London, 8 January 2010

Morgan Stanley expect another strong year for commodities in 2010. Spot returns in 2010 may not match their impressive performance in 2009 (S&P GSCI +50%), but with global GDP growth poised to rebound to 4.0%, driven largely by strength in the commodity-intensive EM, we expect inventories to tighten. This will reduce the roll cost associated with oversupplied markets and allow commodity returns to again impress in 2010.

"The high correlations of 2009 reflected the massive liquidity injection by central banks around the world. The removal of this liquidity will see these correlations fade, leaving individual commodity fundamentals to play a larger role in price determination. We want to own commodities with balances that we expect to tighten further. We also want to own commodities that are exposed to the EM - where our economists see GDP expanding by a robust 6.2%."

MS FX strategy team now expects the USD to strengthen in 2010, but we do not expect this to derail commodity performance.

"Specifically, the USD is expected to strengthen narrowly against the majors as rate and growth differentials are set to shift in favor of the US. However, with EM growth expected to handily outpace the G10, the USD is expected to continue weakening against EM currencies - a notable positive for commodities given that the bulk of incremental production and consumption is coming from these markets.

"Commodities will also benefit from continued concerns surrounding inflation and sovereign risk. Our economists do not expect inflation to be a major risk in 2010, but weighty public sector debt burdens will pressure central banks and commodities have historically outperformed other asset classes in periods of rising inflation.

According to Morgan Stanley:

• Near-term fundamentals for the oil market remain weak, but a rebound in global demand, again driven by non-OECD economies, will contribute to tightening inventories and increased OPEC production in 2H10. As OPEC starts to increase production, we expect the market to focus on falling spare capacity and the need to ration demand.

• Agriculture will need higher prices to encourage acreage expansion as a hungry EM draws down on relatively limited inventories.

• Metals, though unlikely to repeat the stellar performance of 2009, are expected to move higher again in 2010 as strengthening industrial output in the OECD supplements another year of strong growth in China. We expect copper to remain the bellwether of the base metal sector as leverage to strengthening demand will be supplemented once again by the price benefits of constrained concentrate production and tight scrap supply. As a result, the copper market is expected to be the first market to return to a deficit next year, with aluminum, nickel and zinc still expected to record surpluses as rising mine and smelter production outstrips the rate of demand improvement.

• The gold market is expected to see new highs in 2010 amid volatile trading on continued investment demand. However, with some of the recent pillars of the bull market showing signs of fatigue (de-hedging and falling mine supply), the market is expected to become more sensitive to the timetable for the withdrawal of US monetary stimulus and the anticipated upward pressure that this will apply to the US dollar.

• We remain neutral wheat, but expect gains in corn and soybeans. Though we remain very friendly to sugar in the coming months, we caution that prices could fall below $0.20/lb by year-end unless weather interferes again with production in India and Brazil. Feeder cattle and, to a lesser extent, lean hogs will also struggle under the weight of higher grain prices as they search for their new respective equilibriums.

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