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MS 2012 Outlook: Agriculture

MS 2012 Outlook: Agriculture Divergent fundamentals will continue to challenge the traditional correlations between the ag commodities through 1H2012, with near-dated corn the most likely to outperform over that period. However, we expect that corn prices will likely come under pressure in the second half of the year as rebounding production from South America, and ultimately the US, increases supply raising the potential for deferred soybeans to outperform. Corn Tight US and global fundamentals leave us constructive on corn at least through the beginning of 2012 as larger livestock herds suggest higher US feed demand than is currently modeled by the USDA. However, high prices are already eliciting production responses from countries like Argentina, Brazil and the Ukraine, reducing the call on US exports, with US production likely to follow in 12/13 Soybeans Weak global crushing demand and adequate Brazilian supplies have decimated demand for US 11/12 exports, though US crush is likely to rebound in 2012 to rebuild tightening soyoil inventories We see upside to deferred bean prices (Nov 12 and beyond) on the need to preserve US acreage against still-strong corn and cotton values. Wheat A global supply response, brought on by the combination of high prices in 10/11 and normalized weather in the FSU, has shifted the global market from production deficit to surplus. Despite production shortfalls in US high-protein wheat, cheaper alternatives from the Black Sea, the EU and Argentina will likely continue to edge out US exports, leaving upside to US feed demand as the only potential positive catalyst into Q1 2012. Corn: Supply to Rebound by 2H2012 Supply US 11/12 production is likely to fall to 3-year lows of 12.3 bln bu, down 1% YoY, as a delayed spring planting and hot, dry summer weather left yields at a 9-year-low of 146.7 bu/acre. This production disappointment is likely to pull US stocks-to-use (S/U) down near the record low of 5% seen in 95/96. However, attractive economics should encourage an increase in US planted area in 2012. We expect that competitive farmer returns vs. soybeans and wheat should encourage further corn acreage expansion in 12/13 to an estimated 93 mln acres. This would imply production of 13.6 bln bu, up 11% YoY, assuming a slightly sub-trend yield of 160 bu/acre. South America 11/12 corn production prospects look rosy with an early start to planting and higher acreage encouraged by attractive prices. We estimate output could reach 27.5 mln MT and 61.5 mln MT for Argentina and Brazil, up 22% and 7% YoY, respectively. The predicted return of a mild La Nina climate pattern could provide downside risk to our estimates, particularly if the dryness usually associated with La Nina emerges during pollination in late Dec/early Jan. To date, however, the region has enjoyed normal rainfall. Better than expected European corn production in 11/12, though early signs point to challenging 2013. Late season rains and a dry harvest helped European yields; we have raised our EU and Ukrainian production estimates to 62 mln MT (up 12% YoY) and 21 mln MT (up 76% YoY). However, signs are already emerging that the continent could face a dry winter/spring in 2012, which could bode poorly for next years production.

Corn: Strong Demand to Keep Balances Tight Near Term Demand Despite high prices, US feed demand is still running strong: We continue to see upside to USDAs 11/12 US feed demand estimates as robust livestock inventories through the fall and winter portend to a YoY increase in feed demand rather than the 4% decline currently modeled by the USDA we model an 3% YoY increase. The first indication of the pace of 11/12 feed demand will come on January 12th with the USDAs quarterly Grain Stocks report. Expecting steady US ethanol demand in 2012. We expect ethanol demand for corn to remain robust through YE2011 as blenders rush to take advantage of the $0.45/ gal blenders credit before it sunsets at year end. However, with forward blending margins positive ex-credit, we do not expect a meaningful drop in domestic ethanol demand in 2012. With the RFS mandate growing to 13.2 bln gal (~4.7 bln bu), we see total 11/12 corn demand from ethanol, down only modestly by ~50 mln bu YoY, on lower US ethanol exports. Globally, we see feed consumption increasing modestly by 4% YoY as growing EM demand for meat requires a further expansion in the livestock herd. This demand growth will likely be tempered by an increase in wheat feeding elicited by high relative corn prices. South American and Ukrainian supplies are likely to reduce demand for US 11/12 exports, which we see falling 21% YoY to 1.45 bln bu, 150 mln bu lower than the USDAs estimate and the lowest level of US exports since 85/86.

Soybeans: Fight for US Acreage Positive for Bean Prices Supply Expect deferred soybeans to outperform in 1H12. While soybeans have faltered in 2011 (and front-month beans could continue to struggle), owing largely to abundant Brazilian supply, we expect that the fight for US acreage and the need to rebuild US soy oil stocks in 2012 should continue to support Nov 12 soybean prices relative to corn and wheat. Disappointing US production in 11/12 necessitates more 2012 acreage. After a year in which US soybean production fell 9% YoY on poor yields and lower planted area, we see US acreage needing to rise by at least 2.4 mln acres YoY in 2012 to keep US soybean S/U from falling in the 12/13 marketing year (from already-high levels). Brazilian crop off to a good start, though acreage competition from corn stiff. Timely and adequate rains have allowed for a faster than average start to soybean planting in Brazil. We expect the country to produce 75.2 mln MT of soybeans in 11/12, flat YoY, with yields seen falling 3% YoY but harvested area up 0.7 mln Ha (3%) YoY. We expect yields to fall slightly as favorable corn returns (relative to soybeans) will likely elicit a marked increase in Safrinha (second crop) corn cultivation, requiring farmers to plant more soybean acreage to quickmaturing/loweryielding hybrids. Indian 11/12 soybean crop seen up 9% YoY to 10.6 mln MT as good soil moisture and favorable weather encouraged farmers to expand bean area in Madhya Paradesh, Maharashtra and Rajastan. We expect aggregate planted area to increase by 11% YoY to 10.3 mln Ha.

Soybeans: After Prolonged Weakness, Demand Outlook Positive in 2012 Demand Competition from other origins pressuring US exports: We model US 11/12 soybean exports falling by 11% YoY to 1.3 bln bu, as other origins continue to undercut US prices. Argentina and Brazil will likely take share of global soybean exports from the US as adequate 10/11 ending stocks and an early harvest broaden their traditional export windows. We see combined exports from Argentina and Brazil growing by 25% YoY in 11/12. Biodiesel production should remain strong through 2012. In the US, we expect that improving economics and a growing federal mandate will support a near tripling (YoY) in US biodiesel production, fueling a 3% YoY increase in 11/12 US soybean crush demand to 1.7 mln bu. Similarly, we expect that Argentine 11/12 crush demand will likely grow by 5% YoY to 39 mln MT taking up 76% of the countrys soybean production largely as a result of strong biodiesel demand from both domestic blenders and exporters. Growth in Chinese livestock production supporting China bean imports. As China seeks to rebuild its domestic hog herd after a year of low supply and high pork prices, we see Chinas soybean imports rising 8% YoY in 11/12 to 56 mln MT as domestic consumption continues to outpace production. Chinas crush demand is expected to increase 10% YoY.

Wheat: Price Weakness to Persist Through 1H2012 on Oversupply Supply European wheat production surprised to the upside in 2011, leaving the 2011/12 supply outlook very comfortable. European yields were better than expected after early-season drought concerns; we model 11/12 EU wheat yields at 5.3 MT/ha, up 3% YoY. Even more importantly, we expect that Russia and Ukraine will see combined production increase by 20.1 mln MT YoY (3% of 10/11 global production), most of which will be exported. Another strong harvest in the works for Australia. After a record wheat harvest of 27 mln MT in 2010/11, better precipitation in the western states and full eastern irrigation reservoirs have together supported yields again in 11/12; we currently forecast this years harvest, just getting underway, to total 26.2 mln MT. With this years crop more concentrated in Western Australia, the countrys traditional wheat-exporting region, more of Australias production may find its way to the global market (we model 11/12 exports up 0.7 mln MT or 4% YoY) Feed wheat surplus persists. We expect an excess of feed quality wheat to persist through the 1H12. After heavy rains lowered the average quality of last years Australian crop, nearly 49% of the countrys Sep 2011 stocks were still feed quality, compared to 11% of stocks in Sep 2010. The US has also found itself relatively oversupplied with lowprotein Soft Red Winter (SRW) wheat, with stocks of high-protein Hard Red Spring (HRS) wheat constrained by poor 2011 planting, which is seen falling to its lowest level since 2007/08. Bullish risks remain, particularly for 2012/13 production. The National Oceanic and Atmospheric Administration (NOAA) has forecast the return of a moderate La Nina weather pattern this winter, portending to lower than average precipitation in the US

southern plains. If realized, these predictions may bode poorly for US HRW wheat yield prospects; last years drought reduced HRW winter wheat production by 23% YoY.

Wheat: Discount to Corn to Strengthen Global Feed Demand Demand Improved global production reducing the call on US exports. We expect demand for US exports, which has persisted for months at or around 5-year lows, will remain under pressure through 1H12. We currently model 11/12 exports at just 1.025 mln bu (27.9 mln MT), down 20% YoY, as other origins continue to price US exports out of their traditional markets. Expecting feed demand to remain robust: With the corn balance historically tight in the US as well as globally, and wheat prices broadly trading at a discount to corn, we continue to expect that wheat will steal feed share from corn. We model global wheat feed demand up 9% YoY, with corn demand growing by only 3% YoY. In the US, where SRW wheat has averaged at a $20/MT discount to corn since the start of the marketing year, and cash HRW wheat is now trading near parity to corn, we model US wheat feed demand at 200 mln bu, 40 mln bu higher than the USDA, and up 68 mln bu YoY. While wheat feeding usually disappears seasonally in the quarter from Sep-Nov, we expect that this persistent discount has kept wheat in the livestock ration much longer in the season. Quality to remain at a premium: Demand for high-protein wheat remains relatively robust, considering the availability of supply; with production down 30% YoY, we only project US HRS (Hard Red Spring) wheat demand to

fall 18% YoY. Sources indicate that Russias high-protein wheat supply has begun to dwindle, owing to high early-season volumes shipped to milling customers such as Egypt. If these reports prove true, this would be positive for US high-protein wheat in the second half of the marketing year and may lead to some additional widening in the MinneapolisChicago wheat spread which has widened to nearly $2.50/bu. Any weakening in Russian export supplies, not replaced by Ukrainian exports, also bodes will for HRW export sales which currently lag the 5-yr average pace by 52 mln bu (18%)

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