

2012e 5.54

2013e 5.20

2014e 4.92

2015e 4.47

2016e 3.60

11.03 2.72 13.76

11.89 2.71 14.60

12.23 2.69 14.93

12.17 2.83 15.00

12.48 2.99 15.48

12.45 3.09 15.55

12.66 3.25 15.92

12.79 3.32 16.13

12.73 3.42 16.16

13.72 3.88 17.61

14.58 4.04 18.63

15.41 3.94 19.37

15.86 3.83 19.70

15.31 3.70 19.02

11.15 1.36 12.50 13.43 93.1 12.2 -112.7

11.26 1.61 12.87 13.77 93.5 14.3 631.6

11.78 1.71 13.49 14.63 92.2 14.5 446.5

11.97 1.98 13.95 15.19 91.9 16.5 194.9

12.14 2.12 14.26 15.98 89.2 17.5 343.0

12.35 2.26 14.61 16.69 87.5 18.3 93.3

12.44 2.09 14.53 17.28 84.1 16.8 212.5

12.87 2.30 15.16 17.57 86.3 17.9 -72.6

12.87 2.87 15.74 18.24 85.9 18.3 -141.5

13.78 2.98 16.75 18.95 85.9 18.3 -55.3

14.64 3.10 17.73 19.70 85.9 18.3 -56.9

15.47 3.12 18.59 19.85 85.9 18.3 -59.4

15.92 3.14 19.06 20.00 85.9 18.3 -60.7

15.36 3.16 18.52 20.11 85.9 18.3 -52.1

2.72 10.76 1.79 15.27 18.54 82.4 15.72 3.2 24.5 -0.9

2.71 11.14 2.07 15.92 18.92 84.1 16.84 7.1 11.9 6.0

2.69 11.72 2.16 16.57 19.90 83.3 16.67 -1.0 8.0 -3.2

2.83 11.85 2.61 17.29 20.65 83.7 17.03 2.2 -1.3 3.1

2.99 12.20 2.74 17.93 21.82 82.2 18.20 6.9 37.5 -1.4

3.09 12.29 2.82 18.20 22.69 80.2 18.04 -0.9 4.9 -3.1

3.25 12.23 2.79 18.28 23.62 77.4 18.10 0.3 38.3 -15.0

3.32 12.40 3.36 19.08 24.11 79.1 19.33 6.8 5.0 7.9

3.42 13.36 3.31 20.09 25.28 72.0 20.35 5.3 3.2 6.6

3.88 13.90 3.55 21.33 26.58 72.6 21.43 5.3 8.1 3.6

4.04 14.68 3.72 22.44 27.59 74.0 22.36 4.4 7.2 2.5

3.94 15.26 3.87 23.08 27.64 77.0 23.00 2.8 5.9 0.8

3.83 15.80 3.80 23.42 27.62 79.0 23.30 1.3 4.0 -0.5

3.70 15.62 3.72 23.04 27.58 77.5 22.98 -1.4 1.0 -3.1

3.02 1.04 2.24 3.72 1.20 4.49 -0.44 1,780 -268 -176 5.91 58.0 5.8 1,780 0.81

3.38 1.27 2.41 3.81 1.28 4.69 -0.92 923 -857 -64 2.86 43.0 4.3 2,863 1.30

3.65 1.38 2.27 3.47 1.22 4.67 -0.10 867 -56 -46 2.71 85.5 8.5 3,684 1.67

3.60 1.47 2.13 3.84 1.28 4.71 0.26 1,131 264 -8 3.46 95.0 9.5 6,727 3.05

4.96 1.48 2.14 3.62 1.25 4.75 -0.27 1,051 -80 -163 3.01 60.0 6.0 7,126 3.23

5.20 1.54 2.02 3.43 1.18 4.66 0.16 1,342 291 31 3.88 45.0 4.5 6,952 3.15

7.19 1.20 1.63 2.75 0.88 4.46 0.17 1,415 73 102 4.08 75.0 7.5 5,076 2.30

7.55 1.45 1.63 2.93 1.00 4.76 -0.25 1,266 -148 -98 3.42 46.5 4.7 7,536 3.42

7.79 1.77 1.68 3.03 1.03 5.04 -0.26 1,006 -260 0 2.58 75.0 7.5 9,700 4.40

8.42 1.92 1.68 3.03 1.05 5.33 -0.10 905 -102 0 2.20 70.0 7.0 10,141 4.60

9.03 2.11 1.63 2.96 1.07 5.57 0.07 976 71 0 2.28 68.0 6.8 8,378 3.80

9.56 2.27 1.58 2.86 0.97 5.75 0.08 1,061 85 0 2.41 68.0 6.8 6,834 3.10

9.94 2.40 1.51 2.74 0.86 5.85 0.12 1,182 122 0 2.65 68.0 6.8 6,173 2.80

10.03 2.46 1.40 2.54 0.78 5.77 0.06 1,240 58 0 2.81 68.0 6.8 5,512 2.50

e = Morgan Stanley Research estimates Source: ICSG, Wood Mackenzie Brook Hunt, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Lead

The second best performer in 1H 2011…

 Following strong growth of the Chinese auto market in 2009 and 2010, lead is receiving a consumption boost from

demand for replacement batteries. Globally, approximately 40-50% of lead demand is used in replacement batteries, which bodes well for consumption of this base metal even when global auto sales weaken.  US auto sales to recover sharply. Our US Autos team expects a sharp recovery on improved vehicle availability and the

impact of improved auto credit, which will underpin demand for lead-acid batteries, for which there remains no cheap alternative.  Banning of e-bikes in China may hurt battery demand. Safety concerns have been behind Shenzen’s six-month ban on

battery-powered electric bicycles from July 2011. Other Chinese cities may follow, further stemming lead-acid battery demand by the world’s largest consumer of refined lead. Research firm Antaike states that e-bike batteries accounted for ~20% of Chinese refined lead consumption in 2010. Global refined lead rolling 12-month balance vs. consumption growth, 2007-2011 150.0

Global lead end-use consumption, 2010 SLI OE batteries 12%

25.0%

Stationary batteries 15%

20.0%

100.0

Traction batteries 8%

15.0% 50.0

10.0% 5.0%

0.0

0.0%

-50.0

Non-Battery 20%

-5.0% -100.0

-10.0%

-150.0 Jan-07

-15.0% Jul-07

Jan-08

Jul-08

Jan-09

Rolling 12-month balance (LHS)

Source: ILZSG, Morgan Stanley Research

Jul-09

Jan-10

Jul-10

SLI Replacement batteries 45%

Jan-11

YoY chg in global consumption (RHS)

Note: SLI = starting, lighting and ignition Source: ILZSG, Wood Mackenzie Brook Hunt, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Lead

…but China pollution policies’ impact on production is the key in 2H 2011

 With inventories near record highs and government policies cracking down on pollution-intensive industries,

lead production growth in China is likely to slow in conjunction with reduced domestic demand. In May 2011, lead producers, lead-acid battery makers, and producers of recycled lead cut or shut output due to environmental issues. Demand concerns will likely remain, as there is no timeframe for the restart of these battery plants.  2H 2011 – watch for how production fares. Additional cutbacks and closures (e.g. 20% of 2011 lead smelting production has been targeted to be phased out by the government) in 2H 2011, particularly during summer power shortages, is likely to contribute to near-term lead market tightness, though new efficient capacity is likely to offset this in the longer term.  Environmental concerns are not restricted to China. Canada’s Ivernia Inc. has once again shut down indefinitely its Magellan lead mine in Australia due to breaches of environmental conditions. Shipments of lead concentrate have been halted after the company received a notice from the local environmental protection authority.  We envision a market surplus of 196Kt in 2011, followed by a 93Kt deficit in 2012, and our price forecasts for those years reflect this profile, at US$1.19/lb (US$2,633/t) and US$1.24/lb (US$2,728/t), respectively. China’s domestic refined lead production vs. LME price, 2008-2011

China’s net trade in refined lead, 2000-2010 600 504

450

1.80

400

1.60

350

1.40

300

1.20

250

1.00

200

0.80

150

0.60

100

0.40

-100

0.20

500 400

425

408

404

Net Exports

419

362

300

206

200 100 3

-200

Net Imports -134

0.00 0 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

-300 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011e

Source: Thomson Reuters, Morgan Stanley Research. e = Morgan Stanley Research estimates

Refined Chinese Production, Kt (LHS)

Lead Price, US$/lb (RHS)

Source: Thomson Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Lead

Global supply / demand Units %

2003 4.57

2004 5.71

2005 5.26

2006 5.80

2007 5.54

2008 2.20

2009 -2.61

2010e 7.31

2011e 5.49

2012e 5.54

2013e 5.20

2014e 4.92

2015e 4.47

2016e 3.60

Total world mine production World Mine Production Growth

Kt %

2896 3.2

2932 1.2

3336 13.8

3305 -0.9

3673 11.1

3886 5.8

3950 1.6

4130 4.6

4318 4.5

4593 6.4

4759 3.6

4937 3.7

4925 -0.2

5069 2.9

Total World Primary Smelter Production Requirement for lead from concentrate

Kt Kt

3741 2914

3795 2933

4179 3294

3852 2845

3847 2869

4010 2975

4237 3176

4673 3991

4954 4266

5334 4585

5534 4745

5664 4877

5749 4956

5979 5198

Total World refined production Primary Refined Production Secondary Refined Production Total World refined production growth US stockpile disposals Total refined availability Refined production by region China N America W Europe Japan India Australia ROW

Kt Kt Kt % Kt Kt

6906 3741 3165 1.4 60 6966

7129 3795 3334 3.2 56 7185

7711 4179 3532 8.2 29 7740

7984 3852 4132 3.5 190 8174

8150 3847 4303 2.1 0.0 8150

8705 4010 4695 6.8 0.0 8705

8898 4237 4660 2.2 0.0 8898

9414 4673 4826 5.8 0.0 9414

10007 4954 5053 6.3 0.0 10007

10417 5334 5189 4.1 0.0 10417

10954 5534 5421 5.2 0.0 10954

11271 5664 5721 2.9 0.0 11271

11760 5749 6071 4.3 0.0 11760

12449 5979 6471 5.9 0.0 12449

Kt Kt Kt Kt Kt Kt Kt

1612 1624 1301 289 170 308 1602

1958 1504 1267 293 156 273 1678

2395 1514 1362 279 170 268 1722

2799 1554 1334 220 218 241 1618

2898 1541 1379 218 239 240 1635

3174 1541 1406 225 274 280 1805

3707 1494 1291 191 306 265 1644

4164 1510 1299 219 317 236 1669

4510 1510 1321 194 381 250 1841

4938 1457 1281 225 410 254 1852

5368 1494 1291 227 414 256 1905

5586 1496 1321 232 423 262 1950

5859 1551 1370 241 439 271 2031

6218 1637 1446 254 463 286 2144

World Usage Total world refined usage growth Refined usage by region China W Europe USA ROW

Kt %

6979 3.8

7317 4.8

7802 6.6

8008 2.6

8234 2.8

8615 4.6

8842 2.6

9395 6.2

9811 4.4

10334 5.3

10927 5.7

11236 2.8

11679 3.9

12341 5.7

Kt Kt Kt Kt

1175 1632 1510 2662

1401 1693 1504 2720

1850 1630 1598 2724

2269 1652 1573 2514

2650 1623 1514 2447

3053 1525 1560 2477

3660 1254 1390 2538

4025 1314 1425 2631

4446 1343 1460 2562

4889 1360 1449 2636

5335 1389 1451 2752

5710 1343 1414 2768

6126 1324 1419 2810

6581 1343 1468 2949

Kt Kt Kt Wks

-74 386.4 21.2 2.9

-188 294.9 -96.9 2.1

-91 313.0 -109.1 2.1

-24 276.9 12.1 1.8

-84 278.4 -86.0 1.8

90 274.4 94.5 1.7

55 388.1 -58.6 2.3

20 454.5 -46.7 2.5

196 650.3 0.0 3.4

83 733.7 0.0 3.7

27 760.6 0.0 3.6

35 795.7 0.0 3.7

82 877.3 0.0 3.9

108 985.7 0.0 4.2

USD/t US$/lb USD/t USD/t

515 0.23 120 480

885 0.40 125 650

977 0.44 128 650

1,287 0.58 133 600

2,590 1.18 165 500

2,094 0.95 350 2500

1,676 0.76 170 1000

2,164 0.98 210 1500

2,633 1.19 243 1947

2,728 1.24 224 1865

2,579 1.17 197 1630

2,315 1.05 197 1630

2,205 1.00 197 1630

2,116 0.96 198 1631

World IP growth (Adjusted PPP Weights)

Market balance Reported total commercial stocks Change in reported total commercial stocks Reported stock to usage ratio Annual average LME cash prices Annual average LME cash prices Pb Contract TCs (on 70% Pb grade) Pricing Basis

e = Morgan Stanley Research estimates Source: ILZSG, Wood Mackenzie Brook Hunt, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Nickel

Nickel pig iron production in China pressures prices

• After a strong performance in 1Q, the LME nickel price rapidly deteriorated in 2Q and ended the quarter as the worst performing metal in the complex. We were somewhat surprised by this outcome, as the majority of supply/demand fundamentals that supported nickel’s relative outperformance since the beginning of 2010 remain intact. • We have concluded that the nickel market is suffering from the effects of greater-than-anticipated levels of substitution from nickel pig iron (NPI) production in China. According to Wood Mackenzie Brook Hunt, as much as 70% of China’s stainless steel production now relies on integrated NPI feed and the substitute is making up an increasingly larger share of the nickel raw material mix. • In our view, the faster-than-expected pickup in NPI production and use is a direct result of the combination of: 1) nickel prices remaining above the break-even cost level for the vast majority of NPI plants, and 2) a response to an industry-wide need to fill gaps left by the persistent delay of new mining projects. • Following our detailed review of the global nickel industry in late June, we have made downward revisions to our price expectations. We have lowered our forecasts for 2011 and 2012 by 9% and 5% respectively to US$11.13/lb (US$24,528/t) and US$11.00/lb (US$24,251/t). China’s NPI production vs. % share NPI use 400

Global primary nickel balance is showing signs of deterioration

50%

200

40%

150

20.00

30%

100

15.00

20%

10.00

5.00

US$/lb

25.00

350 300 250 200 150 100 10% 50 0

0% 2006

2008

2010

2012e

2014e

2016e

-50 Jan-05

0.00 Jan-06

Jan-07

Jan-08

Jan-09

Rolling 12-month global market balance (LHS)

Source: Wood Mackenzie Brook Hunt, Morgan Stanley Research. e = Morgan Stanley Research estimates

Source: INSG, Morgan Stanley Research

Jan-10

Jan-11

LME price (RHS)

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Nickel

Demand strong for stainless steel remains robust this year and next…

• Following elevated nickel prices in 2H 2010 through 1Q 2011, stainless steel consumers speculatively destocked and pushed stainless prices lower in 2Q 2011 – another key factor in nickel’s recent underperformance. As stainless steel prices decline, distributors typically scale back orders and use existing inventory to avoid holding material that could fall in value in the near term. • Moreover, many Chinese stainless mills are now undertaking maintenance, thereby weakening nickel demand in the coming quarter. Coupled with the fact European stainless steel producers traditionally run down inventories at their mills during 3Q, restocking and a subsequent increase in stainless output is likely to be delayed until 4Q 2011. • Nevertheless, we expect 7.2% growth in global stainless steel output this year and 7.6% in 2012, a level of demand that should keep the global primary nickel market close to balance. • We moderately increased our estimate of primary nickel in non-stainless steel applications for 2011 and 2012 as a result of stronger-than-expected consumption, primarily from the aerospace sector. Some companies at June’s Paris Air Show are expecting record levels of aircraft orders over the next two years. However, given the rise in NPI production and use, we have reduced our usage estimate of primary nickel in stainless steel by 2.5% in 2011 and 2.2% in 2012. LME nickel vs. benchmark China stainless steel price, 2004-2011 25.00

US$/t

US$/lb

5500

Nickel stock-to-consumption ratio 300

Days

80 70

250 20.00

4500

200

15.00 3500 10.00

150

40 30

100

2500 5.00

0.00 Jan-04

1500 Jan-05

Jan-06

Jan-07

LME Nickel Price (LHS)

Source: CRU, Morgan Stanley Research

Jan-08

Jan-09

Jan-10

Jan-11

China Stainless Steel Price (RHS)

0 Jan-95

0 Jan-97

Jan-99

Jan-01

Total commercial stocks (LHS)

Jan-03

Jan-05

Jan-07

Stock to consumption ratio (RHS)

Source: INSG, WBMS, Morgan Stanley Research

Jan-09

Jan-11 Avg ratio

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Nickel

…but supply-side developments will drive price in medium term

• It has been our long-standing view that there is significant risk of slippage in the delivery timetable of a number of very large greenfield projects. The majority of the new projects are extremely complex and largely untested facilities, several utilizing high-pressure leach (HPAL) processes. • Indeed, since the last Metals Playbook, a number of delays and setbacks have been announced: 1) Goro is experiencing a “very problematic start-up,” according to Vale; 2) Ambatovy’s operators pushed start-up out another six months due to technical difficulties; 3) the Murrin Murrin operation remains offline until a heat exchanger is replaced; and 4) the 2012 start-up of the Ramu project in PNG remains in doubt pending a court ruling on environmental regulation. • Taking into account the large sums of capex still needed for a number of these projects and given that pig iron’s marginal costs currently come in around the present nickel price, we believe there is substantial risk that the owners and operators of these projects may reconsider project start-up or even the viability of some of their projects as a whole. Global nickel market depends on success of a few key projects

NPI avg cash costs and primary producer marginal cost vs. LME nickel price 18.00

Project (Kt) Mu r in Mu r in (Au st r alia) On ca-Pu m a (Br azil) Bar r o Alt o (Br azil) Go r o (New Caled o n ia) Am b at o vy (Mad ag ascar ) Ram u (PNG) Raven st h o r p e (Au st r alia) Ko n iam b o (New Caled o n ia) Total % Sh ar e Glo b al Pr o d MS Market Balance

2011e 2012e 2013e 2014e 2015e 2016e 30 35 32 30 30 30 10 20 35 47 50 50 12 25 32 38 40 40 0 12 25 34 46 50 0 12 24 36 45 51 0 4 13 22 25 28 0 16 29 36 38 36 0 0 15 24 36 48 52 3%

124 6%

204 10%

267 13%

310 14%

334 14%

-7

-6

-43

US$/l 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 2006 NPI avg cash cost

e = Morgan Stanley Research estimates Source: Wood Mackenzie Brook Hunt, Morgan Stanley Research

2007

2008

2009

2010

Primary producer marginal cost

e = Morgan Stanley Research estimates Source: Wood Mackenzie Brook Hunt, Morgan Stanley Research

2011e Nickel price

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Nickel

Global supply / demand Unit %

2003 4.57

2004 5.71

2005 5.26

2006 5.80

2007 5.54

2008 2.20

2009 -2.61

2010e 7.31

2011e 5.49

2012e 5.54

2013e 5.20

2014e 4.92

2015e 4.47

2016e 3.60

Total world mine production World mine production growth rate

Kt %

1,269 3.3

1,308 3.1

1,363 4.2

1,468 7.7

1,599 8.9

1,510 -5.6

1,341 -11.2

1,578 17.7

1,769 12.1

1,954 10.5

1,982 1.4

2,085 5.2

2,212 6.1

2,314 4.6

Total world refined production World refinery capacity World refined production growth rate Regional Production Breakdown China Pig Iron China Ferro-Nickel Russia Europe Japan Canada ROW

Kt Kt %

1,281 1,410 2.8

1,269 1,452 4.1

1,286 1,572 1.1

1,366 1,663 4.0

1,413 1,800 1.9

1,379 1,949 -2.5

1,330 2,224 -5.1

1,445 2,283 5.1

1,620 2,100 5.9

1,808 2,299 12.4

1,877 2,319 3.8

1,935 2,319 1.7

1,959 2,319 1.4

1,994 2,319 0.0

Kt Kt Kt Kt Kt Kt Kt

0 69 261 200 165 125 563

0 81 263 212 170 154 560

2 102 268 216 164 136 561

30 121 275 226 153 154 558

54 143 268 244 162 154 551

53 151 260 253 157 164 497

73 177 256 200 144 117 508

124 206 264 238 163 105 507

220 255 239 226 138 114 566

235 284 240 243 154 130 677

245 307 232 239 159 122 732

275 318 225 231 167 126 759

275 323 220 227 169 140 773

310 323 219 227 169 125 790

Total world nickel usage Primary Nickel in Stainless Primary Nickel in Non-Stainless World nickel usage growth Regional Usage Breakdown China USA Europe ROW

Kt Kt Kt %

1,232 845 387 5.2

1,253 877 377 1.7

1,232 809 422 -1.7

1,401 898 503 13.8

1,323 861 462 -5.6

1,278 773 505 -3.4

1,232 821 411 -3.6

1,464 982 482 18.8

1,627 1,118 509 5.7

1,753 1,205 548 7.5

1,805 1,221 584 6.7

1,887 1,271 616 5.4

1,965 1,320 645 4.7

2,036 1,369 668 3.6

Kt Kt Kt Kt

136 115 435 546

161 129 444 520

195 135 412 490

243 151 448 558

321 146 409 447

297 141 393 448

419 129 335 348

494 141 361 468

590 151 394 491

647 157 417 532

699 158 406 541

738 163 419 568

786 169 423 587

835 173 429 599

Refined Nicket Market Balance

-13.1

15.8

54.7

-34.9

90.7

100.3

98.3

-18.4

-7.5

55.3

72.7

48.2

-6.2

-42.6

Kt Kt Kt Wks

116 0.3 -13.3 4.88

121 5.2 10.6 5.02

140 19.0 35.7 5.91

102 -37.5 2.6 3.80

151 48.9 41.8 5.95

186 35.0 65.3 7.58

253 67.1 31.2 10.70

235 -18.9 0.5 8.33

227 -7.5 0.0 7.26

282 55.3 0.0 8.38

355 72.7 0.0 10.23

403 48.2 0.0 11.11

397 -6.2 0.0 10.51

355 -42.6 0.0 9.05

US$/t US$/lb

9,637 4.37

13,840 6.28

14,751 6.69

24,237 10.99

37,255 16.90

21,087 9.57

14,414 6.54

21,873 9.92

24,528 11.13

24,251 11.00

23,810 10.80

22,597 10.25

22,046 10.00

21,826 9.90

World IP growth (Adjusted PPP Weights)

Reported total commercial stocks Change in reported Stocks Apparent change in off-warrant stocks Reported stock to usage ratio Annual Average Prices Annual Average Prices

e = Morgan Stanley Research estimates Source: INSG, Wood Mackenzie Brook Hunt, CRU, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Tin

Record prices stimulate strong export response from China

 A surge in tin prices in 4Q 2010 and 1Q 2011 has had a strong impact on marginal sources of supply. Small-scale miners

and recyclers across Asia have seized the opportunity presented by prices that averaged US$11.72/lb (US$25,838/t) in 4Q 2010 and US$13.57/lb (US$29,917/t) in 1Q 2011 to boost output.  As a result, the estimated refined market deficit for 2010 of 12.0Kt was nearly 35% below our earlier estimate of 18.9Kt based on figures from the International Tin Research Institute.  A strong supply response was also evident in a surge in Chinese exports in 4Q 2010 and 1H 2011, with CRU estimating that China exported more than 13Kt of refined tin between October 2010 and April 2011, the majority of which flowed into LME warehouses in Singapore. Total LME stocks of tin rose from 13,200t in October 2010 to 24,200t in June 2011 as a result.  This strong growth in exports from China in 4Q 2010 was triggered by the domestic/LME price arbitrage favouring exports and the existence of substantial domestic refined stocks carried forward from 2009 and added to in 1Q-3Q 2010. Mined production – top five countries

China’s net trade balance 70

Net Exports

350

300

50 250 200

150

10 100 50

-10 Net Imports

0 2000

-30 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: WBMS, Morgan Stanley Research

2001 China

2002

2003 Indonesia

2004

2005 Peru

2006

2007

Bolivia

2008 DRC

2009

2010 Other

Source: CRU, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Tin

Structural change underpins longer-term bullish outlook

 Partly as a result of rising production in Indonesia and increasing LME stocks due to Chinese exports, tin prices have been

markedly volatile. The strong investor demand evident in 4Q 2010 and 1Q 2011 saw prices reach a peak of US$15.01/lb (US$33,100/t) on 15 April 2011, before increased risk aversion in the face of weakening growth indicators and a deepening sovereign debt crisis in Europe triggered aggressive profit taking. By mid-June, LME cash prices had fallen 24.8% to US$11.25/lb (US$24,800/t). Since then, prices have recovered by 11.0% to US$12.49/lb (US$27,540/t).  The mark-to-market effect of this volatility has forced us to lower our base-case price forecasts for 2011 by 8% and for 2012 by 9% to US$12.88/lb (US$28,396/t) and US$13.14/lb (US$28,969/t). However, we have retained our rising price profile into 2013, as our forecasts for consumption and refined production growth show continuing deficits, renewed falls in LME stocks, and a decline in the stock-to-consumption ratio to a cyclical low of 3.3 weeks in 2013 vs. 7.5 weeks in 2009.  The basis of this still robust outlook lies in the continued growth in lead-free solder demand in the electronics market as well as significant constraints on mine production growth before 2013/14, when new capacity in Australia, Morocco, and Rwanda is forecast to come into production. China and Indonesia: The largest producers (refined) 400

Tin stock-to-usage ratio reflecting market tightness

Kt 80

Days

350

100 90

300 60

250 50

200 150 100

50 10

0 2000 China

2001

2002

Indonesia

2003

2004

Peru

2005 Bolivia

2006

2007

Malaysia

2008

2009

Thailand

2010

0 Oct-96

Oct-98

Oct-00

Oct-02

Oct-06

Oct-08

0 Oct-10

Other

Total commercial stocks (LHS)

Source: CRU, Morgan Stanley Research

Oct-04

Stock to consumption ratio (RHS)

Source: WBMS, CRU, Morgan Stanley Research

Avg

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Tin

Global supply / demand Unit

2003

2004

2005

2006

2007

2008

2009

2010

2011e

2012e

2013e

2014e

2015e

2016e

Kt Kt Kt % Kt Kt Kt %

268 257 276 2.9 18.7 9.9 286 3.4

286 275 308 11.7 33.3 9.2 317 11.0

325 312 347 12.5 34.9 7.8 355 11.7

317 304 355 2.3 50.3 9.3 364 2.6

301 289 345 -2.7 56.3 7.7 353 -3.1

291 280 326 -5.6 46.1 3.7 329 -6.6

279 268 336 3.1 67.7 0.0 336 2.0

282 271 350 4.2 78.8 0.0 350 4.2

305 292 358 2.3 65.8 0.0 358 2.3

311 298 365 2.0 67.1 0.0 365 2.0

322 309 378 3.6 69.5 0.0 378 3.6

325 312 382 1.0 70.2 0.0 382 1.0

327 314 384 0.5 70.5 0.0 384 0.5

328 315 386 0.5 70.9 0.0 386 0.5

World refined consumption World refined consumption growth

Kt %

296 6.2

322 8.6

333 3.4

362 8.8

356 -1.7

342 -4.1

320 -6.3

362 11.1

369 1.3

380 2.9

382 0.5

380 -0.3

377 -1.0

375 -0.3

Balance

-10.4

-4.5

21.7

1.7

-3.4

-12.3

15.7

-12.0

-11.0

-14.5

-3.2

1.9

7.4

10.7

Kt Kt Kt Wks

38.1 -10.2 -0.2 6.7

29.7 -8.4 3.9 4.8

38.3 8.6 13.1 6.0

35.7 -2.6 4.3 5.1

35.4 -0.3 -3.1 5.2

32.4 -2.9 -9.3 4.9

46.1 13.7 2.0 7.5

35.3 -10.8 -1.2 5.1

42.0 6.7 -17.7 5.9

27.5 -14.5 0.0 3.8

24.2 -3.2 0.0 3.3

26.1 1.9 0.0 3.6

33.5 7.4 0.0 4.6

44.2 10.7 0.0 6.1

US$/t US$/lb

4,896 2.22

8,513 3.86

7,370 3.34

8,763 3.97

14,539 6.59

18,446 8.37

13,350 6.06

20,374 9.24

28,387 12.88

28,963 13.14

29,762 13.50

28,660 13.00

27,560 12.50

24,251 11.00

Supply Total world mine production Refinery recovery of contained tin in concentrate Reported world refined production World refined production growth Imputed Secondary Production DLA Disposals Total refined availability Total supply growth

Reported commercial stocks Change in reported Stocks Apparent change in off-warrant stocks Stock to Consumption Ratio Annual average LME Cash Prices Annual average LME Cash Prices

e = Morgan Stanley Research estimates Sources: WBMS, CRU, ITRI, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Zinc

Oversupplied until Century mine closes

ď&#x201A;ˇ The global zinc market has been in structural oversupply since 1Q 2008, and our global supply/demand model is

not showing any relief in this condition until 2013 at the earliest. Despite weakness in 2Q, prices have still failed to fall to levels that would trigger a supply-side response. Without greater producer discipline, it will have to be long-awaited mine closures that tighten the market. The closure of Century in Australia, Brunswick in Canada, as well as a number of other operations, will result in a loss of 312Kt and 440Kt of zinc and bulk concentrate in 2013 and 2104, respectively. ď&#x201A;ˇ Until then, however, there are other market dynamics with potential consequences for the global zinc market. At the end of June, China announced it would cut the import tax on unwrought zinc to 1% from 3% from July 1. In our view, the policy move will have little impact in the near term given the already ample domestic (as well as global) supply of the metal. However, from 4Q we believe Chinese imports of zinc could begin to rise should the imported price become more competitive. We believe Beijing is roughly mid-way through the same policy shift undertaken in the domestic aluminium market with a view to slowing production growth in energy-intensive industrial processes.

Refined zinc production to exceed consumption until 2013e 800 600 400 200

Zinc stock to consumption ratio: Still rising

16.0

2000

15.0

1800

80.0

14.0

1600

70.0

13.0

1400

12.0 11.0

Days

60.0

1200

50.0

1000

40.0

800 10.0

-200

9.0 -400

8.0

-600

7.0 2000

2002

2004

Market Balance (LHS)

2006

2008

2010e

World Production (RHS)

2012e

2014e

2016e

90.0

30.0

600 400

20.0

200

10.0

0 Jan-95

0.0 Jan-97

Jan-99

Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

World Consumption (RHS)

e = Morgan Stanley Research estimates Source: ILZSG, Wood Mackenzie Brook Hunt, Morgan Stanley Research

Total Commercial Stocks

Stock-to-Consumption Ratio (RHS)

Avg Ratio (RHS)

Source: ILZSG, Wood Mackenzie Brook Hunt, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Zinc

Inventory financing: Is zinc the new aluminium?

• A string of complaints about long delays in receiving aluminium metal from LME warehouses have resulted in those familiar with aluminium financing deals (investors, warehousing companies, and physical traders) looking elsewhere for inventory financing opportunities, as scrutiny of aluminium warehousing by the LME and the financial press continues. • We think that the ingredients are in place for an upturn in zinc inventory financing deals, with potential support for the zinc price above marginal cost. Recent trade articles have reported that warehouse operators are approaching US producers with offers to deliver zinc into storage. Freight incentives of US$170/t are high relative to history, in addition to above-market spot premiums. Also, already high zinc inventories are continuing to rise, with an increase in the concentration of warehouse locations reporting zinc stocks. • Zinc is no stranger to such financing arrangements. Substantial amounts of zinc in Asian warehouses have been tied up in financing deals for years; however, we point to a few factors that indicate the potential for proliferation of such deals: 1) Strong contango price structure based on 15m and 27m prices. The cash to forward delivery price spread for these two prompt dates have risen steadily since January 2011; 2) Contango in the LME forward curve when combined with continued record low nominal interest rates increases the net investment yield of these deals; 3) Elevated and rising LME and SHFE stocks are evidence that growing levels of zinc inventory financing have materialised as market participants take advantage of the arbitrage opportunity.

Estimated yields on zinc inventory financing deals

20%

10%

-10%

-20%

-30%

-40% Jan-01

Jan-03 Cash to 3-month

Jan-05

Jan-07

Cash to 15-month

Jan-09

Jan-11

Cash to 27-month

LME/SHFE zinc stocks at all-time highs 1400

USc/lb

250

1200 200 1000 150

800 600

100

400 50 200 0 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 LME stocks, (LHS)

SHFE stocks (LHS)

LME price (RHS)

Source: Thomson Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Zinc

Global supply / demand Units %

2003 4.57

2004 5.71

2005 5.26

2006 5.80

2007 5.54

2008 2.20

2009 -2.61

2010e 7.31

2011e 5.49

2012e 5.54

2013e 5.20

2014e 4.92

2015e 4.47

2016e 3.60

World Mine Production World Mine Production Growth

Mt %

9.43 7.2

9.73 3.2

10.15 4.3

10.45 3.0

11.13 6.5

11.69 5.0

11.38 -2.6

12.36 8.6

12.57 1.7

13.12 4.4

13.47 2.6

13.91 3.2

14.15 1.7

14.14 0.0

World Refined Production Primary Refined Production Secondary Refined Production World Refined Production growth US stockpile disposals Total Refined Availability

Mt Mt Mt % Mt Mt

9.89 9.26 0.63 3.28 0.01 9.90

10.21 9.43 0.77 3.18 0.03 10.24

10.22 9.58 0.64 0.16 0.03 10.25

10.66 10.05 0.60 4.24 0.03 10.68

11.36 10.62 0.74 6.62 0.01 11.37

11.66 11.02 0.64 2.60 0 11.66

11.29 10.67 0.62 -3.16 0 11.29

12.83 12.14 0.69 13.69 0 12.83

13.61 12.88 0.73 6.07 0 13.61

14.51 13.71 0.80 6.60 0 14.51

14.86 14.01 0.85 2.42 0 14.86

15.03 14.16 0.87 1.15 0 15.03

15.16 14.26 0.89 0.83 0 15.16

15.05 14.09 0.96 -0.69 0 15.05

World Refined Usage World Refined Usage Growth Regional Usage Breakdown China BRI (Brazil, Russia, India) USA W Europe ROW Market balance Reported commercial stocks Change in reported commercial stocks Apparent change in off-warrant stocks Stock to uage ratio

Mt %

9.65 7.1

10.43 8.1

10.61 1.7

11.02 3.8

11.31 2.7

11.44 1.1

10.84 -5.2

12.54 15.7

13.21 5.3

14.20 7.5

14.79 4.1

15.15 2.4

15.40 1.6

15.34 -0.3

Mt % % Mt Mt Mt Mt Mt Mt Wks

1.98 0.74 1.15 2.32 2.83 0.25 1.19 0.10 -0.15 6.43

2.42 0.75 1.25 2.34 3.03 -0.19 1.02 -0.17 0.02 5.09

2.85 0.81 1.18 2.23 2.91 -0.36 0.81 -0.21 0.15 3.96

3.17 0.87 1.22 2.32 2.80 -0.33 0.49 -0.32 0.02 2.32

3.53 0.94 1.10 2.34 2.80 0.06 0.53 0.04 -0.02 2.46

3.80 0.94 0.98 2.15 3.01 0.22 0.84 0.30 0.08 3.80

4.10 0.85 0.90 1.63 2.94 0.44 1.10 0.26 -0.04 5.25

5.07 1.05 1.02 2.08 2.74 0.29 1.44 0.35 0.09 5.98

5.52 1.10 1.05 2.05 2.90 0.40 1.85 0.40 0.06 7.27

6.07 1.19 1.12 2.08 3.17 0.31 2.15 0.31 -0.10 7.88

6.48 1.27 1.14 2.04 3.30 0.07 2.22 0.07 -0.24 7.81

6.80 1.32 1.12 2.00 3.36 -0.12 2.11 -0.12 -0.18 7.23

6.99 1.36 1.11 1.94 3.45 -0.24 1.87 -0.24 -0.12 6.31

7.05 1.38 1.08 1.87 3.44 -0.29 1.57 -0.29 -0.05 5.34

US$/t US$/lb

827 0.38

1,048 0.48

1,383 0.63

3,277 1.49

3,252 1.48

1,879 0.85

1,628 0.74

2,180 0.99

2,351 1.07

2,480 1.13

2,535 1.15

2,425 1.10

2,249 1.02

2,205 1.00

US$/t

148

142

126

128

300

194

250

229

225

210

205

US$/t

1000

1400

3500

2000

1250

2000

2500

2300

2000

1800

World IP growth (Adjusted PPP Weights)

Annual average LME cash prices Annual average LME cash prices Negotiated Term Contract TC - Base Price (Europe excl. PP on 51% Zn grade) Pricing Basis

e = Morgan Stanley Research estimates Source: ILZSG, Wood Mackenzie Brook Hunt, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Commodity Commentary â&#x20AC;&#x201C; Precious Metals

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Gold

Investment demand is strengthening again…

• Identified and implied investment has become the main driver of demand in the gold market over the past decade and has become essential to absorb the fundamental surplus resulting from mine production, secondary supply, any net sales from central banks and producer hedging, and the long-term decline in jewellery fabrication demand. •As the transparency of reporting of bar hoarding demand has increased along with the growth in physically backed ETF demand, the depth and structure of the physical investment market has become more visible. In our view, assessing the sustainability of this investment flow has become critical to the gold price outlook. • According to GFMS, total identifiable investment demand for gold reached a record 1,514t in 2011, or 1,675t if implied investment demand is included, for a new annual record of US$66bn. • More dramatic growth in investment demand for gold can be pinpointed to 2008-09 and the global financial crisis, which raised serious concerns about a debt deflationary spiral and the long-term purchasing power of the world’s major fiat currencies, especially the US dollar and the Japanese yen. Gold price in different currencies, 1971-2011 1800

Total gold investment demand vs. gold price, 2000-12e Medals/Imitation coins

2500

per oz

US$/oz

1800

Official Coin Sales

1600

Bar Hoarding

2000

ETF investment Demand Grow th

1400

1500 tonnes

1200

1400

Implied investment 1200

Gold Price (RHS) 1000

1000

800

500

800

600

1000

600 400

400 -500

200

200 0 Jan-71

-1000

Jan-75

Jan-79 Jan-83 US$

Jan-87

Euro

Jan-91 Jan-95 UK Pound

Source: WGC, Morgan Stanley Commodity Research

Jan-99

Jan-03 Jan-07

Jan-11

0 2000

2002

2004

2006

2008

2010

2012e

2014e

2016e

Australian Dollar

e = Morgan Stanley Research estimates Source: WGC, GFMS, Morgan Stanley Commodity Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Gold

…as sovereign debt concerns highlight fiat currency risks

• More recently, a sharp rise in inflationary pressures partially driven by a surge in oil prices since February 2011 and the growing risk of sovereign debt default in peripheral countries of the Eurozone have given added impetus to investment demand growth as the fear of sovereign debt contagion has also raised questions over the long-term future of the euro. • Even more recently, the impending threat of technical default by the US government if the government debt ceiling is breached, and the associated risk of a sovereign debt rating downgrade if a satisfactory long-term debt reduction program is not established have added to investor concerns about the long-term outlook for US treasuries and “risk-free assets.” • In these circumstances, we expect the long-running bull market in gold will receive further impetus, even if there is no return to QE in the US. However, QE3 is a potential further upside risk to prices in the current environment. • A further illustration of the growing quasi-monetary role of gold in the current global financial environment has been the persistent trend in official sector sales from net selling to net buying, a trend that we expect to continue, especially now that the sale of the IMF gold tranche has been completed. • We have increased our annual gold price forecasts by 8%, 22% and 24% for 2011, 2012 and 2013 respectively to US$1,511/oz, US$1,624/0z and US$1,550/oz.

Gold jewellery fabrication demand by region

Official gold world holdings, 2011 vs. 2007

3500

9,000 tonnes 3000

8,000 7,000

2500

ETFs: +270%

6,000

Russia: +97%

5,000 4,000

India: +56%

China: +76%

3,000

2000

1500

2,000 1000

1,000

IM F

Ita l Fr y an ce ET Fs Sw Chi i tz na er la nd Ja N p et he an rla nd s R us si a In di a EC Ta B iw a Po n r tu Ve g ne al U ni te zue d Ki l a ng d Le om ba no n Sp ai n Au st ria

ni te d

St at e er s m an y

Q1 2011

Q1 2007

Source: WGC, GFMS, Morgan Stanley Commodity Research

500

0 2003

2004

2005 E Asia

2006 2007 India

2008

2009

Middle East

2010 2011e 2012e 2013e 2014e 2015e 2016e Europe

N America

e = Morgan Stanley Research estimates Source: WGC, GFMS, Morgan Stanley Commodity Research

Other Countries

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Gold

Global supply / demand Unit

2003

2004

2005

2006

2007

2008

2009

2010

2011e

2012e

2013e

2014e

2015e

2016e

tonnes % tonnes % tonnes % tonnes % %

2560 1.7 986 12.9 505 37.4 -360 3691 10.1

2484 -3.0 881 -10.6 441 -12.8 -424 3382 -8.4

2445 -1.6 902 2.4 849 92.6 -142 4054 19.9

2441 -0.2 1133 25.5 289 -66.0 -434 3428 -15.4

2437 -0.2 982 -13.3 430 48.9 -444 3404 -0.7

2377 -2.5 1316 34.0 -36 -108.5 -352 3305 -2.9

2521 6.1 1672 27.1 -100 173.4 -254 3839 16.2

2638 4.6 1645 -1.6 25 -124.9 -121 4187 9.0

2775 5.2 1365 -17.0 -110 -543.0 -50 3980 -4.9

2941 6.0 1502 10.0 -70 -36.4 -30 4342 9.1

3041 3.4 1427 -5.0 -30 -57.1 -5 4433 2.1

3113 2.4 1355 -5.0 -30 0.0 10 4448 0.3

3082 -1.0 1247 -8.0 -10 -66.7 25 4344 -2.4

3141 1.9 1241 -0.5 -10 0.0 25 4397 1.2

tonnes % tonnes % tonnes % tonnes % tonnes %

2484 -6.7 237 15.3 67 -2.2 164 4.0 3004 -4.4

2616 5.3 266 12.1 37 -44.9 176 5.4 3146 4.7

2718 3.9 286 7.3 62 69.1 121 -30.6 3224 2.5

2298 -15.5 316 10.7 61 -2.7 129 19.4 2863 -11.2

2418 5.2 322 1.8 58 -4.8 125 4.8 2994 4.6

2193 -9.3 312 -3.2 56 -3.6 192 29.0 2815 -6.0

1758 -19.8 275 -11.8 53 -5.4 229 12.4 2371 -15.7

2017 14.7 327 19.0 50 -4.9 207 3.4 2689 13.4

2018 0.1 335 2.3 53 4.8 302 33.6 2800 4.1

2038 1.0 345 3.1 53 0.0 311 2.6 2841 1.5

2265 11.1 355 2.9 53 0.0 305 -1.1 3073 8.2

2588 14.3 360 1.4 55 4.8 289 -3.4 3391 10.3

3038 17.4 370 2.8 55 0.0 269 -4.8 3832 13.0

3175 4.5 385 4.0 55 0.0 275 2.0 3991 4.1

ETF Holdings Bar Hoarding Implied Investment/Disinvestment Total Investment Demand Investment as a % of Total Demand

tonnes tonnes tonnes %

32 180 475 687 18.6

156 357 -246 235 7.0

365 237 385 831 20.5

625 193 113 566 16.5

877 203 -45 410 12.0

1198 672 -503 490 14.8

1816 493 358 1468 38.2

2154 854 306 1498 35.8

2404 922 8 1180 29.7

2754 885 266 1502 34.6

2854 832 427 1360 30.7

2804 791 317 1058 23.8

2704 767 -155 512 11.8

2604 759 406 406 9.2

Total Demand (Fabrication + Investment)

tonnes

3691

3382

4054

3428

3404

3305

3839

4187

3980

4342

4433

4448

4344

4397

Gold Price

US$/oz

363

410

445

605

697

872

976

1226

1511

1624

1550

1450

1300

1150

Supply Total Mine Production year-over-year chg Scrap supply year-over-year chg Official sector net sales/(purchases) year-over-year chg Net producer hedging Total Supply year-over-year chg Demand Jewellery year-over-year chg Electronics year-over-year chg Dental year-over-year chg Official Coins, Medals & Imitation coins year-over-year chg Total Fabrication Demand year-over-year chg

e = Morgan Stanley Research estimates Source: WGC, GFMS, CRU, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Silver

May 2011 correction has reduced risks of demand destruction…

 As GFMS observed in the 2011 World Silver Survey published for the Silver Institute, silver’s “hybrid” precious and industrial

nature leads to links with gold, copper, and the CRB index, which can vary greatly.  In the course of 2011, silver’s precious metal status and therefore its links with gold have been strongly reinforced by investors’ preference to hedge systemic financial risk, rising inflationary pressures, and resurgent political risk in MENA through a cheaper vehicle with characteristics similar to gold as a store of value.  Driven by a spectacular rally between late March and May led by retail investors, the gold:silver ratio narrowed sharply, reaching its lowest point since October 1980 in early May 2011 at 30:1.  Closing prices for silver at the peak of the rally in late April 2011 at US$48.70/oz came within 1.5% of the all time high established in January 1980 during the Hunt brothers’ squeeze. Successive increases in the Comex margin requirements then saw prices trade between US$33 and US$36/oz and the gold:silver ratio stabilize around 40 to 44:1. Gold:Silver ratio, 1970-2011 100.0

Plus 2 St Dev

90.0

80.0

Plus 1 St Dev 70.0

41-year avg Ratio 60.0

50.0

40.0

Minus 1 St Dev

30.0

20.0

Minus 2 St Dev

10.0

0.0 Jan-70

Oct-73

Jul-77

Apr-81

Jan-85

Oct-88

Jul-92

Apr-96

Jan-00

Oct-03

Jul-07

Apr-11

Source: Thomson Reuters, Morgan Stanley Commodity Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Silver

…helping sustain investment demand going into 2012

 In our view, the 2,000t outflow of silver from ETF funds that has followed this correction is likely to be temporary, as all of

the drivers for the initial 3,500t surge in ETF inflows between September 2010 and late April 2011 are still in place.  Furthermore, the lower trading range for prices since the crash in early May should be an incentive for investors to return to

the physical investment market now that the impact of the violent correction has largely been discounted.  Investor sentiment should also be encouraged by evidence of strongly rising fabrication demand, especially in the brazing

alloy/solder and jewellery markets, which are forecast to grow by 8.2% and 3.7%, respectively, in 2011.  As a result, we have made significant upgrades to prices throughout the forecast period. For 2011, we now expect an

average price of US$36.21/oz, up 15% from our previous forecast, and in 2012 we see prices averaging US$36.90/oz, 30% higher than our previous estimate. For 2013, we have raised our forecast 32% to US$32.98/oz. Precious metal relative price performance, 2010-2011 Base: 1 Jan 10 = 100

Reported holdings in iShares Silver ETF vs. price, 2006-2011 50

300

Tonnes in Trust

US$/oz

280

10,000

260

12,000

240

8,000

220

200

6,000

180

160

4,000

140 10

120

2,000

100 80 Jan-10 Mar-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Jan-11 Mar-11 May-11 Jul-11

0 2006

0 2007

2008

Silver holdings in Trust (RHS)

Silver

Palladium

Platinum

Source: Thomson Reuters, Morgan Stanley Commodity Research

2009

2011

Silver price (LHS)

Gold

e = Morgan Stanley Research estimates Source: CRU, iShares, Morgan Stanley Commodity Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Silver

Global supply / demand 2003

2004

2005

2006

2007

2008

2009

2010e

2011e

2012e

2013e

2014e

2015e

2016e

tonnes % tonnes % tonnes % tonnes tonnes %

19126 -0.1 -2150 41.0 6025 -1.2 -500 22501 -2.3

19663 2.8 -1891 -12.1 5950 -1.2 200 23922 6.3

20556 4.5 -2239 18.4 6200 4.2 350 24868 4.0

20807 1.2 -2296 2.6 6475 4.4 -200 24786 -0.3

21773 4.6 -1474 -35.8 6250 -3.5 -500 26049 5.1

22265 2.3 -800 -45.7 6075 -2.8 -250 27290 4.8

23207 4.2 -425 -46.9 5875 -3.3 -500 28157 3.2

24036 3.6 -1300 205.9 6700 14.0 1250 30688 9.0

24375 1.4 -750 -42.3 6040 -9.9 750 30414 -0.9

25475 4.5 -500 -33.3 5552 -8.1 0 30526 0.4

25950 1.9 -250 -50.0 5564 0.2 0 31263 2.4

26825 3.4 -100 -60.0 5691 2.3 0 32415 3.7

26850 0.1 -75 -25.0 6129 7.7 0 32904 1.5

27387 2.0 -75 0.0 6313 3.0 0 33625 2.2

tonnes % tonnes % tonnes % tonnes % tonnes % tonnes %

4940 0.2 6020 -5.8 1370 0.7 1110 12.1 4780 5.3 26350 1.4

5420 9.7 5600 -7.0 1550 13.1 1250 12.6 4410 -7.7 25710 -2.4

6050 11.6 5000 -10.7 1730 11.6 670 -46.4 5160 17.0 26050 1.3

6550 8.3 4450 -11.0 1780 2.9 1200 79.1 5170 0.2 26130 0.3

7290 11.3 3700 -16.9 2110 18.5 1310 9.2 5300 2.5 26540 1.6

7350 0.8 3260 -11.9 2390 13.3 2100 60.3 5000 -5.7 26700 0.6

6100 -17.0 2660 -18.4 2150 -10.0 2520 20.0 3770 -24.6 23870 -10.6

7840 28.5 2580 -3.0 2370 10.2 3180 26.2 4370 15.9 27050 13.3

7851 0.1 2419 -6.2 2565 8.2 3260 2.5 4524 3.5 27575 1.9

8558 9.0 2280 -5.7 2731 6.5 2184 -33.0 4704 4.0 27675 0.4

8795 2.8 2172 -4.7 2897 6.1 1791 -18.0 4889 3.9 27975 1.1

9103 3.5 2072 -4.6 3023 4.3 1746 -2.5 5074 3.8 28475 1.8

9592 5.4 1980 -4.5 3149 4.2 1746 0.0 5256 3.6 29225 2.6

10023 4.5 1881 -5.0 3285 4.3 1763 1.0 5413 3.0 29943 2.5

Fundamental Balance

tonnes

-3849

-1788

-1182

-1344

-491

590

4287

3638

2839

2851

3288

3940

3679

3682

ETF Holdings year-over-year Implied Other Investment Total Demand

tonnes % tonnes tonnes

462

814

963

4825

-3939 22501

-2140 23922

-1332 24868

-5206 24786

7166 48.5 -2832 26049

9763 36.2 -2007 27290

14593 49.5 -544 28157

18408 26.1 -178 30688

22733 -76.5 -1486 30414

26508 -12.7 -924 30526

30308 0.7 -512 31263

34483 9.9 -235 32415

38333 -7.8 -171 32904

42083 -2.6 -68 33625

Price

USD/oz

4.88

6.66

7.31

11.60

13.18

15.02

14.70

20.11

36.21

36.90

32.98

29.00

25.00

20.91

Supply Mine Production year-over-year Net Government Sales year-over-year Old Silver Scrap year-over-year Net Producer Hedging Total Supply year-over-year Demand Electronics year-over-year Photography year-over-year Brazing Alloys and Solders year-over-year Coins & Medals year-over-year Other Applications year-over-year Total Fabrication Demand year-over-year

e = Morgan Stanley Research estimates Source: CRU, GFMS, Silver Institute, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

PGMs Investment demand critical for metal group trading below incentive price  2Q is an active period for PGM news flow, with (1) the annual Platinum Week, when representatives of the platinum

     

industry gather in London; (2) Johnson Matthey's updated review of the PGM markets; and (3) leading precious metal consultancy GFMS presenting its PGM commodity views. As Johnson Matthey (JM) is the basis for our historical data set and our forecast categories, we look at the adjustments that it has made to 2010 estimates. JM's interim review of the PGM markets in 2010 was generally positive: Platinum – adjusted 2010 surplus down from 290 to 20koz (higher SA supply, but even higher adjustment to demand); Palladium – adjusted from 45koz surplus to 490koz deficit (mainly revisions to autocat and investment demand); Rhodium – raised surplus estimate from 79 to 114koz (mainly from raised est. of South African supply). JM estimated 6-month price range for Pt of US$1750-c.2000/oz (avg. 1870 vs. prior MSe 1750 and GFMS range of 1675-1925) and Pd US$715-975/oz (avg. 825 vs. prior MSe 750 and GFMS range of 650-975). Forecast adjustments – We generally raise our Palladium price deck, mostly at the expense of reducing Rh and to a lesser extent Pt. This is supported by revision of our scrap recycling (risk to the upside on prior estimates) and, in the case of Pd, offset by phasing out Russian destocking by 2016 (limited visibility on this line item).

US auto recovery (scrappage rate/new vehicle registrations) – autocat recovery vs. new demand is a potential headwind 1.6

Average (m)

PGM price forecast changes

120%

YTD

1,750 1,725 1% 775 725 7% 2,000 2,400 -17%

1,800 1,749 3% 825 767 8% 2,200 2,669 -18%

2012e

2013e

2014e

2015e

2016e LT Real

100% 1.2 80% 0.8

60% Average new vehicle registrations per month (m)

0.4

40%

Average vehicle scrappage per month (m) 20%

Scrappage as a % of registrations 0.0

Platinum (US$/oz)

1,792 New old chg Palladium 776 New (US$/oz) old chg Rhodium 2,250 New (US$/oz) old chg

1,911 1,915 0% 956 823 16% 2,293 3,205 -28%

1,952 2,057 -5% 976 885 10% 2,927 4,264 -31%

2,115 2,270 -7% 1,058 907 17% 3,173 5,140 -38%

2,325 2,458 -5% 1,393 1,133 23% 3,745 5,886 -36%

2,413 2,667 -10% 1,942 1,336 45% 4,826 6,727 -28%

1,900 1,900 0% 950 633 50% 3,800 4,750 -20%

1999

2000

2001

2002

2003

Source: Morgan Stanley Research

2004

2005

2006

2007

2008 2009*

e = Morgan Stanley Research estimates Source: Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Platinum Investment critical near-term to turn market surplus into “deficit”  We reiterate our view that near-term pricing support (particularly platinum, but also palladium) arises from

investment demand (favourable stock movements) compensating for auto demand inertia. This is not to say auto demand has not recovered materially – just that it is not yet sufficient to tighten the markets to support significant price action, in our view.  European auto sector represents a near-term threat to market tightening. European contribution to platinum

demand was 27% in 2010. (For palladium, 18% of 2010 demand was from Europe.)  Over the past 9 quarters, the QoQ change in platinum ETF demand and platinum price has been almost 1:1 (i.e. 100koz of new ETF money per quarter corresponds to c.US$100/oz/qtr). This linkage has continued; the lack of net ETF inflows in 2Q has been associated with a flat price. While it is debatable whether ETF/investment demand drives price or price drives ETF demand, it is clear in our view that investment demand has created a higher price than what would be supported by traditional market fundamentals, and is the difference between a “surplus” and “deficit” in the platinum market in the medium term. Platinum COTR (net non-commercial positions): Platinum ETF demand vs. price, 2008-2011 investors are net long 2.0

2,250

1.6

2,000

Swiss

1.4

UK 1 1,500 0.8 0.6

1,250

0.4 1,000

US$/oz

1,750

Price

2,000 1,750

1.2 1,500 0.8 1,250 0.4

1,000

0.2

Source: Bloomberg, Morgan Stanley Research

Jan-11

Apr-10

Jul-09

750 Oct-08

0.0 Jan-08

Apr-11

Nov-10

Jun-10

Jan-10

Aug-09

Mar-09

Oct-08

750 May-08

0 Jan-08

Million oz

1.2

Platinum position (moz)

1.6

2,250

Net Spec Long Platinum Price

Price (US$/oz)

1.8

Source: CFTC, Bloomberg, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Platinum Autocat scrap recycling offers price elastic supply – a threat to weak sales  We identified in May that scrap recycling is the next potential threat to market tightening. Efficiency of recycling

appears correlated to price and thus offers a price elastic source of supply that mining does not offer (longer leads and lags). Relative to our current supply assumptions, we could envisage an additional 1moz pa of both Pt and Pd from 2009 to 2016.  Typically for platinum, 30-40% of the available metal was recovered in the 1990s (on the basis of our assumption that the average age of a recycled vehicle is 11yrs), but this has risen to an apparent 50-60% in the past few years. Visually, this recovery is correlated to metal price (targeting Pt rich old catalysts with rising prices, and likely improvements in refining efficiency). Other reasons for reduced recoveries include loss of metal from catalyst substrate whilst in use (likely minimal), transfer of used cars from developed markets to emerging markets accompanied by sub-optimal collection of old vehicles/catalysts in EM, and metallurgical limitations on recovery.  Adjusting for 50% global recovery of platinum raises our 2015 supply estimate to 1.7moz (incremental 0.5moz pa of Pt supply vs. 2010 est.). This compares to our 2016 mine supply estimate of 7.5moz and balanced market assumption; and increases the risks of keeping the market looser for longer, particularly in an environment where demand recovery waivers.

Estimated % Pt recovered and price

Source: Johnson Matthey, Morgan Stanley Research. e = Morgan Stanley Research estimates

2011

2006

2001

1996

1991

2015e

2005

1995

1985

25%

50% recovery assumption

800 MS forecast

400 0

2013e

35%

1,000

35% recovery assumption 1,200

2009

2,000

MS forecast

45%

Actual

1,600

2005

MS forecast

3,000

2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0

2001

Price

55%

4,000

US$/t

Apparent recovery

1997

Auto recycled

1975

Platinum (koz pa)

65%

Gross Auto

Pt (koz)

6,000 5,000

Pt recovered from autocats – actual, MS prior model (35%) and implied at 50% recovery level (new base case)

1993

Platinum - consumed and recovered from autocats

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Platinum

Global supply / demand Unit

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011e

2012e

2013e

2014e

2015e

2016e

Platinum Production South Africa Russia North America Others Total World Production % change

Koz Koz Koz Koz Koz %

4450 980 390 150 5970 1.9

4630 1050 295 225 6200 3.9

5010 845 385 250 6490 4.7

5115 890 365 270 6640 2.3

5295 920 345 270 6830 2.9

5070 915 325 290 6600 -3.4

4515 805 325 295 5940 -10.0

4635 785 260 345 6025 1.4

4635 825 210 390 6060 0.6

4821 819 302 397 6338 4.6

5176 827 313 438 6755 6.6

5510 850 321 498 7179 6.3

5618 860 321 554 7352 2.4

5745 870 321 554 7489 1.9

5903 870 321 575 7669 2.4

Platinum Consumption Autocatalyst (net) gross recovery Chemical Electrical Glass Investment¹ Jewellery % change jewellery Petroleum Other Total Demand

Koz Koz Koz Koz Koz Koz Koz Koz % Koz Koz Koz

2025 2590 565 325 315 235 80 2820 8.9 130 540 6470

2625 3270 645 320 260 210 15 2510 -11.0 120 470 6530

2800 3490 690 325 300 290 45 2160 -13.9 150 470 6540

3025 3795 770 325 360 360 15 1965 -9.0 170 475 6695

3045 3905 860 395 360 405 -40 1640 -16.5 180 490 6475

3210 4145 935 420 255 470 170 1455 -11.3 205 495 6680

2525 3655 1130 400 225 315 555 1365 -6.2 240 535 6160

1355 2185 830 290 180 10 660 2245 64.5 210 440 5390

2040 3125 1085 445 210 345 650 1670 -25.6 170 510 6040

2301 3386 1086 403 232 381 435 1788 7.0 230 556 6326

2785 3994 1209 403 244 395 435 1703 -4.7 240 560 6764

2943 4292 1349 402 248 405 435 1889 10.9 245 575 7142

3177 4675 1499 399 253 416 435 1824 -3.4 245 583 7331

3428 5055 1627 403 259 427 435 1699 -6.9 255 594 7500

3429 5149 1720 402 267 439 435 1818 7.0 260 600 7650

Koz

-500

-330

-50

-55

355

-80

-220

635

-9

-10

US$/oz

540 2.1

691 28.0

846 22.4

897 6.0

1143 27.4

1304 14.1

1576 20.9

1210 -23.2

1607 32.8

1784 11.0

1911 7.2

1952 2.1

2115 8.4

2325 9.9

2413 3.8

Historic Conventional Balance Average Price (US$/oz) % price change

¹Before 1980, Investment demand is included in Other estimates. ²Before 1993, estimates include Eastern Europe; for 1993 and subsequent years, demand in this region is included in European figures. e = Morgan Stanley Research estimates. Source: Johnson Matthey, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Palladium Investment demand necessary to combat Russian/Swiss destocking  There generally seems to be scope for Pd price to converge with Pt price in the medium term – We understand

substitutability is now close to 1:1 in gasoline applications, from 2:1 around 10yrs ago. We also understand US auto manufacturers are keen to reduce dependence on SA supply (so appear likely to retain weighting to Pd, which has broader geographic supply).  Johnson Matthey estimates Russian destocking at 1moz in 2010 – Furthermore, Pd stock in Switzerland is an estimated 5-7moz (from Swiss customs data). While the underlying market is deemed to be in fundamental deficit (and thus needs to be supplied from surface stock), we believe investors are likely to be incentivised to hold their positions. There is nevertheless likely to be a price point at which this stock is mobilised – for now, we consider this to be a function of a level of convergence of Pd/Pt prices.  While Pd is a beneficiary of US$ weakness, we view this as similar to other industrial commodities, rather than as a safe-haven precious metal (i.e. gold). The relevance of this is that we consider investment appetite for palladium to be driven by positive risk appetite – and thus vulnerable to periods of risk aversion, as seen in 2Q.  Long term, we adjust our price ratio for Pd/Pt up from 1:3 to 1:2. This skews the historical average ratio for Pd up – in line with the above argument for Pd, in terms of technical substitutability in gasoline applications. We still believe the best way to forecast the by-product metals is as a ratio to platinum. Palladium COTR (net non-commercial positions): Palladium ETF demand vs. price, 2007-2011 net long 900

Swiss

700

600

Price

1.5

2.0

moz

500 400 1 300 200

0.5

900

Net Spec Long

800

Palladium Price

1.6

700 600

Price (US$/oz)

800

US$/oz

Palladium Position (moz)

2.5

1.2

500 400

0.8

300 200

0.4

100

Source: Bloomberg, Morgan Stanley Research

Jan-11

Apr-10

Jul-09

0 Oct-08

0.0 Jan-08

Apr-11

Nov-10

Jun-10

Jan-10

Aug-09

Mar-09

Oct-08

May-08

0 Jan-08

Source: CFTC, Bloomberg, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Palladium Scrap recycling poised for growth (adding 1moz pa from 2009 to 2015)  Return of scrap recycling as Pd price strength continues. Whilst platinum autocat scrap recovery has been in an

apparent uptrend, Pd has declined from apparent >70% recovery in 2000-2002 to c.30% currently – and also appears to have followed the price trend down, with c.2yr lag. Recent strong price, and our expectation of continued price strength, would suggest that recyclers would apply themselves to Pd scrap recycling going forward.  Recent trends of US rate of new car sales and rate of scrapping threatens a specific headwind for the palladiumrich US auto sector – exacerbated by the elevated Pd intensity of the 11-13 yr vehicle age that is likely to be seen increasingly in the scrap yard. North America accounted for 32% of palladium demand in 2010 (vs. 19% for platinum) – thus, whereas platinum is a European auto story, at the margin, palladium is much more a North American story (enhanced by growth in the Chinese auto sector).  We have adjusted our base case to assume 50% global autocat recovery is achieved for palladium by 2015 (increasing base case from 1.5moz pa to 2moz; adding 0.7moz pa vs. 2010 est.). This compares to our 2014 mine supply estimate of 7.6moz and 500koz deficit. Further scrap supply upside would exist if recovery rates increase faster or if the apparent under-recovery of the past c.5yrs is caught up.

2,500

1,000

2,000

20%

Source: Johnson Matthey, Morgan Stanley Research. e = Morgan Stanley Research estimates

1,500 1,000

MS forecast

500 0

2014e

200

50% recovery assumption

2010e

30% 2012e

400

2008

40%

30% recovery assumption

2006

600

Actual

2002

50%

2004

2010e

2000

1,200

800 MS forecast

2000

2,500

60%

1996

5,000

Apparent recovery

MS forecast

1990

Price

70%

Auto recycled

1980

Palladium (koz)

apparent recovery

80%

Gross auto

1998

10,000 7,500

Pd recovered from autocats – actual, MS prior model and implied at 50% recovery level (new 2015 base case)

Pd - % recovered (according to assumed distribution) and price

Pd (koz)

Palladium – consumed and recovered from autocats

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Palladium Palladium Production South Africa Russia North America Others Total Supply % change Palladium Consumption Autocatalyst (net) gross recovery Chemical¹ Dental Electronics Jewellery Investment Other Total Demand Historic Conventional Balance Average Price (US$/oz) % price change

Global supply / demand Unit

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011e

2012e

2013e

2014e

2015e

2016e

Koz Koz Koz Koz Koz %

2160 1930 990 170 5250 1.9

2320 2950 935 245 6450 3.9

2480 4800 1035 265 8580 4.7

2605 4620 910 270 8405 2.3

2775 3920 985 270 7950 2.9

2765 4540 990 285 8580 -3.4

2430 3660 910 310 7310 -10.0

2370 3635 755 340 7100 1.4

2575 3720 590 405 7290 0.6

2718 3480 634 420 7252 4.6

2875 3115 910 452 7353 6.6

3222 3200 1008 503 7933 6.3

3272 2818 991 550 7630 2.4

3356 2850 973 550 7728 1.9

3466 2850 973 567 7857 2.4

Koz Koz Koz Koz Koz Koz Koz Koz Koz

2680 3050 370 255 785 760 270 0 90 4840

3040 3450 410 265 825 900 260 30 110 5430

3260 3790 530 310 850 920 930 200 90 6560

3240 3865 625 415 815 970 1430 220 265 7355

3210 4015 805 440 620 1205 1005 50 85 6615

3530 4545 1015 375 630 1235 715 260 85 6830

3325 4465 1140 350 625 1025 855 420 75 6675

3085 4050 965 325 635 975 705 625 70 6420

4125 5450 1325 395 580 970 540 1085 85 7780

4174 5678 1504 387 635 952 540 410 80 7177

4513 6196 1683 417 630 971 540 295 85 7451

5058 6920 1862 449 635 1010 540 279 85 8055

5336 7377 2041 471 625 1036 540 29 91 8127

6078 8082 2004 506 630 1061 540 -256 93 8652

6237 8254 2017 530 620 1085 540 -286 100 8826

Koz

410

1020

2020

1050

1335

1750

635

680

-490

-98

-122

-497

-924

-970

US$/oz

337 -44.1

201 -40.4

230 14.4

201 -12.6

320 59.2

355 10.9

352 -0.8

263 -25.3

522 98.7

788 50.8

956 21.3

976 2.1

1058 8.4

1393 31.7

1942 39.4

¹ Before 1986, Chemical demand is included in Other estimates. ² Between 1986 and 1998, Chinese demand is included in our Rest of the World estimates. e = Morgan Stanley Research estimates. Source: Johnson Matthey, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Rhodium

Surplus market without investment to mop up excess

 Rhodium recovery from scrap recycling also shows some correlation with price – although as part of a 3-way

catalyst system it will also be correlated to recoveries of the other major platinum group metals (correlated to basket price, rather then specific rhodium price).  Adjusting to 50% recovery for rhodium by 2016 implies upside from our prior consumption estimate of 265koz pa to 365koz (adding 180koz vs. 2010 est.) – relative to mine supply estimate of 900koz in 2016.  Market to remain in surplus, ETF demand yet to be proven. The medium-term risk for rhodium is exacerbated by the market remaining in near-term surplus, and as the underlying market tightens, the cumulative surplus takes time to unwind. The launch of a Rh ETF in 2Q resulted in a short-lived price recovery, but investment appetite for this illiquid metal is yet to be proven.  Long term, we adjust our price ratio for Rh:Pt from 2.5:1 to 2:1. This skews the historical average ratio for Rh down – a bit more conservative on Rh given current pricing and our view of extended market looseness (bearing in mind the historical average is an average of very high and very low ratios). Rhodium price vs. market balance

2,000

200

3,000 2,000

30%

1,000

25%

2014e

2012e

2010

2008

0 2006

300 2004

1,000

2002

250

35%

Price (US$/oz)

150

4,000

0 2013e

3,000

2011e

100

5,000 40%

2009

4,000

7,000 6,000

2007

Price

45%

2005

5,000

2000

Rhodium (koz)

Apparent recovery

50%

2003

6,000

2001

-50

7,000

Apparent recovery

Average Price (US$/oz)

Rhodium price (inverted $/oz)

Surplus(deficit)

-100

Rh - % recovered (according to assumed distribution) and price

Source: Johnson Matthey, Morgan Stanley Research. e = Morgan Stanley Research estimates

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Rhodium Global supply / demand Unit

2002

2003

2004

2005

2006

2007

2008e

2009

2010

2011e

2012e

2013e

2014e

2015e

2016e

Rhodium Production South Africa Russia North America Others Total Supply % change

Koz Koz Koz Koz Koz %

490 90 25 10 615 1.8

544 140 26 14 724 17.7

587 100 17 16 720 -0.6

627 90 20 17 754 4.7

690 95 20 19 802 9.3

696 90 20 18 824 0.0

574 85 18 18 695 -15.7

663 70 15 22 770 10.8

642 70 12 27 751 -2.5

643 76 17 28 765 1.8

662 74 18 32 785 2.7

716 76 18 37 847 7.9

737 78 18 42 876 3.4

744 78 18 42 883 0.8

759 78 18 44 900 1.9

Rhodium Consumption Autocatalyst (net) gross recovery Chemical Electrical Glass Other Total Demand

Koz Koz Koz Koz Koz Koz Koz Koz

500 599 99 39 6.0 37 10 592

536 660 124 39 6.0 26 13 620

618 758 140 43 8.0 46 14 729

692 829 137 48 10.0 57 20 827

692 863 171 49 9.0 65 23 838

695 887 192 63 3.0 59 24 844

541 768 227 68 3.0 34 24 670

432 619 187 54 3.0 19 21 529

488 724 236 68 4.0 57 20 637

483 754 271 62 4.4 63 22 634

532 823 291 62 4.6 65 22 686

612 919 307 61 4.7 67 23 769

654 980 326 61 4.8 69 24 812

728 1074 346 62 4.9 71 25 890

731 1097 365 61 5.1 73 25 896

Oversupply/(Undersupply)

Koz

23.0

104.0

-9.0

-73.0

-36.0

-20.0

25.0

241.0

114.0

130.2

99.4

78.3

63.7

-6.9

4.2

US$/oz

838 -47.8

530 -36.8

986 86.0

2056 108.5

4552 121.4

6191 36.0

6564 6.0

1591 -75.8

2454 54.2

2175 -11.4

2293 5.4

2927 27.6

3173 8.4

3745 18.0

4826 28.9

Average Price (US$/oz) % price change

e = Morgan Stanley Research estimates. Source: Johnson Matthey, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Commodity Commentary â&#x20AC;&#x201C; Steel and Bulk Commodities

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Steel

Forecasts left broadly unchanged

ď&#x201A;ˇ Industry operating rates continue to slowly recover. Our global steel production forecasts remain broadly unchanged.

The largest change is to our production forecasts for China, which we have lifted by 20-27mt in 2011-12. However, the bulk of this lift in Chinese production is forecast to go into increased exports as a result of relatively attractive pricing, which results in just modest changes in our global operating rate forecast for 2011 to 85% from 84% previously. We cut demand forecasts for North America by c.3% for 2011-12, resulting in global demand growth of 6.4% for 2011 (vs. 6.6% previously). ď&#x201A;ˇ Our global steel price forecasts for 2011 remain broadly unchanged. In China, demand for flat steel this summer,

particularly in the auto and white-good segments, has been decelerating. Major Chinese steel mills recently announced flat August contract pricing, which is a modestly positive development after a 4% cut in contract pricing into June. For China, we have moderately lowered our price forecasts for 2011-12, due to the weakness in pricing, especially in 1H. Our global steel pricing forecasts are left broadly unchanged, with moderate upward revisions in 2013-15, from increases in our iron ore price forecasts for this period. Base-case HRC price forecast

100%

Global HRC New

Old

Chg

95%

US$/t

90%

2014e

755

735

65%

2015e

710

685

60%

2016e

685

655

55%

600

50%

Note: Prices are global averages, e.g., 2010 includes US$665 for US, US$645 for China, and US$679 for Europe. Source: Morgan Stanley Research

Global Operating Rate

EU (25)

NAFTA

China

2015e

70%

2014e

2013e

780

2012e

795

2010

2013e

2011e

75%

2009

2008

790

2007

790

2006

2012e

2005

80%

2004

2003

810

2002

810

2001

2011e

1998

665

2000

85%

2010

1999

Period

Global operating rates return to mid-cycle levels of 85% in 2011e

Japan

Source: Morgan Stanley Research. e = Morgan Stanley Research estimates

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Steel

Chinese steel leading indicator sees a modest 2H recovery

 Steel apparent consumption in China has been weaker in 2Q but may recover modestly in 2H, based on our

bottom-up consumption index. Key drivers to our index have been property sales, infrastructure investment, plus sales data for machinery, white goods, and autos, plus China’s PMI. Whilst 2Q showed slowing trends in most segments, latest data points for June are highlighting the potential for a 2H recovery as property sales begin to recover and we anticipate an acceleration in social housing construction.  We see a potential positive pricing catalyst emerging from producer downtime, which should accelerate this summer,

triggered by a continued margin squeeze from high raw material costs and declining steel prices. China: Steel leading indicator for apparent consumption sees modest recovery

Chinese steel production stays strong; pricing starting to moderate

80%

Steel: Pricing & Annualised Monhtly Production

Steel Consumption Index (3MMA)

Jun-11

Mar-11

Dec-10

Jun-10

Sep-10

Mar-10

Dec-09

Jun-09

Sep-09

Mar-09

Dec-08

Jun-08

400 Sep-08

-20% Mar-08

500

5,500 5,000 4,500

300

4,000

200

Steel - apparent consumption

3,500

100

China's Steel Consumption Index (SCI): Feb-11

Mar-11

Apr-11

May-11

Jun-11e

YTD-11

17% 19% 107% 18% 4% 0% 13% 8%

-25% 14% 43% 25% 5% -3% 2% 5%

-49% 5% 16% 19% -2% -5% -4% 6%

11% 2% -4% 21% -5% -4% 1% 8%

38% -16% -1% 21% 1% -2% 10% 15%

-11% 10% 31% 24% 3% -3% 5% 8%

Source: CEIC, Bloomberg, NBS, Morgan Stanley Research e = Morgan Stanley Research estimates

Production

Jul-11

Jan-11

Jul-10

Jan-10

Jul-09

Jan-09

Jul-08

3,000 Jan-08

0 Jul-07

Key Drivers & Weightings (YoY chg) Property (units sold) - 42% Infrastructure (real FAI) - 14% Machinery (sales) - 13% White goods (sales) - 8% Auto (sales) - 6% Other (PMI) - 17% Steel Consumption Index Steel Appt. Consumption

Rmb/t 6,000

Jan-07

Dec-07

Jun-07

600

Sep-07

20%

Mar-07

700

Dec-06

40%

Jun-06

800

Sep-06

YoY Change - %

mt 60%

Price

Source: Bloomberg, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Post earthquake recovery in Japan – high inventory level needs correcting; earlier recovery of auto production will be supportive

Steel

 Japanese domestic demand saw a large decline in 2Q. “Revival demand” to appear mostly from 2012 to 2014. Due

to lower demand from key users affected by the earthquake, major Japanese steel mills’ shipping volume was depressed by 10-15% vs. initial plans in 2Q11. In particular, an auto vehicle production decline due to auto parts shortages negatively impacted both domestic and East Asian auto steel sheet demand. Domestic flat product inventory hit a 2-year high and spot steel prices weakened (mainly for construction demand). It will take time before we see “revival demand,” but we expect it will lift domestic construction demand by 3-5%.  Auto production recovering earlier than first expected; high-grade steel prices to increase by US$160-185/t HoH. Auto

production started to recover in late May, which was earlier than initial market expectations. It now seems that 3Q shipping volume will be 95-100% of original plans, and 4Q will be higher. High-grade steel contract prices for Jun–Nov are being finalized, and price hikes are covering cost increases of key raw materials, despite concerns of margin deterioration due to spot market weakness. An earlier recovery will work positively not only for domestic inventory correction but also for supply/demand of flat product in East Asia. This could be a supportive factor for our expectation of price recovery toward 4Q11. Ordinary steel orders for autos in Japan; declined Japanese HRC contract price (domestic, export) 37.6% YoY in Apr, expect to recover from May 1200

200%

(Kt)

($/Mt FOB)

1,150

HRC Contract to Korea (Export)

1,050

1000

150%

800

100%

950

Auto steel sheet contract (Domestic, Estimated)

850 750

600

50%

400

650 550

Automobile

200

-50%

YOY

350 250

-100% 06

450

Source: Morgan Stanley Research

150 01

Source: Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Steel

Global steel summary supply / demand & operating rate model

Demand - Finished Steel (mmt) EU (27) Other Europe CIS/Russia North America South America China Japan S.Korea India Other Asia/Pacific Africa/Middle East Global Demand - Finished Steel % change Y-o-Y World ex-China % Change China % Change Global Demand - Crude Steel % change Y-o-Y Ratio Finished/Crude - % Production - Crude Steel (mmt) EU (27) Other Europe CIS/Russia North America South America China Japan S.Korea India Other Asia/Pacific Africa/Middle East Global Production % change Y-o-Y World ex-China % Change China % Change Operating Rate - Crude Steel Global Operating Rate

2002

2003

2004

2005

2006

2007

2008

2009

2010e

2011e

2012e

2013e

2014e

2015e

2016e

159 18 34 138 25 191 72 44 31 69 43 822 5.9 631 2.0 191 21.1 908 6.1 90.6

160 20 37 131 25 240 73 45 33 69 48 883 7.4 643 1.8 240 25.7 973 7.2 90.8

172 22 38 151 31 276 77 47 35 76 50 975 10.4 699 8.8 276 14.7 1072 10.2 90.9

166 23 42 138 30 347 77 47 40 71 56 1035 6.2 688 -1.6 347 26.0 1131 5.5 91.5

189 27 49 155 34 378 79 50 46 66 58 1130 9.1 752 9.3 378 8.7 1239 9.5 91.2

198 30 57 141 39 423 81 55 52 69 66 1211 7.2 788 4.8 423 11.9 1331 7.4 91.0

183 27 50 129 41 435 78 59 51 71 68 1193 -1.5 758 -3.9 435 2.9 1310 -1.5 91.0

118 24 36 81 31 542 53 45 57 61 67 1116 -6.4 573 -24.3 542 24.8 1226 -6.4 91.0

164 31 49 109 40 582 66 53 62 70 76 1300 16.5 718 25.3 582 7.3 1429 16.5 91.0

172 33 53 118 44 625 63 56 67 73 80 1382 6.3 757 5.5 625 7.4 1519 6.3 91.0

179 34 57 127 48 656 67 57 73 77 84 1457 5.4 802 5.8 656 4.9 1601 5.4 91.0

186 36 60 138 50 687 68 57 80 79 87 1527 4.8 841 4.9 687 4.7 1678 4.8 91.0

192 37 63 143 53 718 69 58 88 81 90 1591 4.2 873 3.9 718 4.6 1748 4.2 91.0

196 38 66 149 56 743 70 58 97 81 91 1645 3.4 902 3.3 743 3.4 1808 3.4 91.0

200 39 69 152 59 767 70 59 103 82 93 1694 3.0 927 2.7 767 3.3 1861 3.0 91.0

188 19 101 123 41 182 108 45 29 39 28 903 6.3 721 3.3 182 20.3

193 21 106 126 43 222 111 46 32 40 30 970 7.4 747 3.7 222 21.9

202 24 113 134 46 283 113 48 33 43 31 1069 10.2 786 5.1 283 27.2

195 25 113 127 45 353 112 48 46 47 33 1145 7.2 792 0.8 353 24.8

207 28 120 131 45 419 116 48 49 51 34 1274 11.2 855 7.9 419 18.7

210 30 124 133 48 489 120 52 53 52 34 1346 5.7 857 0.2 489 16.8

198 31 113 126 47 500 119 53 58 49 33 1329 -1.3 829 -3.3 500 2.2

140 29 97 82 38 574 88 49 63 37 31 1227 -7.7 653 -21.2 574 14.7

173 33 107 112 44 627 110 56 67 32 36 1396 13.8 769 17.8 627 9.3

184 36 115 121 51 686 108 63 73 40 38 1515 8.6 830 7.8 686 9.5

192 38 120 128 55 723 111 68 81 48 40 1603 5.8 880 6.1 723 5.4

199 39 126 141 56 765 113 69 89 52 41 1692 5.5 926 5.2 765 5.9

205 40 132 145 58 808 115 70 98 55 43 1768 4.5 960 3.7 808 5.6

209 42 133 149 60 834 118 70 108 59 43 1825 3.2 991 3.2 834 3.2

214 43 135 150 62 860 120 71 119 64 44 1882 3.2 1022 3.1 860 3.2

82%

83%

88%

87%

90%

89%

87%

75%

81%

85%

86%

87%

e = Morgan Stanley Research estimates. Source: SBB, World Steel Association, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Iron Ore

Stronger Chinese import demand and supply constraints keep prices high

• Global crude steel production is forecast to rise to 1.515bn tonnes in 2011 compared to 1.429bn tonnes in 2010, an increase of 6.3%. China’s share of crude production is forecast to increase to 686Mt or 45.6% of global output, compared to 627Mt or 44.9% of global output in 2010. • In 2010, Chinese seaborne iron ore imports declined to 619Mt from 628Mt in 2009, as domestic production of iron ore rose faster than the increase in crude steel production. In 2011, the reverse appears to be the case, at least on a run of mine basis adjusted for head grade, and seaborne imports are again rising. In 1H 2011, total iron ore imports in China were 335Mt, an increase of 7.1% on 1H 2010. • Exporters in Brazil and Australia have struggled to keep pace with the lift in Chinese demand, in part due to adverse weather and infrastructure availability in 1Q 2011 and the relative scarcity of Indian exports. This is despite a lifting of the ban on exports from India’s Karnataka State in mid-April, as officials in that state have refused to issue any new export permits until a Supreme Court appointed committee completes its survey on illegal mining activities. Daily blast furnace operating rates, 2008-11

China’s iron ore imports vs. spot price, 2008-2011 70

200

3,000

175

2,500

150

2,000

125

1,500

100

1,000

tonnes/day

US$/t

400 350 300 250 200 150 100

Jan -08

Ju l-08

Jan -09

Ju l-09

Ir o n o r e im p o r t s, Mt

Jan -10

Ju l-10

Jan -11

Sp o t Ir o n Or e, US$/t (RHS)

Source: Thomson Reuters, Morgan Stanley Research

500 50 0 0 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 China EU (27) Japan S Korea & Taiwan Russia

Spot Coking Coal (RHS)

Spot Iron Ore (RHS)

India

Brazil

Source: World Steel Institute, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Iron Ore

Seaborne market not expected to return to surplus before 2014

 Despite the announcement of an acceleration of both Rio Tinto’s and Fortescue’s expansion projects, the industry struggles

to sustain sufficient growth in capacity to match the medium-term growth in seaborne demand, in our view. Our revised seaborne market balance indicates that the seaborne market will sustain deficits until the end of 2013 or early 2014, with the likelihood that prices will remain at elevated levels throughout this period. We have therefore retained our 2011 and 2012 price forecasts of US$177/t and US$172/t, respectively, for 62% Fe fines on a CFR basis, but increased our 2013 and 2014 forecasts by 6.7% and 3.7%, respectively, to US$160/t and US$140/t.  Margin compression resulting from elevated raw material prices is prompting some steel producers to backwardly integrate. For example steelmaker ArcelorMittal will spend C$2.1bn (US$2.2bn ) to raise iron ore output 71% at Canada’s Mont-Wright mine by 2013. The effective capex/tonne for the additional 8mt of iron ore concentrate capacity is US$150/t – which is at the lower end of the US$150-250/t of capex range for iron ore projects being implemented currently. Despite this and other developments, the long-term shift in pricing power to the miners from steel makers shows little sign of abating under forecast supply and demand conditions. Iron ore project pipeline vs. MSe market balance

Shares of “Big 3” iron ore imports into China 100%

80%

60%

40%

20%

2011

2012

2013

2014

2015

2016

Total Australia

465

537

601

733

822

842

377

81%

Rio Tinto

220

225

230

283

333

113

51%

BHP Billiton

150

165

175

200

220

240

60%

Fortescue Metals

124

153

155

101

187%

Other Australia

114

176%

Total Brazil

347

382

427

468

501

531

184

53%

Vale

279

303

329

350

365

374

34%

CSN

67%

MMX

153%

Anglo American

186%

Simandou

247

240

230

277

343

364

117

39%

Rest of World

0% Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Total World

1060

1160

1268

1493

1686

1762

702

59%

Total Seaborne Demand

1092

1182

1295

1414

1507

1629

537

38%

-32

-22

-27

178

133

Morgan Stanley Balance

India

Australia

Source: Thomson Reuters, Morgan Stanley Research

Change 2011-2016

million tonnes

Brazil

e = Morgan Stanley Research estimates Source: CRU, Steel Business Briefing, World Steel Institute, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Iron Ore

Global supply / demand

Million Metric Tonnes

2003

2004

2005

2006

2007

2008

2009

2010e

2011e

2012e

2013e

2014e

2015e

World IP growth (Adjusted PPP Weights)

4.57

5.71

5.26

5.80

5.54

2.20

-2.61

7.31

5.49

5.54

5.20

4.92

4.47

3.60

Total World Steel Production

970

1069

1145

1249

1346

1329

1227

1396

1515

1603

1692

1768

1825

1882

7.4%

10.2%

7.2%

9.1%

7.7%

-1.3%

-7.7%

13.8%

8.6%

5.8%

5.5%

4.5%

3.2%

Brazil

246

271

292

319

337

346

300

361

381

424

456

549

642

689

China (adjusted to world average Fe content)

141

161

285

356

400

321

234

244

269

245

221

209

197

193

Australia

212

235

258

275

299

350

400

422

465

537

601

733

822

842

India

121

143

181

207

214

218

225

236

248

260

273

287

301

Russia

103

105

100

105

107

110

114

117

120

124

128

Ukraine

USA

South Africa

Total World Production

1093

1200

1394

1572

1699

1680

1591

1705

1824

1943

2049

2289

2489

2583

Annual % Change

8.5%

9.8%

16.2%

12.8%

8.1%

-1.1%

-5.3%

7.1%

7.0%

6.5%

5.4%

11.7%

8.7%

3.8%

China (dry basis)

148

208

275

326

383

444

628

619

674

741

821

911

983

1088

Western Europe

133

137

136

139

150

113

148

155

162

167

171

175

Japan

132

135

132

134

139

140

105

130

129

133

135

138

141

144

South Korea

Taiwan

Other Asia

Others (inc Middle East and other DRI)

100

110

117

Total Annual % Change

2016e

Iron Ore Production

Seaborne Iron Ore Demand by Country

Total Seaborne Demand by Country

543

606

681

731

786

849

910

1002

1092

1182

1295

1414

1507

1629

14.7%

11.6%

12.3%

7.4%

7.5%

8.0%

7.2%

10.0%

9.0%

8.3%

9.5%

9.2%

6.6%

8.1%

Australia

187

221

239

247

267

309

400

422

465

537

601

733

822

842

Brazil

184

201

223

248

269

282

264

311

323

365

400

494

587

638

India

103

114

103

Canada

S.Africa

ROW

105

112

119

124

Annual % Change Seaborne Iron Ore Supply by Country

Total Seaborne Iron Ore Supply by Country Annual % Change Apparent Seaborne Market Balance Seaborne balance as % of total derived demand

534

593

670

718

776

854

949

1006

1060

1160

1268

1493

1686

1762

7.3%

11.0%

13.0%

7.2%

8.0%

10.1%

11.1%

6.0%

5.4%

9.5%

9.3%

17.8%

12.9%

4.5%

-9.1

-13.4

-11.1

-13.3

-10.6

5.2

38.7

3.9

-32.1

-22.2

-26.8

79.5

178.1

132.6

-0.8%

-1.1%

-0.9%

-0.7%

0.3%

2.4%

0.2%

-1.7%

-1.1%

-1.2%

3.4%

7.3%

5.2%

Prices Annual Average Prices (JFY annual negotiated FOB price prior to 2010) Australian Iron Ore Fines price (US$/t)

19.73

23.03

39.50

47.01

51.47

92.58

62.08

145.75

177.66

172.50

160.00

140.00

125.00

110.00

Australian Iron Ore Lump price (US$/t)

25.18

29.40

50.41

59.99

65.69

129.08

71.68

165.27

200.40

194.58

184.00

162.40

147.50

132.00

Brazilian Iron Ore Fines (US$/t)

18.83

22.23

38.13

45.37

49.68

82.23

59.04

112.77

149.34

153.75

169.50

112.50

97.50

86.88

e = Morgan Stanley Research estimates Source: CRU, UNCTAD, Tex Report, Steel Business Briefing, World Steel Institute, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Metallurgical Coal

Impact of Queensland floods still being felt in seaborne market

 The major La Nina event that commenced in 2H 2010 and produced the highest rainfall for any rainy season in northern

Australia in more than 100 years is estimated to have removed at least 26Mt of metallurgical coal from the seaborne market, mostly in 1Q 2011. However, Queensland flood recovery has been slower than expected due to delays to the dewatering of flooded mines, although rail and port infrastructure availability has effectively normalised.  Reflecting this slow recovery, BHP announced in May 2011 that its force majeure status due to the Queensland flooding would remain in place through to the end of the year. As a result, contract price settlements for premium hard coking coal have only fallen slowly from the flood affected peak of US$330/t for 2Q 2011 to US$315/t for 3Q 2011.  Current spot indications of US$311/t at time of publication indicate a further easing in 4Q 2011 contract prices can be expected, with further moderate declines anticipated in 2012 to an average of US$275/t as normalized output and expansions delayed by the floods increase hard coking coal supply. This supply impact on prices will likely be further impacted by the commencement of exports from Vale’s Moatize project in Mozambique at the end of this year, the greater availability of US exports, and the displacement effect of increased overland exports from Mongolia into China. Australian coal fields saw record rainfall in 1H 2011

Source: Australian Bureau of Meteorology

Forecasts suggest a reprieve for the Queensland coal region, in 3Q 2011

Source: Australian Bureau of Meteorology

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Metallurgical Coal

Metallurgical coal markets likely to be in deficit until 2016

 We expect metallurgical coal supply to remain challenged over the medium term. We estimate crude steel output in India

and China will rise from a combined 759Mt in 2011 (China 686Mt, India 73Mt) to 979Mt in 2016 (China 860Mt, India 119Mt).  We expect this to boost combined imports of all types of metallurgical coal in these two countries from 93.2Mt in 2011 to 152Mt in 2016 despite further growth in Chinese domestic coal production. Imports of metallurgical coal by Brazil are also forecast to increase, from16.6Mt to 24.9Mt over the same time frame as crude steel production capacity increases from 35.3Mt in 2011 to 45.2Mt in 2016.  We are forecasting a seaborne metallurgical coal market with a narrowing deficit until 2016, when supply from new metallurgical coal basins in Mongolia, Mozambique, and Russia and increased output of metallurgical coal from Australia, Canada, and Indonesia are expected to bring the seaborne market back to balance.  Key supply variables in this outcome will be the rate of domestic metallurgical coal production increase in China and the share of China’s imports that is taken by expanding output in Mongolia. We are forecasting that Mongolia accounts for 60% of all of China’s import requirements for metallurgical coal by 2016, a development that will place increasing importance on the Indian and Brazilian markets. Chinese metallurgical coal net trade balance, monthly Coking coal prices, 2007-2016e 1.0 350

Net Exports

US$/t

0.0

300 250

-1.0

200

-2.0 150 MS forecast 100

-3.0

Net Imports

-4.0

0 997 1-1999 1-2001 1-2003 1-2005 1-2007 1-2009 1-2011 1-2013 1-2015 Q1-1 Q Q Q Q Q Q Q Q Q

Premium HCC (Quarterly contract)

Semi-soft

Source: Platts Steel, Reuters, Morgan Stanley Research

-5.0 Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Low-vol PCI

Source: Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Metallurgical Coal

Global supply / demand

(Mt, natural weight) Total Pig Iron Production Apparent consumption of coke in pig iron blast furnaces Apparent total coke consumption Metallurgical Coal/Coke Conversion Ratio Apparent metallurgical coal usage in coke making Apparent metallurgical coal usage in PCI

2003 670 283 396 1.29 510 66

2004 724 304 423 1.42 601 71

2005 801 336 464 1.42 660 80

2006 875 366 519 1.42 737 88

2007 949 396 561 1.42 797 96

2008 929 387 549 1.42 779 94

2009 901 377 534 1.42 758 92

2010e 1090 453 642 1.42 911 112

2011e 1185 491 695 1.42 988 122

2012e 1256 519 735 1.42 1044 129

2013e 1324 546 774 1.42 1099 136

2014e 1386 571 809 1.42 1149 143

2015e 1432 589 834 1.42 1184 148

2016e 1481 608 861 1.42 1222 153

Total Metallurgical Coal Usage in Steel Making 575 672 740 825 Requirement for metallurgical coal for coke making 510 601 660 737 Metallurgical Coal Seaborne Exports Australia 111.5 116.9 125.1 124.9 USA (excluding exports to Canada) 17.1 19.2 28.8 28.1 Canada (excluding exports to the USA) 19.0 24.7 26.7 24.6 China 17.3 15.7 9.4 8.5 Indonesia 4.4 4.4 5.4 7.0 Mongolia 0.0 0.0 2.3 2.2 Mozambique 0.0 0.0 0.0 0.0 Russia 5.2 6.2 13.1 12.3 South Africa 2.0 2.0 4.8 4.8 Colombia 0.9 0.7 0.7 0.3 New Zealand 2.0 1.7 2.0 2.3 Venezuela 1.8 2.7 2.0 2.2 Vietnam 0.2 0.4 1.4 1.8 Total Seaborne and Overland Metallurgical Coal Exports 184 198 225 222 Seaborne and Overland metallurgical coal imports (coking and direct injection coals) Japan 63.8 65.0 63.6 61.6 China 2.6 6.8 7.2 4.7 India 15.3 16.6 20.4 22.0 South Korea 19.9 20.7 19.8 19.7 Brazil 14.8 16.4 15.8 14.6 Total Europe 57.2 60.6 62.8 70.7 Rest of World 27.6 30.0 29.1 29.7 Total metallurgical coal imports 201 216 219 223

893 797

873 779

851 758

1023 911

1109 988

1173 1044

1235 1099

1292 1149

1332 1184

1375 1222

137.3 32.0 26.7 4.4 7.0 3.2 0.0 12.0 4.3 1.1 1.7 2.0 1.4 235

134.6 39.6 27.4 6.4 6.0 3.4 0.0 13.6 4.2 0.6 2.2 1.5 1.7 243

131.0 34.5 21.0 0.2 3.5 4.0 0.0 7.9 0.5 0.5 1.0 0.2 0.4 205

159.3 47.5 27.5 1.1 4.4 15.2 0.0 14.0 1.4 0.6 1.0 0.5 0.0 274

143.1 62.7 32.5 0.8 5.6 14.6 0.3 15.4 2.2 0.5 3.3 0.5 2.2 285

166.0 70.0 35.9 0.7 6.2 21.1 3.7 14.7 2.4 0.5 3.8 0.5 2.2 329

175.0 72.0 42.0 0.6 6.3 25.5 4.2 15.0 2.4 3.0 3.7 0.5 2.2 354

178.0 74.0 44.0 0.6 6.8 29.5 5.7 15.4 3.2 3.0 3.8 0.7 2.2 368

183.0 80.5 45.0 0.5 8.6 35.3 8.0 16.5 4.2 3.0 3.8 1.3 1.2 392

185.0 88.6 46.6 0.5 10.8 37.2 11.0 17.2 5.2 3.0 3.8 1.3 1.2 413

63.5 6.2 21.7 20.5 16.7 76.1 30.7 235

66.8 6.9 22.1 19.7 18.5 69.7 29.8 233

54.2 33.0 22.7 16.5 14.1 45.6 28.2 214

53.4 48.3 35.7 27.9 14.7 59.7 43.3 283

64.5 61.3 38.4 26.1 16.6 64.1 34.3 305

68.1 70.3 44.0 27.0 18.4 70.1 39.9 338

69.3 80.3 51.8 27.5 19.6 68.1 46.8 363

69.8 75.1 55.9 28.4 23.1 65.2 42.6 360

69.2 84.9 62.9 28.6 24.0 66.6 46.9 383

70.2 92.9 69.6 28.7 24.9 67.5 48.6 402

9.4

-9.5

-9.3

-20.2

-8.6

-9.5

8.4

9.4

10.5

305 240 260

129 80 90

191 141 147

293 228 237

275 217 226

260 202 210

235 183 190

215 167 173

210 163 169

Apparent Surplus/Deficit -17.0 -18.5 6.3 -0.5 0.1 Annual Average Prices (JFY annual negotiated price prior to 2010; CY Quarterly Averages from 2010) Conract Premium hard coking coal (US$/t) 46 59 125 115 101 Conract Semi-Soft Coking Coal (US$/t) 30 41 78 65 64 Contract Low Volatile PCI Coal (US$/t) 33 47 100 65 67

e = Morgan Stanley Research estimates Source: Wood Mackenzie, McCloskey Coal, Tex Report, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Manganese Ore

Prices edge closer to the marginal cost of production

 Short-term pricing pressure – Chinese manganese stockpiles remain high despite increasing steel production as domestic

output and imports remain high. In our view, the market is unlikely to tighten in the very near term as producers in South Africa, Brazil, West Africa, and Australia maintain high levels of output.  As a result, prices have fallen sharply below our previous forecast of US$7.50/dmtu for 2011. We have thus lowered our forecast prices for the remainder of 2011 to US$5.00/dmtu for 3Q 2011 and US$5.30/dmtu for 4Q 2011, price levels that are close to the marginal cost of production. We have also lowered our 2012 forecast to US$5.30/dmut from US$9.00/dmtu previously, as producers are not expected to respond quickly to this adverse environment by cutting output.  Medium term, we expect to see pricing improve – While we still look for the market to remain in surplus in the medium term, we anticipate that steel production growth will outpace ore supply growth next year, providing some basis for modest price recovery in 2013 and 2014.  Longer-term supply surge possible, but likely backdated – Significant potential new supply is likely to come from South African miners as rail logistics out of the Kalahari basin improve. A major surge in supply, however, will probably be delayed until post 2016 – the earliest likely time for new rail capacity. This may be partially offset by declining Chinese production (driven mainly by falling grades). Manganese ore supply/demand and price forecasts 2010e

2011e

2012e

2013e

2014e

2015e

2016e

Mn Ore Production Volumes Global ore production Global contained Mn produced % change Y-o-Y

39.10 12.51 30%

41.81 13.38 7%

43.61 13.95 4%

46.08 14.75 6%

48.20 15.43 5%

49.92 15.97 4%

50.74 16.24 2%

Global crude steel production (Mt) Total apparent consumption % change Y-o-Y Excess/(Deficit) supply Excess/(Deficit) as % of demand

1,396 11.92 17% 0.59 5%

1,515 12.90 8% 0.48 4%

1,603 13.63 6% 0.32 2%

1,692 14.42 6% 0.33 2%

1,768 15.11 5% 0.32 2%

1,825 15.65 4% 0.32 2%

1,882 16.22 4% 0.02 0%

Price Forecast (US$/dmtu)

7.70

6.33

5.30

7.00

7.50

7.00

6.50

e = Morgan Stanley Research estimates. Source: Company data, USGS, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Mined Energy

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Thermal Coal

China is driving near-term tightness…

 Between February and June 2011 seaborne prices have trended lower as a result of weak domestic prices in China and

the displacement effects of the Japanese earthquake on seaborne demand.  The negative price differential led to a significant fall in Chinese import volume (February-April 2011 averaged 1.7Mt per month vs. the 2010 average of 4.8Mt). However, the Newcastle-Qinhuangdao price arbitrage has narrowed significantly since mid-June as a drought-induced shortage of hydro capacity has lifted demand for coal-fired generation capacity.  Following this development, China’s NDRC said that it will approve a number of new coal-fired power generation units and power grid projects, mainly to resolve shortages in Zhejiang, Jiangsu, Chongqing, Guangdong, Fujian, Shandong, and Shanghai. The aim is to speed up projects totalling 180GW that are under construction today, a development that is expected to underpin import requirements over the next couple of years.  However, the continued growth in domestic coal production capacity in China and improvements in coal rail carrying capacity and north-south direct access are expected to result in a fall in Chinese imports from 2014 onward. China’s domestic price discount to imports has shrunk to 0% from c.17%

China’s net thermal coal imports look set to pick up in the coming months 9.0

200

US$/t

7.0

Net Exports

5.0 150

3.0 1.0 100

-1.0

Net Imports

-3.0

-5.0 0 Jan-04

Jan-05

Jan-06

Jan-07

NEWC Coal index

Jan-08

Jan-09

Jan-10

Jan-11

-7.0 Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Datong Prime coal (adjusted to 6000kcl/kg)

Source: Bloomberg, Morgan Stanley Research

Source: Thomson Reuters, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Thermal Coal

…but India’s import demand is the key to medium/long-term outlook

 Offsetting these developments in China, Indian imports are forecast to rise strongly over the forecast period

from 62Mt in 2010 to 230Mt in 2016, to become the largest component of the Asia Pacific seaborne market. This development is expected to underpin a deficit market, despite continued growth in Indonesian exports to 371Mtpa by 2016.  According to our India utilities analysts, slow domestic production capacity growth, a constrained distribution network, and environmental restrictions will cause the domestic coal deficit to hit 130Mt by FY2013 (35mt in FY2011), implying customers will increasingly be forced to rely on seaborne imports.  By 2013, we expect ~42GW of new coal-fired generation capacity to be commissioned, equating to incremental coal demand of ~47Mt in FY2012 and ~42Mt in FY2013. We believe most of the new demand will have to be satisfied via imports as a consequence of the numerous difficulties India’s domestic coal mining industry faces (environmental approvals, land acquisition, port and rail infrastructure), which, according to Platts, have prevented the development of 203 coal mines whose production could fuel 130GW of capacity. India to dominate Asia Pacific seaborne trade growth, 2010-16e

Richards Bay vs. Newcastle thermal coal price, 2006-11

250

200

160

150

120

100

2010e

2011e China

2012e Japan

2013e South Korea

2014e

2015e

Rest of Asia

2016e India

e = Morgan Stanley Research estimates. Source: Wood Mackenzie, Morgan Stanley Research

US$/t

0 Jan-06

Jan-07

Jan-08

Jan-09

Newcastle Index

Source: Global Coal, Morgan Stanley Research

Jan-10

Jan-11

Richards Bay

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Thermal Coal

Global supply / demand

Mt Supply of Seaborne Thermal Coal Indonesia Australia China Russia Vietnam South Africa Colombia USA Venezuela Canada Poland Other Total Supply of Seaborne Thermal Coal % Change Demand for SeaborneThermal Coal China India Japan South Korea Taiwan South East Asia Total Asia Total Europe Total Americas ROW Atlantic Market (Europe, ME, NAFTA, Argentina and Brazil) % Chg Pacific Market (Asia+Chile) % Chg Total Imports of Seaborne Traded Thermal Coal Annual % change Apparent Surplus/(Deficit) Japanese Contract Reference Price (US$/t) (JFY)

2003

2004

2005

2006

2007

2008

2009

2010e

2011e

2012e

2013e

2014e

2015e

2016e

88 105 81 38 7 70 44 19 6 2.1 17.4 2 461

104 108 81 48 12 67 52 19 6 2.7 16.7 1 497

123 112 66 70 18 70 55 19 6 1.4 17.6 4 542

159 114 58 77 30 68 59 20 5 2.8 13.1 4 593

180 114 51 84 33 67 65 24 3 4.3 9.4 3 623

186 125 42 84 20 64 68 35 5 6.3 6.9 1 630

190 146 22 84 25 66 65 7 2 5.8 4.4 15 622

259 139 19 77 23 67 71 17 3 6.1 10.9 2 694

271 145 21 79 25 76 64 22 4 6.2 11.6 4 728

300 167 20 84 25 78 72 25 4 6.2 11.7 4 798

330 183 20 84 21 78 85 34 4 6.4 11.7 4 863

344 187 16 74 22 81 90 19 4 9.0 11.7 4 863

350 208 19 83 20 84 96 34 5 9.5 11.7 4 930

371 221 19 81 18 84 101 36 5 9.5 11.7 4 969

14.1%

7.8%

9.0%

9.5%

5.0%

1.1%

-1.3%

11.7%

4.9%

9.6%

8.1%

0.0%

7.8%

4.1%

7 6 103 52 47 19 247 130 35 30

9 9 115 58 52 25 284 145 34 32

16 22 117 57 53 25 304 144 41 33

28 23 116 60 54 33 330 154 50 37

41 28 123 68 58 38 370 148 49 40

31 33 125 80 58 39 380 146 47 37

87 53 107 81 52 31 431 128 36 27

136 62 120 90 51 46 521 111 36 37

113 90 104 94 60 56 534 124 31 44

131 115 111 94 62 60 595 132 30 48

138 150 115 97 65 63 649 136 31 57

77 186 119 106 68 65 643 133 35 63

90 222 119 113 70 69 708 133 35 65

101 230 119 120 72 78 744 131 38 68

193

208

215

236

231

224

186

178

193

203

216

223

225

228

12.3%

7.6%

3.6%

9.9%

-2.2%

-3.1%

-16.9%

-4.4%

8.5%

5.1%

6.5%

2.8%

1.0%

1.2%

249

287

308

334

375

386

437

526

541

601

657

651

716

753

5.5%

15.5%

7.0%

8.6%

12.4%

2.7%

13.2%

20.5%

2.9%

11.2%

9.2%

-0.9%

10.1%

5.1%

442

495

523

570

606

610

623

704

734

805

873

941

981

8.4%

12.1%

5.6%

9.1%

6.3%

0.5%

2.2%

13.1%

4.3%

9.6%

8.5%

0.0%

7.8%

4.2%

19.2

2.1

19.2

22.8

16.5

20.3

-0.9

-9.8

-6.0

-6.2

-10.1

-10.6

-11.2

-12.1

125

130

135

140

125

110

e = Morgan Stanley Research estimates Source: Wood Mackenzie, McCloskey Coal, Tex Report, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Uranium

Fundamental story remains compelling…

 In our view, the overarching impact of the demand shock delivered in March has been largely absorbed by the

market and likely fully reflected in current pricing. Following the abandonment of nuclear power in Germany and Switzerland and the closure of a number of plants in Japan, we believe there is only a low risk of other countries similarly reversing nuclear power policies. The greatest risk to current capacity, in our view, is a shutdown of Japan’s entire nuclear reactor fleet.  We maintain our view that the combination of a constrained supply growth profile and international attempts to reduce greenhouse gas emissions underpins an attractive longer-term outlook for the global uranium market. This thesis particularly applies to new power capacity growth in emerging markets, where reliable energy supply remains paramount to policy makers.  In June, China’s nuclear power regulators gave the country’s 13 reactors the all-clear following safety checks ordered in the wake of the Fukushima disaster. This pass officially revives China’s ambitious expansion plans, and construction is to resume with a new national safety framework in place. We expect China’s nuclear power capacity will reach 80Gwe by 2020. Emerging markets dominate new-build growth Emerging Markets To t al React o r Un it s To t al Gw e U3O8 Req u ir em en t (Kt % Sh ar e New Gr o w t h Developed Markets To t al React o r Un it s To t al Gw e U3O8 Req u ir em en t (Kt % Sh ar e New Gr o w t h

2010

2015e

2020e

109 68.0 12.2

155 111.6 20.9 83%

232 191.0 36.2 84%

311 290.1 56.9 17%

320 305.8 59.2 16%

309 281.4 54.7

Share of new nuclear capacity growth to 2020e N America, 3%

ROW, 6% China, 48%

Middle East, 6% E Europe, 7% W Europe (exGer), 5%

Russia, 7%

S Korea & Taiw an, 8% India, 10%

e = Morgan Stanley Research estimates. Source: UxC, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Uranium

…but next trigger is likely to be supply-driven

 We believe over the next several quarters market direction will be driven by supply-side dynamics. Coupled with

existing and persistent production problems such as in Australia (ERA) and Namibia (Rossing, Langer Heinrich), the Fukushima nuclear power disaster has not only altered the demand landscape for uranium, but also introduced a new level of risk to uranium supply, in our view.  At the current spot price of US$53/lb, we estimate 3% (4.9Mlbs, 1,865 tonnes U) of current global mine capacity is operating at a loss. This fact alone is not an uncommon feature in metals markets – spot prices can linger below breakeven points for marginal producers for several months without significantly affecting global production volumes. However, current prices and expectations for future prices have a considerable impact on the economic viability of greenfield and brownfield expansions. We estimate that 27% (54Mlbs, 20,900 tonnes U) of capacity in planned and potential projects through 2020 would operate at a loss in the current price environment. As the global uranium market explicitly relies on the growth in new mined output in order to remain adequately supplied, the risk of material supply shortages in the coming years is becoming increasingly elevated, in our view. Global uranium mining cost curve, 2011 New mine growth is essential to a balanced U3O8 market $90.00

120 $80.00

110 100

$70.00

Primary mine supply Megatons to Megaw atts Enricher Sales and DOE Demand

FSU Supplies Mox + Reprossed U New Mines

90 80 70

$50.00

KtU

US$/lb

$60.00

$40.00

60 50

$30.00

$20.00

30 20

$10.00

$0.00 -

100

150

200

250

300

350

400

450

500

0 2009

2010 2011e 2012e 2013e 2014e 2015e 2016e 2017e 2018e 2019e 2020e

Cummulative Mlbs Current LT Price

Current Spot Price

Source: UxC, Morgan Stanley Research

Operating

Planned

Potential

Source: UxC, Morgan Stanley Research. e = Morgan Stanley Research estimates

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Uranium

Global supply / demand 2004 39,085 102

2005 39,879 104

2006 37,936 99

2007 41,926 109

2008 43,748 114

2009 50,784 132

2010 52,793 137

New mines / Ramp-ups New mines / Ramp-ups Regional Production Breakdown Australia mine production tonnes U Production growth % Canada mine production tonnes U Production growth % Kazakhstan mine production tonnes U Production growth % tonnes U Total mine supply Mlbs Total mine supply % of mined supply in supply mix %

2011 51,472 134 3,344 8.7

2012 57,227 149 2,787 7.2

2013 59,628 155 2,447 6.4

2014 62,972 164 2,633 6.8

2015 66,387 173 2,754 7.2

2016 71,242 185 5,035 13.1

9.0 18.1 11.6 11.4 2.7 -18.79 39,085 101.6 65.1

9.5 5.8 11.6 0.3 2.7 -0.7 39,879 103.7 61.2

7.6 -20.2 9.9 -15.2 3.8 43.4 37,936 98.6 59.6

8.5 12.1 9.5 -3.9 6.6 72.6 41,926 109.0 64.6

8.5 -0.3 9.0 -5.0 8.5 28.3 43,748 113.7 69.1

8.0 -6.0 10.2 13.0 14.0 64.6 50,784 132.0 71.8

5.9 -25.7 9.3 -8.4 17.6 25.6 52,793 137.3 73.4

6.0 1.4 8.6 -7.9 19.6 11.4 54,816 142.5 76.1

7.0 16.2 8.6 0.0 21.9 11.7 60,014 156.0 77.8

6.2 -10.8 8.6 0.0 22.9 4.5 62,076 161.4 78.6

6.8 9.9 9.4 9.0 23.8 3.9 65,605 170.6 85.1

7.0 2.8 10.1 8.2 24.5 2.9 69,141 179.8 86.3

8.8 25.1 13.6 34.1 25.0 2.4 76,277 198.3 87.4

Megatons to Megawatts Enricher Sales and DOE FSU Supplies Total Secondary Supply Secondary Supply

tonnes U tonnes U tonnes U tonnes U Mlbs

5,385 3,077 9,616 20,963 54.5

6,154 3,596 12,308 25,328 65.9

6,539 3,985 11,924 25,717 66.9

6,923 1,931 11,539 22,971 59.7

7,308 2,800 6,923 19,532 50.8

4,616 3,202 9,231 19,972 51.9

4,616 3,557 8,077 19,135 49.7

4,616 3,500 6,539 17,232 44.8

4,616 3,231 6,539 17,078 44.4

4,616 3,039 6,539 16,886 43.9

0 3,039 5,770 11,501 29.9

0 2,539 5,770 11,001 28.6

Total Supply Total Supply Supply growth

tonnes U Mlbs %

60,047 156.1 0.0

65,207 169.5 8.6

63,653 165.5 -2.4

64,897 168.7 2.0

63,280 164.5 -2.5

70,756 184.0 11.8

71,927 187.0 1.7

72,048 187.3 0.2

77,091 200.4 7.0

78,961 205.3 2.4

77,105 200.5 -2.4

80,142 208.4 3.9

87,277 226.9 8.9

Global nuclear generating capacity Gwe Reactor Requirements tonnes U Stockpiling tonnes U Investment demand tonnes U Generating Capacity Breakdown Emerging Markets Gwe Demand growth % Developed Markets (ex Germany, ex Switzerland) Gwe Demand growth % tonnes U Total Demand Mlbs Total Demand Demand growth % tonnes U Market Balance Mlbs Market Balance

361.1 66,174 3,309 348

367.1 64,616 3,231 1,596

367.9 64,181 4,493 904

371.6 64,375 4,506 769

372.7 64,669 4,527 1,202

371.4 65,441 4,581 808

373.0 66,877 4,681 769

374.8 66,527 5,987 778

369.8 67,477 6,073 787

382.3 70,073 7,007 796

402.3 73,738 7,374 806

415.7 77,718 7,772 815

427.6 79,146 7,915 824

68.0 3.9

72.5 6.5

77.4 6.8

84.4 9.0

97.0 14.9

111.6 15.1

123.2 10.4

69,483 180.6 0.0 -9,435 -24.5

69,443 180.5 -0.1 -4,236 -11.0

69,578 180.9 0.2 -5,925 -15.4

69,651 181.1 0.1 -4,754 -12.4

70,398 183.0 1.1 -7,118 -18.5

70,830 184.1 0.6 -74 -0.2

281.4 0.0 72,327 188.0 2.1 -400 -1.0

278.7 -0.9 73,292 190.5 1.3 -1,245 -3.2

277.1 -0.6 74,337 193.3 1.4 2,754 7.2

282.7 2.0 77,876 202.5 4.8 1,085 2.8

290.1 2.6 81,917 213.0 5.2 -4,812 -12.5

290.1 0.0 86,305 224.4 5.4 -6,162 -16.0

290.4 0.1 87,885 228.5 1.8 -608 -1.6

U3O8 Spot Price - annual avg U3O8 Term Price - annual avg

18.65 22.00

28.82 31.00

47.90 50.00

98.77 91.00

62.82 76.00

46.52 70.00

46.10 61.00

58.51 71.33

62.75 75.00

67.50 75.00

75.00 72.00

Existing mine supply

Unit tonnes U Mlbs tonnes U Mlbs

US$/lb US$/lb

e = Morgan Stanley Research estimates Source: UxC, WNA, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Other Metals

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Rare Earths Market background and applications  Rare earths are a group of 17 elements that are used in various clean energy, hi-tech, and defense applications because of 



 

their chemical, optical, electrical, magnetic, and metallurgical properties. China has been the dominant supplier over the past two decades. China has ~50% of the known global REO (rare earth oxide) reserves. The country started production in the mid-1980s, and by the mid-1990s had become the world’s biggest REO producer. For the past five years, China has been producing >90% of REO supply. In recent years, China’s government has shown a desire to conserve REOs for future internal use and even declared that the country’s medium & heavy REO resources are finite (~15 years). It also plans to introduce new environmental laws for REO mining. We think price changes across the rare earth group will be uneven, based on the supply/demand dynamics of each metal. Neodymium and praseodymium are key ingredients of permanent magnets used in hi-tech electronics. Their prices should benefit from the high growth rate of these end-markets, in our view. Rare earth applications Metal Lanthanum Cerium Praseodymium Neodymium Samarium Europium Gadolinium Terbium Dysprosium Holmium Erbium Thulium Ytterbium Lutetium Scandium Yttrium

General Uses Glass, Catalysts, Phosphors, Optics Polishing, Catalyst, Phosphors Pigments, Ceramics, Magnets Magnets, Alloys, Ceramics, Lasers Magnets, Alloys, Ceramics, Catalysts Alloys, Phosphors Alloys, Ceramics, Phosphors Magnets, Alloys, Ceramics, Phosphors Magnets, Alloys Ceramics, Alloys Optical fibre, glass, alloys Phosphors, Ceramics, Alloys Alloys Alloys Electronics, alloys Ceramics, Alloys, Optics

Source: USGS, IMCOA, Morgan Stanley Research

Global REO ore composition Bastnasite Rare Earth % Composition Lanthanum Cerium Praseodymium Neodymium Samarium Heavy REE Yttrium

Mount Pass, US 33.2 49.1 4.3 12.0 0.8 0.3 0.1

Bayan Obo, China 23.0 50.0 6.2 18.5 0.8 1.1 -

Monazite Mount Weld, Aust 24.9 43.6 4.9 17.4 2.5 3.7 2.9

North Capel, Aust 23.9 46.0 5.0 17.4 2.5 2.6 2.4

North Cove Strad., Springs, Aust US 21.5 17.5 45.8 43.7 5.3 5.0 18.6 17.5 3.1 4.9 3.9 8.2 2.5 3.2

Nangang, China 23.0 42.7 4.1 17.0 3.0 6.6 2.4

Eastern Coast, Brazil 24.0 47.0 4.5 18.5 3.0 1.7 1.4

Source: USGS, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Rare Earths Chinese supply remains restricted 

Chinese export quotas have declined for the past six years, and the government has imposed production quotas and limited the issuance of new licenses for exploration.



China announced a 2H 2011 quota of 15,738 tonnes. While market expectations were closer to 15kT, ferro-rare earth alloys were likely included in the announced quota, implying that the effective quota could be meaningfully lower. The latest issue brings China’s total export quota for 2011 to 30,184 tonnes, down slightly from 30,258 tonnes in 2010.



Chinese export blended average prices (based on Mountain Pass product mix) are up 180% YTD to US$184/kg, while domestic prices are up 461% to US$61/kg.



Export cerium and lanthanum prices are ~500% higher than domestic Chinese prices, significantly higher than the 2007-10 average spread, suggesting risk to prices when Mountain Pass and Mount Weld start production. We see stronger fundamental support for neodymium and praseodymium prices as the spread between export prices and domestic Chinese price at around ~40% is more consistent with the historical spread. Additionally, prices for these two metals should benefit from faster growing end-markets.



China allocates export quotas without specifying caps on specific REOs. Recent increases in prices for Eu, Tb, Sm, and Dy raise the possibility that future quotas may differentiate between heavy and light rare earths. Based on available information, there does not appear to be any differentiation among REOs for export in the 2H 2011 quota, though there may in the future.

REO prices have rallied in response to tightening supply

Chinese export quotas continue to decline

$200 Average Chinese Export Prices

$180

$160

$140

Avg. REO Price, $/kg

Chinese Export Quotas, kT

40 30 20

Average Chinese Domestic Prices

$120 $100 $80 $60 $40

$20 -

Jul-11

Mar-11

Nov-10

Jul-10

Mar-10

Note: We understand that the 2011 quota includes ferro- rare earth alloys that were not covered in 2010, effectively reducing net quotas. Source: Metal Pages, Morgan Stanley Research

$Nov-09

2011

Jul-09

2010

Mar-09

2009

Nov-08

2008

Jul-08

2007

Mar-08

2006

Nov-07

2005

Source: Metal Pages, Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Zircon

Supply deficit through 2014; price risk to the upside

 Mineral sands prices for 3Q11 are already confirmed at ~US$2,200/t for zircon. We currently forecast US$2,310/t for

4Q11, but with Iluka (global supply leader) recently highlighting that the market remains in deficit, price risk remains to the upside, in our view.  While a supply response is underway, it will be 2014 before market balance begins to return, not because mineral sands deposits are particularly scarce or difficult to establish, but simply because years of underinvestment means there are no new projects ready to commence.  So far, demand destruction hasn’t occurred. Before prices began to rise (from ~US$800/t in 2008), zircon typically represented 5-10% of input costs in end-use products. It is now 13-25%, assuming all other factors are stable, yet demand remains robust due to limited substitution opportunities, ongoing urbanisation in China (and the resultant need for tiles and bathroom ware), and scope for end-use prices to be lifted. Zircon market (‘000 kt): supply & demand variables

Long-term price linked to 2017 cost curve: US$1,725/t 2,000

Bull case

1,700

1,800

Base Case

Zircon Cost Curve 2017

1,600

1,600 1,400

Bear Case Current Supply Global Demand - Bull case

1,400

Global Demand - Base case

1,300

Global Demand - Bear case

US$/t

1,500

1,200 2011e

L/T Price f'cast

1,200 1,000

Existing

800 600

Probable

400 200

Possible

2012e

2013e

2014e

500

1,000

1,500

2,000

Cummulative Kt

e = Morgan Stanley Research estimates

Source: Morgan Stanley Research

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Zircon

Supply response coming, just not quick enough

ZIRCON Major Producers Current Supply New supply Bear Case Iluka Resources Iluka Resources Astron Mineral Deposits Exxaro Kenmare Sub-Total Base Case Gunson Resources Base Resources Titanium Corporation Diatreme Resources New mine delivery Sub-Total Bull case Matilda Zircon Exarro Mineral Commodities Mineral Commodities White Mountain Sub-Total

2008 1,208

2009 1,099

2010 2011e 2012e 2013e 2014e 2015e 2016e 2017e 2018e 1,274

1,336

1,381

2019e

2020e

1,391

1,379

1,334

1,322

1,310

1,299

1,287

1,276

60 30 120

10 66 60 30 216

50 90 60 30 280

50 20 70 87 60 30 317

50 45 85 86 60 30 356

50 50 85 86 60 30 361

50 50 100 86 60 30 376

50 50 120 84 60 30 394

5 38 10

10 40 25 10 150 235

20 40 40 25 200 325

35 40 55 45 225 400

35 42 70 50 240 437

35 39 70 50 250 444

35 28 70 50 250 433

3 10

9 25

15 35

15 36 5 20

15 38 10 30

15 40 15 35

Weighting JA expansion Cataby Donalson Grande Cote KZN Sands Moma - Stage 2

Australia Australia Australia Sengal South Africa Mozambique

30 15 45

85% Coburn Kwale Athabasca Cyclone

Australia Kenya Canada Australia 60%

Keysbrook Xolobeni Tormin Cerro Blanco

Australia South Africa South Africa South Africa Chile

Rest of World demand China demand Global Demand - Base case Rest of World demand China demand Global Demand - Bull case

105

1,336

1,420

1,507

1,600

1,720

1,796

1,865

1,882

1,889

1,886

850

530 795 1,325

535 843 1,378

541 893 1,434

546 947 1,493

552 975 1,527

557 1,005 1,562

563 1,035 1,597

568 1,066 1,634

574 1,098 1,672

580 1,131 1,710

585 1,165 1,750

850

530 795 1,325

541 859 1,399

551 927 1,479

562 1,001 1,564

574 1,042 1,615

585 1,083 1,668

597 1,127 1,723

609 1,172 1,780

621 1,218 1,839

633 1,267 1,901

646 1,318 1,964

1,375

850

530 795 1,325

546 875 1,420

562 962 1,524

579 1,058 1,637

597 1,111 1,708

614 1,167 1,781

633 1,225 1,858

652 1,286 1,938

671 1,350 2,022

692 1,418 2,110

712 1,489 2,201

1,375

850

1,325

1,399

1,479

1,565

1,616

1,670

1,726

1,784

1,844

1,906

1,971

1,208 Weighting

30%

40%

30%

Market Balance

e = Morgan Stanley Research estimates

1,274

15%

Weighted Average Demand Zircon Price

1,099

Weighted Average Supply Zircon Demand Rest of World demand China demand Global Demand - Bear case

15 40 15 35 105

1,375

-167 US$/t

763

249 853

-51 869

-63 1,928

-59 2,550

-57 2,800

-17 2,800

50 2,525

70 2,150

1,725

Source: Morgan Stanley Research, Company data

-17

-85

1,966

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Titanium Dioxide Different end-use but shares market balance drivers with zircon  Titanium dioxide (TiO2) prices also likely to rise for a few years; 3Q11 prices have already been secured

~75% above 2Q11. Rutile contracts will be ~US$1,300/t.  The TiO2 products – rutile, leucoxene, and ilmenite, which can sometimes be upgraded to synthetic rutile – are typically produced in conjunction with zircon despite different end-uses (pigments, not ceramics). Zircon, with its higher price, is often the primary driver of the project economics, with the other materials as co-products or byproducts.  Demand growth rates for TiO2 lower than for zircon; although there is good demand for the end-use products that pigment products go into, the intermediary industries that make the pigments and other products from the TiO2 materials act as a bottleneck in the supply chain. TiO2 market (‘000 kt): Demand variables

TiO2 price curves and market supply/deficit

TiO2 supply-demand scenarios, '000 tonnes

1,600 1,400

1,200

4,500

3,500 Demand Base

3,000

20 08 20 09 20 10 20 11 e 20 12 e 20 13 e 20 13 e 20 14 e 20 15 e 20 16 e

2,500

e = Morgan Stanley Research estimates

0 '000 tonnes

4,000

Demand Bull

1,000

-50

800 600

-100

400 -150

Demand Bear

US$/t

5,000

100

Weight Avg supply

200

-200

2008

2009

2010

2011e 2012e 2013e 2014e 2015e

MARKET BALANCE Synthetic Rutile (rhs)

Source: Morgan Stanley Research

Ilmenite (rhs) Rutile (rhs)

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Titanium Dioxide Supply response from the same operations as the zircon market TITANIUM DIOXIDE SUPPLY VOLUMES Chloride Ilmenite Slag Synthetic Rutile Rutile Additional mines COMBINED

2008

2009

2010 2011e 2012e 2013e 2014e 2015e 2016e 2017e 2018e 2019e

560 1340 640 820

500 1220 540 700

460 1460 560 800

640 1500 500 780

460 1760 560 820

480 1920 600 780

3360

2960

3280

3420

3600

2020e

3780

460 1900 600 940 100 4000

500 1900 600 820 400 4220

520 1900 680 800 600 4500

540 1880 660 840 800 4720

500 1920 620 780 900 4720

420 1940 600 800 1000 4760

400 1920 600 760 1200 4880

DEMAND VOLUMES Growth rate Demand - Bear case

% wgt 20%

3280

3000

3220

3570

2.0% 3640

2.0% 3720

2.0% 3800

2.0% 3880

2.0% 3960

2.0% 4040

2.0% 4120

2.0% 4200

2.0% 4280

Growth rate Demand - Base case

60%

3280

3000

3220

3570

4.0% 3720

4.0% 3860

4.0% 4020

4.0% 4180

2.0% 4260

2.0% 4340

2.0% 4420

2.0% 4500

2.0% 4600

Growth rate Demand - Bull case

20%

3280

3000

3220

3570

6.0% 3780

6.0% 4000

6.0% 4240

6.0% 4500

3.0% 4640

3.0% 4780

3.0% 4920

3.0% 5060

3.0% 5220

3280 -2%

3000 -9%

3220 7%

3570 11%

3716 4%

3860 4%

4020 4%

4184 4%

4276 2%

4368 2%

4460 2%

4552 2%

4660 2%

-40

-150

-116

-80

-20

224

352

260

208

220

DEMAND PROFILE Y0Y % Change MARKET BALANCE PRICE FORECASTS Price summary Ilmenite

US$/t

2008 105

2009 84

2010 2011e 2012e 2013e 2014e 2015e 2016e Real 2017e 74 118 155 185 200 205 215 210

Synthetic Rutile

US$/t

494

445

462

883

1,150

1,315

1,350

1,225

1,020

975

1,111

Rutile

US$/t

510

536

544

1,069

1,280

1,470

1,500

1,400

1,130

1,100

1,253

e = Morgan Stanley Research estimates

Nominal 2017e 239

Source: Morgan Stanley Research, Company data

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Top Equity Ideas

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Mechel (MTL.N, $25.46, OW, PT $46.00) Upside potential is the highest in our universe Why Overweight?

$ 70 $62.71 (+146%)



 50

$46.00 (+81% )

Highest upside: Mechel is our top pick, offering the highest upside potential (90%) in our universe. Downside risk is limited. We estimate that the market prices in significantly lower coking coal and steel prices than their current levels. We believe that fears of potential IPO of the mining business are overdone.

Key Value Drivers 30

$ 25.46



Strong coking coal demand from Asia should continue to benefit Mechel, which ships over 4mn tonnes of hard coking coal concentrate from Yakutugol. Exports will increase as the Elga project ramps up.



Low cash costs. The company has one of the lowest cash costs per tonne of coking coal concentrate (just $36/tonne in 2Q11) vs. the current spot price of $245/tonne fob Vostochny.



Sothern Kuzbass to increase coking coal output by 28% to 9nm t YoY in 2011.



Steel division underrated. Mechel has one of the highest sensitivities to steel prices among its domestic peers, which the market is ignoring, given that Mechel is perceived as a mining company.

$21.14 (-17%)

0 Jul-09

Jan-10

Price Target (Jul-12)

Jul-10

Jan-11

Historical Stock Performance

Jul-11

Jan-12

Jul-12

Current Stock Price

Source: FactSet, Morgan Stanley Research Price Target $46.00

Derived from base-case DCF (WACC of 12.8%, risk free rate of 6% and Russian/FSU equity risk premium of 7%, terminal growth rate of 1%).

Bull Case $61.71

Implies: 4.55x bull-case 2011E EPS

Higher steel and coal prices: Prices in the steel, mining and ferroalloy divisions are 10% above our base case assumptions across our forecast period (2011-15). Mechel ramps up coking coal production at Bluestone to 5.5mn tonnes/year and reduces cash costs to $60/tonne (from $90/t currently).

Base Case $46.00

Implies: 3.71x base-case 2011E EPS

Conservative commodity forecasts: Average billet export prices of $659/t in 2011 and $690/t in 2012. Average coking coal export prices of $293/t in 2011 and $275/t in 2012. Average coking coal domestic prices of $185/t in 2011 and $179/t in 2012. We assume Mechel will launch the Elga project in 2011, in line with schedule.

Bear Case $21.14

Implies: 2.93x base-case 2011E EPS

Lower steel and coal prices, failure to ramp up production at Elga: Prices in the steel, mining and ferroalloy divisions are 10% below our base case assumptions across our forecast period (2011-15). Mechel fails to execute on Elga production growth strategy; no steel product mix improvement following the launch of the Universal Mill in December 2011.

Potential Catalysts 

Faster ramp-up of coal production at Southern Kuzbass’ Sibirginskaya underground mine where production could reach 2.4bn t of coking coal by 2012.

Key Risks 

Delays to the Elga project. Although Mechel has already started stripping coal, it may take longer to deliver the coal to customers due to high transport costs.



High leverage: Mechel’s net debt was $7.9bn as at March 31, 2011 (net debt to LTM EBITDA of 3.4x – among the highest in our coverage universe).

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

AngloGold Ashanti (ANGJ.J, R301, OW, PT R440) Market has not acknowledged its full gold price exposure and good project pipeline Why Overweight?

ZAR600 ZAR571 (+90%)



ANG has an attractive project pipeline, diversified production (geographic/operational) and lowest operating costs of the SA gold miners. Funding of project opportunities is now dictated by the ability of operating performance to support capex requirements, and closure of the hedge is a significant development, albeit at a very high cost.



Poor capital management characterised by high debt, significant gold hedge in a rising gold price environment, unsustainable dividend payments, all at the expense of underinvestment in capital projects has been materially addressed.

500 ZAR440.00 (+46%) 400 ZAR 301.00 300

ZAR278 (-8%)

200

Key Value Drivers

100

 0 Jul-09

Jan-10

Price Target (Jul-12)

Jul-10

Jan-11

Jul-11

Historical Stock Performance

Jan-12

Jul-12

Current Stock Price WARNINGDONOTEDIT_ RRS4RL~ANGJ.J~

Source: FactSet, MorganStanley Research

What’s in the Price 

Price Target R440

We estimate 2011 cash cost is c.$702/oz, gold output 4.54moz. ANG’s medium-term goal (2014) is 5.5moz pa; greenfields projects (Tropicana/ Australia, La Colosa/Colombia, Kibali & Mongbwalu/DRC)

We do not think the share price discounts a recovery beyond 5moz pa, nor full exposure to the current rand gold price.

Derived from base-case scenario

Potential Catalysts Bull Case

15x 2012e FY PE

The bull case is a combination of $1819/oz gold, 5% weaker ZAR and target PE of 15x on a 2012 view.

15x 2012e FY PE

The base case is a combination of $1624/oz gold, R7/$ and target PE of 15x on a 12-month forward view.

15x 2012e FY PE

The bear case is a $1543/oz gold, 5% stronger ZAR, 5% upside to our SA cost inflation assumption and target PE of 15x on a 2012 view. We also trim half our international contribution for cost risk.



Greenfields project pipeline – updates on technical progress and upward revisions to reserves. Back-end loaded operating performance in 2011 implies that Q2 operating performance unlikely to be a specific positive catalyst, but a strong pipeline of near-term operating projects should deliver positive catalysts on a 6-9mnth view.



We see upside risk to consensus earnings forecasts as gold price forecasts adjust upwards – and relative to SA-dominated peers, as rand forecasts are strengthened.

R571 Base Case R440 Bear Case R278

Risks 

The sector, in general, is exposed to up/downside risk on rand gold prices and to mining-specific operating risks specifically as they relate to mine cost inflation.



We see upside and downside risk from operating outcomes at the Obuasi mine, and from progress of the greenfields project developments 87

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Alcoa (AA, $15.77, OW, PT $22) Leverage to aluminum / alumina and economic recovery $35

$30 (+90%)

25 $22.00 (+40%) 20 $ 15.77

Investment Thesis  Our $22 price target is based on 13x normalized earnings potential of $1.75.  We think Alcoa can increase alumina pricing as recent spot transactions suggest the company has room to improve pricing.  Following the shedding of non-core businesses, downstream segments are better positioned to earn cost of capital, which is not reflected in shares.

15 $11 (-30%)

 

0 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Price Target (Jul-12)

Historical Stock Performance

Current Stock Price



Source: FactSet, Morgan Stanley Research Price Target $22

Based on 13x our normalized EPS estimate of $1.75, implying a 5% RoA, 100bp higher than the last 15-year median to give credit for restructuring, capital spending, and cost cutting.



Bull Case $30

11x Bull Case EPS of $2.70

Economic recovery continues through 2012. Stronger-thanexpected economic growth sustains aluminum demand in a cost push environment. Global economy grows 5.3% in 2012. Price averages $1.51/lb in 2012.



Base Case $22

13x mid-cycle earnings at $1.75

Ytd rally in prices proves sustainable, but high inventories and over-capacity keep a lid on prices. LME inventory continues to decline allowing prices to stabilize well above the marginal cost of production. Demand from key markets improves as global GDP grows 4.6% in 2012, our economists’ forecast.



Bear Case $11

1.4x Tangible Book Value per share

Chinese overproduction and unwinding of financing deals leads to over-supply in the market. Prices come under pressure as market surplus grows. Downstream margins remain depressed due to low operating rates. Global GDP grows 3.5% in 2012. Price averages $1.11/lb in 2012



  

Key Value Drivers The aluminum price. We believe aluminum prices are well supported near current levels based on energy prices, FX and demand pickup. Improving exposure to spot alumina market. AA’s alumina sales are transitioning to spot index-based pricing, with 20% of volumes resetting annually. Spot prices are ~30% higher than AA’s 2010 average realized price ($304/T). LT midstream and downstream earnings potential. Operating margins should improve as key end-markets recover. We estimate $2.3 bn in normalized EBITDA from the Flat-Rolled and Engineered Products segments. Potential Catalysts Western smelters lose access to cheap hydro-power as demand for “green power” increases. Pickup in key end-market demand. Strong government focus on restraining wasteful energy consumption and end of preferential power prices in China leads to capacity cuts. State of Play and Potential Risks Aluminum prices are up 3% YTD as aluminum receives a cost support from high energy prices. Key risks Slowdown in key end markets Increase in Chinese aluminum exports Sharp supply response in alumina depresses spot pricing

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Vale (VALE.N, $33.33, OW, Price Target $43) Cheap leverage to iron ore and exposure to other preferred commodities $60 $52 (+56%)

$43.00 (+29%)

40 $ 33.33

30 $22 (-34%)

0 Dec-08

Jun-09

Price Target (Dec-11)

Dec-09

Jun-10

Historical Stock Performance

Dec-10

Jun-11

Dec-11

Current Stock Price

Source: FactSet, Morgan Stanley Research estimates Price Target $43

Our year-end 2011 price target is based on applying 7.5x P/E multiple to our 2012E EPADR, which is a discount to peers' peak-cycle multiple.

Bull Case $52

Fe (CIF) 2011: $206/t 2012: $203/t 2013: $165/t LT: $99/t

Accelerated growth; iron ore price >$200/t. A stronger rebound in growth of European economy and supply constraints drive higher shortterm and long-term iron ore prices, as we believe the marginal cost of production is above our current long-term pricing forecast. Vale’s efficient fiscal structure and tax incentives remain in place throughout the forecasting period. Rapid completion of growth projects.

Base Case $42

Fe (CIF) 2011: $171/t 2012: $176/t 2013: $150/t LT: $95/t

Tight iron ore market support prices at peak levels. Chinese steel production remains strong, driven by FAI growth and social housing construction, resulting in healthy demand for iron ore. Effective tax rate stable at 24% through 2015 and rises to 34% thereafter as incentives expire. Company delivers future growth projects with six months delay.

Fe (CIF) 2011: $146/t 2012: $150/t 2013: $128/t LT: $80/t

Economic slowdown in DM derails the EM infrastructure story. Lower global economic growth results in a faster mean-reversion for commodity prices. Effective tax rate rises to 34% after 2011, as incentives expire ahead of expectations. Growth projects face further delays and cost inflation.

Bear Case $22

Investment Thesis  Vale looks poised to benefit the most from strong iron ore prices forecasted by our commodity team as it has meaningful volume expansion in the next three years, allowing it to fully capture the benefits of the pricing cycle. Our constructive view on iron ore is driven by an increasingly tight market, with deficits of 32Mt in 2011 and 22Mt in 2012.  The company is also expanding its exposure to copper, coal and nickel (and will grow in all of them), which are among our favorite commodities.  We estimate earnings growth of 18%/yr over the next three years and an undemanding valuation, with the stock trading at a 2012E P/E of 5.8x, ~35% below historical levels. Key Value Drivers Vale benefits from a low production cost relative to the industry. This supports above-average operating margins and cash flow generation, especially in iron ore and nickel.  Attractive growth projects will support future earnings growth and cash flows. 

Potential Catalysts  Positive: the recent nomination of an industry-seasoned new CEO diminishes concerns with the government’s influence in the company.  Positive: Vale obtains environmental licenses for its flagship iron ore growth projects (Serra Sul, Apolo, etc) and breaks ground on construction work.  Negative: Vale intensifies investments in steelmaking capacity in Brazil, lowering returns to shareholders. Key Risks  China reduces iron ore imports, by ramping-up domestic production.  European fiscal issues result in lower steel production and iron ore demand.  Commodity pricing profiles significantly lower than our base case. 89

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Vale (VALE.N) Morgan Stanley is currently acting as intermediation agent to Vale S.A. ("Vale") with respect to its announced tender offer to acquire, through its subsidiary Mineracao Naque S.A., up to 100% of the free float of Vale Fertilizantes S.A in order to delist. This report and the information provided herein is not intended to (i) provide advice with respect to the tender offer, (ii) serve as an endorsement of the tender offer, or (iii) result in the procurement, withholding or revocation of a tender in the tender offer or any other action by a security holder. Vale has agreed to pay fees to Morgan Stanley for its financial advisory services, including transaction fees that are contingent upon the consummation of the proposed transaction. Please refer to the notes at the end of the report.

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Newcrest Mining (NCM.AX, A$40.60, OW, PT A$48.90) Golden exposure Why Over-weight?

A$70

A$63.60 (+57%)



Despite recent one-off issues we still see ~10% production growth in FY12 and FY13 on a like-for-like basis; this generates EPS growth of +25%.

A$48.90 (+20%)



Costs should be stable in FY12 (~A$490/oz), then reduce in FY13 as Cadia Valley East starts and Lihir Island expands; this should lift the EBITDA margins to +60%.

A$32.70 (-19%)



Fundamentally strong position being able to self fund several major projects while also increasing dividends and maintaining a low gearing.

A$ 40.60 40

Key Value Drivers



We have a positive view on the gold price and copper price to which Newcrest is fully exposed. Newcrest has long-life, low-cost mines.



Newcreast is a gold producer with copper by-product credits. A +/-10% change to our gold price assumptions would change our price target by approximately +/-12%. A +/-10% change in forecast production volumes would move our price target by +/-14%.

0 Jul-09

Jan-10 Price Target (Jul-12)

Jul-10

Jan-11 Historical Stock Performance

Jul-11

Jan-12 Current Stock Price

WARNINGDONOTEDIT_RRS4RL~NCM.AX~

Source: FactSet, MorganStanley Research

Price target A$48.90

Our target price is set at 1.7x NPV. This is above the mid range multiple for a large-cap gold stock (1.3-2.0x), but is applied given Newcrest’s first quartile mine life

Potential Catalysts 

In the near term, we are looking for the Lihir Island Resource upgrade in August and details on mine optimization and a potential stage 2 expansion.



By the end of 2011 the Wafi-Golpu PFS will be out – we are looking for confirmation of a high grade core and positive project fundamentals.

and growth profile.

Bull Case A$63.60

Implies: 33x base case FY12E EPS

Incorporates higher commodity assumptions. Growth projects Wafi-Golpu and Namosi are successfully developed; therefore, risk weightings are eliminated. Gold premium 1.65x NAV

Base Case A$48.90

Implies: 25x base case FY12E EPS

Wafi-Golpu to start production in FY15 (risk weighting 20%) and Namosi in FY17 (risk weighting 20%). Utilises our base-case commodity price assumptions. Gold premium 1.65x NAV.

Bear Case A$32.70

Implies: 17x base case FY12E EPS

Assuming our bear-case commodity price assumptions. Growth projects Wafi-Golpu and Namosi are unsuccessful in being developed. Gold premium to our NAV valuation remains 1.65x.

Key Risks 

Delivering the Cadia Valley East Panel cave (2012 ramp up) is critical given production plans and growth aspirations.



The positive commodity price view is inherent to the positive company view.

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

Freeport McMoRan (FCX, $55.34, OW, Price Target $65) Exposure to copper and under-appreciated brown-field growth at attractive cost $90 80

$80 (+45%)

70 $65.00 (+17%) $ 55.34

60 50

$45 (-19%) 40 30 20 10 0 Mar-09

Sep-09 Mar-10 Price Target (Jul-12)

Sep-10 Mar-11 Historical Stock Performance

Sep-11

Mar-12 Current Stock Price

Source: FactSet, Morgan Stanley Research Price Target $65

Bull Case $80

4.3x Bull Case 2012e EBITDA

4.6x 2012e EBITDA at $4.60 copper price and 4.30 bn lbs p.a. copper. Multiple consistent with historical trading. Strong copper prices and growth above 5 bn. Unprecedented global stimulus, EM industrialization, and recovery in the US and Europe lead to a sharp risk rally. Global economy grows 5.3% in 2012; copper market remains tight. Valued at ~$5.00/lb copper and 4.6 bn lbs volumes in 2012. Volumes grow to 5.3 bn lbs in 2014-15.

Base Case $65

4.6x Base Case 2012e EBITDA

Sustainable recovery. Copper fundamentals remain strong as demand in China exceeds expectations, combined with falling grades and tight scrap supply. Higher oil price offset by higher product revenues. Copper averages $4.60/lb in 2012, with volumes of 4.3 bn in 2012, and 4.6 bn in 2013. Volumes grow to 5 bn lbs by 2014-15. Global GDP grows 4.6% in 2012.

Bear Case $45

6x Bear Case 2012e EBITDA

Another leg down. Widespread economic slowdown results in larger than expected copper surplus. Copper averages $4.05/lb in 2012 and volumes 10% lower than guidance. Global GDP grows 3.5% in 2012.

Investment Thesis  We believe FCX is an attractive play on copper, our preferred base metal. Shares are pricing in $3.75/lb copper, 18% below our 2012 forecast.  Growth opportunities. We see supply issues continuing to challenge the copper industry. We expect FCX to grow volumes by ~30% in 2011-15 (vs. 13% for the industry), capitalizing on brownfield growth opportunities at its long-lived operations.  Attractive cost structure. We think FCX’s position on the cost curve will improve. Current State of Play  Copper price. YTD copper has averaged 4.28/lb, (2006-10 average $3.04).  Copper Inventories at LME warehouses in Asia are down 7%.  Chinese imports fell 24% in 1H over last year, but due to destocking, in our view. We think that the Chinese destocking is mostly over. Key Value Drivers  Copper Play. We forecast $4.40/lb copper in 2011 and $4.60/lb in 2012. Macro concerns may keep prices volatile, but we would consider this a buying opportunity based on our constructive view on copper.  Growth. Opportunities at Tenke, Grasberg, Climax, El Abra, Cerro Verde and several North American operations.  Costs. Better economics at Grasberg and lower cost Tenke and Cerro Verde expansions should help reduce overall cost of operations Potential Catalysts  Capital return announcements.  Growth projects: Advancement of Cerro Verde (feasibility study completed in 2Q11), Climax (2012 start-up announced), Tenke, Morenci and El Abra should drive volume growth.  Copper related: LME inventories begin to decline faster; Shanghai prices move above LME, Chinese imports rebound strongly. Key Risks  Beyond restocking, Chinese demand disappoints.  Dilutive M&A to use excess cash.  China tightens lending, imports remains weak in 2H11 92

MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

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MORGANSTANLEYRESEARCH

July 26, 2011 Global Metals Playbook, 3Q11

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July 26, 2011 Global Metals Playbook, 3Q11

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Count

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July 26, 2011 Global Metals Playbook, 3Q11

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July 26, 2011 Global Metals Playbook, 3Q11

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