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Base metals Current (last month): copper USD 7,317/mt(7792); nickel USD 16,528/mt(16833); aluminum USD 1,825/mt(1989) UBS View 6-month target: copper: UDS 7,400/mt nickel: USD 18,000/mt; aluminum: USD 2,200/mt ¢ With the exception of aluminum, base metal prices stabilized broadly in June. But we see room for somewhat lower prices in the short run (4-6 weeks). Deteriorating industrial activity in Asian countries, weak US data and the Euro-zone crisis remain a price burden for the sector in the early part of 3Q12. ¢ To weigh on scrap supply and compensated for lower Chinese copper imports, copper prices are likely to decline towards USD 6600/mt, in our view. For the rest of the base metals, prices could move deeper into the cost curve of production. When it comes to aluminum and nickel, however, prices have already declined deeply into the production cost curve. In both cases supply cuts could come quicker and limit the price downside from current levels. ¢ In addition, supply uncertainty related to aluminum and nickel needs to be considered as well. Indonesia's new regulations on ore exports could jack up Chinese import costs by around 20% in the coming quarters. We think such an increase would be meaningfully, as 60% of China's nickel pig iron (NPI) production and 80% of China's bauxite imports depend on Indonesia. ¢ The reason why base metals overall should trade at current levels or higher in six months from now, relates to China. We think the People's Bank of China has made the right monetary policy steps to achieve stronger credit activity and higher sequential GDP growth in 2H 2012. With this fairly balanced risk reward on a six-month horizon, we maintain our neutral position. A Positive scenario ¢ China eases monetary policy aggressively, by pushing credit growth beyond 20% y/y. Additional QE in the US paired with stable European and Japanese demand would allow the sector to rally by around 25%. & Negative scenario e Chinese monetary conditions remain behind the curve, resulting in an economic hard landing. A severe escalation of the Eurozone crisis (deep recession/global impact) could also bring prices close to 2009 levels. What we're watching Why it matters Demand The latest uptick in Chinese imports, driven by technical factors, do not reflect stronger end demand. The June figures (on 10 July) should give some clarity. That said, the attractiveness to import from an arbitrage perspective SHFE to LME has improved. Interest for physically backed copper ETFs needs to be tracked as exchange inventories are structurally low. Supply Copper supply has room to improve in 2H 2012 from poor mine output in 1H 2012. Fading supply disruptions and capacity additions put copper at risk. Indonesia's new export rules could have a positive one-off impact on aluminum Preference: neutral Recommendations Tactical (3-6 months) e From a timing perspective, building up exposure to base metals is not yet advised. While we still expect higher prices over the next 6-12 months, the short-term downside risks should offer investors better entry points, particularly for copper. That said, existing aluminum and nickel positions should be kept. Strategic (>1 year ) e Rising energy and labor costs provide the backdrop for base metal prices to trend higher. The strongest performance is likely to come from zinc and lead, where existing mine capacity is expected to peak in 2014. Environmentally challenged base metals, like tin, should be in line with the sector average. For nickel and aluminum, ample production capacity should lead to an underperformance in the long run. Due to its high current price versus production costs, copper should lag too. Heavy industrial activity in China, with high commodity use, slumped 26 Cumulative year-on-year values, in % 20 ie) Bndiniccel Feb-99 Feb-02 Feb-05 Feb-08 Feb-11 . r 0 q q 9 P — Light indust lue added H dust lue added Economic data/forward People's Bank of China meeting, Chinese economic data (especially IP and loan eNOS SONS curve growth by financial institutions) Key dates: 11-15 July Source: Bloomberg, UBS CIO, as of 18 June 2012 UB S Note: Past performance is not an indication of future returns. For further information please contact CIO's asset class specialists Dominic Schnider, dominic.schnider@ubs.com or Giovanni Staunovo, giovanni.staunovo@ubs.com Please see important disclaimer and disclosures at the end of the document. HOUSE_OVERSIGHT_024172