Pfgbest Research Outlook 2011

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RESEARCH

OUTLOOK 2011

RESEARCH

TA B L E O F CONTENTS

An introduction to the PFGBEST Research Outlook 2011 by Russell R. Wasendorf, Jr., President and COO of PFGBEST

CURRENT INDUSTRY AND BUSINES S T R E N D S

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CURRENCIES O U T L O O K

by Paul Kavanaugh

INTEREST RATES O U T L O O K

by Mike Marshall

INSTITUTIONAL FOREX O U T L O O K
by James Brown

STOCK INDICES O U T L O O K
by Sean Lusk

PRECIOUS METALS O U T L O O K

by Mike Daly

ENERGY O U T L O O K

by Phil Flynn

GRAINS O U T L O O K
by Tim Hannagan

LIVESTOCK O U T L O O K

by Robert Short

by Robin Rosenberg

SOFTS O U T L O O K

The outlooks provided herein represent the professional opinions of the PFGBEST Research analysts and should not be construed as statements of fact. There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products. Past performance is not indicative of future results.

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C U R R E N T I N D U S T R Y A N D B U S I N ESS TRENDS
An Introduction to PFGBEST Research Outlook 2011 by Russell R. Wasendorf, Jr., President and COO of PFGBEST

A year ago, PFGBEST and U.S. businesses were squarely focused on the need for the U.S. Federal Reserve Board to delicately maneuver monetary policy to avoid deepening the economic downturn. The Fed has managed to keep inflation at bay and interest rates low, thereby helping consumer spending to grow modestly. That trend continues. Here are additional factors we are closely monitoring as the doors open to 2011 investing: • Markets are demonstrating investor concern over the ballooning U.S. deficit, set to remain at $1.1 trillion, even after a $100 billion reduction in 2011. Potential state and local government bankruptcies are also front and center. • Slow expansion in the U.S. economy: The slow, 2.7% growth pace established in 2010 is expected to be the same through 2011. • The decline in government stimulus spending – which markets will this impact, and how? • Unemployment: New job growth will barely keep pace with the rise in population, and an unemployment rate of 9% or more is anticipated all year. This would mark the weakest postrecession job recovery on record. • Business spending was very brisk in 2010 and appears to be on track for a double digit rate again in 2011. Companies have been rebuilding low inventories and registering solid profits! That is certainly positive. • The Bush era tax cuts, set to expire in January 2011, were extended in a $700 billion tax deal that continues the 2001 and 2003 tax cuts to keep rates low for ordinary income as well as for capital gains and dividends. It keeps expanded child credits and earned income credits from the 2009 stimulus. It also creates a new, one-year payroll tax cut for all workers regardless of income. What are the plusses and minuses of this legislation, from a trader’s perspective? I direct you to some of our finest PFGBEST market analysts to pinpoint the ways in which these, and other, more specific sector trends, will manifest in the markets throughout the coming year. We hope you will benefit from recognizing both the challenges you will want to be aware of, and the opportunities for you that are inherent in constantly shifting and evolving markets.

HAPPY NEW YEAR! With BEST regards,

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C U R R E N C I ES OUTLOOK
by Paul Kavanaugh [email protected] 888-439-6033
OVERARCHING THEMES FOR CURRENCIES AT THE START OF 2011 • Quantitative easing (QE2) by the Fed and in Europe • Stronger yen and Swiss on flight to quality There are several trends likely to dominate the currency markets in 2011. For the U.S. dollar (USD), the key issue will be the impact of Federal Reserve easing or tightening. The Fed first moved to lower the USD in March of 2009, and this program was successful in lowering the dollar some 17 percent by November of that year. Then, sovereign debt concerns of the Euro Zone surfaced and we saw a significant flight-toquality rally in the USD. • Stronger Canadian and Aussie due to demand for commodity resources there

Source: CQG Inc.

However, in the second half of 2010, slow economic growth and a lack of employment growth made Source: CQG Inc. it likely the Fed would have to move again to stimulate the economy with another round of quantitative easing, known as QE2. Again the dollar sold off as 2010 drew to an end, and it appeared the Fed’s next action involving the planned purchase of $600 billion of additional securities to stimulate Source: CQG Inc. the economy by June of 2011 had been priced in. In a classic example of buy the rumor/sell the fact, the dollar has actually strengthened since the Fed announced QE2. Look for the dollar to move lower on poor economic news and higher on Euro Zone debt concerns in the year ahead. In Europe, the Euro and British pound will likely see pressure from additional European quantitative easing in 2011. The stability of the European Union will be a major theme in 2011, with the economic strength of France and Germany tempered by the debt concerns of the other members including

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Portugal, Italy, Ireland, Greece and Spain, the PIIGS. It’s a financial quagmire, and this is likely to remain a key theme in 2011. The Swiss franc, often considered a financial currency (as opposed to a manufacturing one, like the Source: CQG Inc. German mark or Euro, has been moving sharply higher as a safe haven from further Euro Zone weakness. In December 2010, the Swiss franc hit record highs relative to the Euro. Another beneficiary of risk aversion has been the Japanese yen, which hit 15-year highs against the USD in October, 2010. Strength in the yen has caused difficulty for manufacturing and export sales in Japan. The currencies of commodity exporting nations such as Canada and Australia should continue to strengthen on increasing demand from China. We anticipate further commodity inflation heading into 2011, with many of the markets putting in multiyear and all-time record highs in markets like copper, gold, coffee, sugar, and cotton. The one thing we can be sure of when markets make new all-time highs is that volatility will likely remain extremely high for a good part of the year. Expect a battle between risk aversion/appetite to impact commodity and currency prices, as there is an inverse correlation between the dollar and commodity prices. As the American economy regains its strength and employment begins to improve, the USD is likely to strengthen, and in doing so, it will pressure commodity markets.

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I N T E R E S T R AT ES OUTLOOK
by Mike Marshall [email protected] 800-216-1485
OVERARCHING THEMES FOR INTEREST RATES • Fed buying of Treasuries, and Fed easing to continue • Currency devaluations are a critical influence • Trend is bearish U.S. Treasury rates were on the rise in the fall of 2010, but from the top in early November, the markets met much panic selling amidst mixed talk of recovery. Stocks continued higher through the period, and precious metals were bumping against 30-year and all-time highs as. Some analysts have claimed that the recent rate increases occurred as the market is pricing in the beginnings of the recovery. I suppose this is possible, though I suspect it has much more to do with falling demand for U.S. dollar-denominated investments.
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  had gotten to extreme levels on Indirect
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  fears of soverign default. While 20.00%
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  President Trichet’s decision to increase the ECB’s monetary efforts have reigned in the runaway markets and stopped the ascent. Though foreign rates remain elevated, concern has waned since their extremes.

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Meanwhile, there is no diminished concern about rising U.S. interest rates. And, as worry mounts, we can notice a trend forming in foreign buying of U.S. Treasuries. The charts provided plot the takedown percentages for the recent 30-year and 5-year auctions, respectively. Notice how the indirect bidders, where foreign buying is registered, have pulled away from the belly and short end of the curve, while increasing their bidding on the 30-years. This may be indicative of foreign investors chasing the higher returns of the longer-dated securities. Notice, too, how the primary dealers have gradually been reducing their purchasing over the past two years. Primary dealers buy most of the U.S. Treasuries at each auction, then sell them to their clients, thus creating the initial market. As interest rate risk increases, we have seen investors, both foreign and domestic, reign in their purchases.

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The bigger question of where rates will be in 2011 is extremely difficult to predict at this juncture. On one hand, we have investors, both foreign and domestic, leaving the Treasury market, while at the same time, we have a Federal Reserve Board (Fed) that has pledged to keep rates low. One major development occurring in late 2010 was the change to the System Open Market Account (SOMA) securities lending program allowing the Fed to double its holdings of any particular debt security. So, despite dimishing global investment, the Fed may be readying itself for a far more aggressive round of action. The announcement of further quantitative easing (QE2) brought much speculation, yet the interest rate markets have performed poorly despite the Fed’s pledge to continue the Permanent Open Market Operations (POMO). The recent increase in primary dealer purchases on the short end can also be explained when taking the POMO purchases into account. Since the POMO buying seems to be focused on the belly of the curve (5to 10-years), we could argue that primary dealers see what lies ahead; they may be positioning themselves for more aggressive Fed buybacks. If the primary dealers can continue to front-run the Fed as they have, I would expect a relative bid to be put into belly-of-the-yield-curve pricing for the near term. With this reasoning in mind, I believe the Fed will shortly begin a more significant and aggressive round of QE2. This could come in the form of an increased POMO schedule, or higher SOMA injections at the monthly auctions. It may also be that when QE2 is finished, we will quickly move to QE3 and QE4. As long as the Fed continues to expand its balance sheet to prop up the U.S. bond market, U.S. Treasuries will be at risk to currency devaluation. Fear of this risk will keep investors away from the U.S. Treasury auctions and force the Fed to take ever-increasing amounts of Treasury debt onto its own balance sheet. The negative impact will likely be continued heft to the Fed balance sheet, thus threatening the security of the U.S. dollar and the U.S. Treasury markets. Ultimately, I suspect the Fed will be powerless to stem another tide of panic selling should it occur. I imagine 2011 will bring about a increasingly volatile interest rate market whose direction will remain lower.

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I N S T I T U T I O N A L F O R EX OUTLOOK
by James Brown [email protected] 888-655-5176
OVERARCHING THEMES FOR FOREIGN EXCHANGE FROM THE INSTITUTIONAL PERSPECTIVE • The U.S. dollar’s resiliency • Less pressure on the Fed to raise rates

• Continued interest in emerging currencies like the yuan THE DOLLAR IS BEGINNING TO SHOW SIGNS OF A CORRECTION: After a strong rally in the first half of 2010, the U.S. dollar (USD) reversed course in June and finished the year well below its June highs. Depreciation in the USD in 2010 was interrupted at times by systemic shocks in Europe (sovereign funding crisis), tighter monetary policy in China (and the risk of a hard landing), and the economic slowdown in the U.S. Recently, however, the USD has been showing signs of resilience and has some market participants thinking a sustained rally could be in the cards for the New Year, at least into the spring. There are six primary reasons for the recent strength of the dollar and why this rally could carry into 2011. Treasury yields are backing up, and this fact is supportive of the dollar. Listed are some of the reasons why yields have been moving high recently. • The extension of the Bush tax cuts have some worried about the large U.S. government deficit; if it grows, this could crowd out investment in the real economy;

• Inflation concerns stemming from additional stimulus and government spending which were part of the tax deal; • Higher supply of U.S. Treasury issuance at historically low yields; • A correction in the bond market which had rallied since April;

• Inflation concerns on the back of the proposed QE2 measures unveiled after the November FOMC meeting;

• An end to the Build America Bonds program pressured the municipal securities market and pushed yields higher as market participants were driven to sell Treasuries to hedge their muni-bond exposure. Real yields in the U.S., at 2.3 percent, are currently trading at a premium to Germany (1.53 percent), the UK (.44 percent) and Japan (1.2 percent) in the 10-year period. Euro weakness (and USD strength) is back in vogue on renewed uncertainty in Ireland, Spain and other countries in the Euro Zone. Renewed tensions between North and South Korea have been supportive of the dollar through safe haven buying. China is erring toward tighter monetary policy, and it has raised its reserve requirement three times in just the last weeks of 2010 to 18.5 percent for China’s largest banks to moderate lending and speculation in the over-heated real estate sector. The PBOC raised its one-month lending rate 25 basis points on December 27 to 5.81 percent. On a side note; slower growth in China as a result of this tightening could weigh heavily on commodities and equities if the Chinese economy begins to slow.

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The extension of the Bush tax cuts has put more emphasis on fiscal policy (versus monetary policy) and reduced pressure on the Federal Reserve to ramp up QE2 in 2011. INFLUENCES THAT IMPACT WHETHER THE USD GOES UP OR DOWN IN 2011 The large U.S. external balances and deteriorating budget deficits will be problematic for the dollar in the coming months. Some argue that the economy should respond favorably to the tax extension which would be favorable to the Canadian dollar, LATAM currencies and most Asian currencies. (Note, 75 percent of all Canadian exports come to the U.S., along with a large percentage of Asian exports, so there could be a risk/carry trade influence.) Or, the Fed could go on hold for an extended period as employment growth remains tepid and inflation remains benign. In this scenario, the USD would not be strengthening. The markets are now at a critical juncture because the interest rate/currency link has become highly correlated and a large spike in rates could push the dollar much higher. In turn, a stronger dollar could preempt or trigger a liquidation of the risk/carry trade (short USD, long commodities, long equities and long fixed income), sending commodities and equity prices lower. If one considers the extent to which asset prices have become a function of the ever-growing pool of liquidity by the major central banks of the world, this liquidation could be profound, and a correction across all of these asset classes would not be out of the ordinary. TRADE RECOMMENDATIONS • USD/Chinese yuan In the June 2010 PFGBEST Research Outlook Midyear Update we wrote, “We have heard interest by discretionary managers to buy the 12-month CNY NDF around current levels (6.7900) with stops above 6.8400 and targeting a move to 6.6000 into late 2010. The trade offers an attractive risk:reward opportunity.” For those who are still in this trade we recommend staying with the trade or reinitiating the short 6-month USD/CNY NDF at 6.5600 with a stop at 6.6100 and targeting 6.4500 by July 2011. We expect USD/CNY to fall ahead of Hu Jintao’s visit to Washington in mid-January and believe that the recent focus on domestic inflation complements this trade. • USD/Canadian dollar USD/CAD has been hovering between 1.0000 and 1.0400 since September 2010 and has shown considerable strength compared to the other high-risk currencies. Recent economic data from Canada has been mixed, with better retail sales and higher-than-expected inflation reports suggesting a rate hike by the Bank of Canada (BOC) in the near future. Conversely, the current account deficit is now four percent of GDP (17.5 billion) and Canada’s trade balance is at its worst levels in decades. Weak structural demand in the U.S. (housing, inventory overhang, employment) may keep the BOC on hold. Additionally, USD/CAD could weaken on higher U.S. Treasury yields, lower commodity prices, and China monetary policy tightening as mentioned earlier. Therefore, a recommended trade is buying USD/CAD close to parity with stops down below .9925 with an upside target in the 1.0375 to 1.0650 area. • USD/Brazilian real USD/BRL strengthened 6.5 percent since the beginning of June, 2010, primarily on risk sentiment, attractive yields and external capital flows. But recently, inflationary pressures have been building,

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driven by higher wages, increasing credit and rising consumer confidence. Industrial production and capacity utilization have been tailing off and their trade and current account balance have been narrowing. Throw in weak corporate profits and the likelihood of tightening in China, (Brazil’s largest trading partner) and the fundamental picture begins to look unattractive. Add in higher U.S. yields and an improving economic climate in the U.S., a newly-elected president in Brazil, a weakening stock market based on the IBOV Index…all of this indicates a correction in USD/BRL is in order. Buy the 3-month USD/BRL NDF at 1.7050 (1 unit) with a stop at 1.6825 and target 1.7725 for 1/2 unit and 1.8000 for 1/2 unit.

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S T O C K I N D I C ES OUTLOOK
by Sean Lusk [email protected] 877-294-7757
OVERARCHING THEMES FOR STOCK INDICES • U.S. monetary policy to continue as a supporting influence for stock prices and indices • Persistence of government budget strains and government debt • Bubbles could arise in emerging economies • Housing, consumer spending, and borrowing levels are not going to change dramatically

Entering 2011, the positive news is that the economic recovery is expected to continue, though consumer spending momentum and earnings for the corporate sector will continue to battle headwinds. I do not anticipate the recovery is going to be strong enough to push the U.S. unemployment rate back down to pre-recession levels, however. This means that there is a significant risk that growth will be limited, even as monetary policy from the Federal Open Market Committee (FOMC) will remain supportive. After the market meltdown in 2008, the National Bureau of Economic Analysis had pegged the ending date for the recession in June 2009. While that was certainly premature, there were two strong, temporary factors that did support U.S. economic growth in the last two quarters of 2009: fiscal stimulus from the Fed and a rebuilding of inventories by manufacturers and suppliers. In early 2010, growth shifted to more basic underlying demand, and fixed business investment. Unfortunately, the pace of growth has not been strong enough to jump start employment statistics. Going forward, we would like to see GDP growth closer to five percent, with corresponding monthly gains in non-farm payrolls at or near 300,000. The domestic economy faced a number of challenges that did not let up in 2010, and I see these continuing to limit the pace of economic recovery in the first half of 2011. The following is my assessment of lingering problems and the impact on markets. RESIDENTIAL REAL ESTATE AND THE HOUSING SECTOR OVERALL The housing sector is likely to remain weak in many areas of the country. Two rounds of homebuyer tax incentives helped to stabilize housing activity, but appear to have had little or no lasting impact. It will take a long time to work through the volume of troubled mortgages and foreclosures. The foreclosure documentation scandal hasn’t helped either. Ultimately, a recovery in the housing market will depend critically on better job growth. This should get better over time but not immediately. In the interim, a further decline in home prices would be an unwelcome development. Home prices fell following the expiration of the homebuyer tax credit. A continued decline would worsen the problems in the housing sector and impede any improvement in consumer spending statistics. STATE AND LOCAL GOVERNMENT BUDGETS REMAIN UNDER SEVERE PRESSURE This is going to be a long-lasting issue as debt pressures are resulting in pro-cyclical policies like higher taxes and cutbacks in services. The Federal fiscal stimulus will ramp down in 2011, but the year-end 2010 tax deal involving a two-year extension of the Bush tax cuts, extension of unemployment insurance benefits, and a reduction in payroll taxes will prevent a significant drag on economic growth near term. The tax deal is not so much a positive for growth as it is a non-negative. State and local government usually provides a base level of support in a recovery. However, state and local government has been contracting, and that is a drag on economic revival. State and local government payrolls fell by 250,000

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over the 12 months ending in November 2010. Some of the Federal fiscal stimulus was aid to the states, which will be going away in 2011. Budget strains will fade away only as the economy and revenues recover, but they will not be going away any time soon. MONETARY POLICY U.S. Fed policy will remain supportive of equity markets in 2011 and into 2012. With mortgage rates low, the Fed found that principal payments in its portfolio of mortgage-backed securities reduced its overall balance sheet. The FOMC voted on August 10 to reinvest these principal payments into longterm Treasury securities, buying about $35 billion per month. At the November 2-3 meeting, the FOMC voted to purchase an additional $600 billion in long-term Treasuries by the end of Q2 in 2011, which is about $75 billion per month. Total monthly purchases by the Fed amount to $110 billion per month, which is large relative to the amount of debt the government is issuing. These purchases became known as quantitative easing/QE2. The Fed’s asset plan has been widely criticized and politicized. Many fear that the Fed will inflate the money supply excessively, and that could lead to inflation. OTHER FACTORS Bank terms and standards for consumer and business loans tightened further in 2010, but should ease in 2011. Credit to small firms tightened sharply during the economic downturn and has not loosened up. However, many small firms are unenthusiastic about future demand, and they don’t even want to take on further financial obligations. Borrowing is a lot easier for large firms, which have access to big banks and the corporate bond market. Consumers and big businesses generally paid down debt in 2010, and a massive deleveraging continued in the financial sector. Government borrowing will remain high in 2011, but that is unlikely to impede private sector borrowing. The consumer outlook for 2011 is slightly positive. We should see some improvement in the labor sector which will add to incomes, thereby stimulating consumer spending. The reduction in payroll taxes especially in middle class incomes will add to disposable incomes near term. As usual, any rise in energy prices is an important wildcard in the consumer spending outlook. A further rise in gasoline prices could dampen the positive effect of the tax agreement in early 2011. Business investment is also likely to remain moderately strong, fueled by strength in corporate profits and continued strong earnings. U.S. imports and exports fell sharply during the global recession, but continued to recover in 2010. However growth in imports and exports appeared to moderate in the second half of 2010 and are not expected to be a major factor in 2011. The European debt crisis is not going away anytime soon, and is likely to be a recurring concern for U.S. investors in 2011. Emerging economies are expected to remain strong in the near term, but there is fear of a possible bubble. In summary, the U.S. unemployment rate is only going to improve marginally. Short-term interest rates are unlikely to start rising until early 2012, as the Fed begins normalizing monetary policy. But it is the monetary policy currently employed by the Fed that carries a dual mandate that traders and investors should continue to be aware of. That is, to pump reserves into the economy and reduce the unemployment rate. The Fed in its statement in November 2010 stated that it can increase bond purchases in the months to come to spur the economy and get the credit markets moving again. In fact, when QE2 was announced, traders and investors were already wondering when QE3 was to begin later in 2011. Remember the QE2 program ends in June, and we could see a third round of asset purchases by Q3 in 2011. The point to this is that I would not recommend trading against the Fed’s mandate.

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The obvious risks to the downside continue to be the ongoing debt crisis in Europe and continued global uncertainty on the Korean Peninsula and in the Middle East. S&P market support is present at the 1160 level and below that at 1075. Resistance is up at 1322 and further up at 1406. Initial support for the E-mini S&P lies at 1168, and below that at 1078. Resistance comes in at 1341, and the next target above it is 1431.

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P R E C I O U S M E TA LS OUTLOOK
by Mike Daly [email protected] 877-294-4669
OVERARCHING THEMES FOR PRECIOUS METALS • Record all-time highs ahead for gold • Choppy market conditions • High volumes

As we look back on 2010, we realize how fragile the global economy has become. Events occurring in the world have fueled a multi-year flight-to-quality in gold futures and physical gold. Issues like record national debt for the U.S., debt contagion throughout the Euro Zone, and geo-political tensions (North Korea, South Korea, China, and the Middle East) have led to a seemingly never-ending stream of demand for gold. The other precious and industrial metals have also benefitted from the bullish factors. Precious metals have indeed captured the world stage and the limelight is not fading. During 2010, gold prices notched to all-time highs, on incredible volumes as the U.S. dollar’s slump drove investors to precious metals as alternative assets. Gold futures reached an all-time record of $1,429.40 in December. Another highlight of the year was silver, which was swept to 30-year highs. In September 2010, silver futures climbed to $21.39 per ounce, the highest price since January 1980 when silver fixed at $49.45. Since the global economy continues to struggle, it is my opinion that savvier investors, as well as seasoned traders, will continue to use the precious metals as an alternative, safe-haven investment. We have certainly realized that the European region is much more fragile than early reports indicated. In fact, today it is commonplace to hear reports of European banking institutions’ credit being downgraded by either Fitch Ratings or Moody’s. This has forced many investors to use their weakened currencies to purchase gold and silver in order to protect their wealth. The Euro region will need time to stabilize and generate, and meanwhile, the flight into gold and silver in their many forms will not subside. We also know that there is and will continue to be an insatiable demand for gold in the Asian sector. India is the largest consumer of gold in the world and it is estimated that 20 percent of all refined gold is consumed by India. The giving of gold and silver is huge part of their gifting tradition during their wedding seasons as well as their Hindu festivals. And, since the citizens have accumulated more wealth in recent decades, they have more money available to spend on this prized commodity. China has become the world’s largest producer of gold and also the number two consumer – “gold fever” has stricken and is not going away. From the government’s investment perspective, it has been reported that the Chinese are seeking to increase their present gold bullion reserves in order to promote their yuan currency to the international level on par with the U.S. dollar and the Euro. They will have to increase their present bullion reserve drastically to achieve that end. Some analysts estimate that China will have quadruple their present reserves, which would certainly pressure gold prices to new highs. Constant worries that China’s central bank – The Peoples Bank of China (PBOC) – will continue to raise rates weigh on gold and silver prices. However, I believe that a drastic price dip due to a Chinese interest rate hike may also offer an excellent opportunity to buy the precious metals at a bargain price.

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Finally, the U.S. economy seems to be stabilizing; the main drags are the jobs sector and the housing sector. Obviously, this should and must be priority one and two so that we can get the unemployed back on a payroll and inject their dollars into their local economies, not to mention putting food on the table and a roof over their families’ heads. Our economy also will need time to progress and regain lost confidence. As the world’s largest economy, the U.S needs to continue to grow and create new jobs. Since the implementation of QE2, which is scheduled to inject more money into the economy through the end of June 2011, it is likely that U.S. interest rates will remain low. That is a fundamental bullish factor as higher U.S interest rates would be bearish for both gold and silver. Federal Reserve Chairman Bernanke said that it could take five years for unemployment to fall to a normal level. Lower rates are meant to help small business borrow money at cheaper rates in order to grow, and that measure is designed to lead to growth in new jobs domestically. I expect the gold and silver rallies to continue through 2011 if these fundamental factors continue. Copper also achieved a new, all-time high as of this writing, on December 27, 2010, when it finished at $4.28 a pound. This has to do with the anticipated need for the base metal as the domestic and other world economies get back on track and continue to grow, sparking need for copper for industrial purposes. Some analysts consider copper prices as an indicator of the health of the construction industry. While I think copper, along with gold and silver, has an upward bias, there is no current shortage of copper.

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E N E R GY OUTLOOK
by Phil Flynn [email protected] 800-935-6487
OVERACHING THEMES FOR OIL AND GAS • $100 target is in sight for a barrel of crude oil • Dollar rally would stem any upward price activity

• Demand improving but economic weakness is blocking rallies in energy futures prices Oil demand will improve in 2011 but will that mean sharply higher prices? After one of the flattest and most fascinating trading years in recent memory for crude oil, 2011 is shaping up to be a bit more bullish on the demand side. Prices are firm at current levels. Improving retail sales and the extension of the Bush tax cuts should set the stage for a year of improving demand. Still, don’t expect oil prices to soar above $100 a barrel unless a major geo-political event occurs, because even as demand recovers, oil has a $15 to $20 stimulus premium built into the price. That premium must come out before cash and futures prices can begin to soar. IMPACT OF THE U.S. DOLLAR ON COMMODITIES GENERALLY The U.S. economic stimulus program has led to more demand and a weak dollar. While the economy seems to be improving, it is the value of the U.S. dollar that should be closely monitored in energy and other commodity markets. If the dollar stages a strong rebound, it would put downward price pressure on crude oil. Recently, Bloomberg reported on the relationship between the dollar’s value and commodities. “Speculators betting the commodities rally will continue into a third year are being confronted by currency investors wagering the dollar will strengthen in 2011. If history is any guide, the foreignexchange market will win.” That article pointed out that the dollar has moved in the opposite direction of commodity prices 18 of the past 22 quarters. During the 11 quarters in which the dollar index has gained since the first quarter of 2005, the CRB index fell eight times. That is a strong indicator of the continued status of opposing directions for the U.S. dollar and the price of commodity markets. PRESSURE FROM ECONOMIC FACTORS STARTING WITH THE 2010 DUBAI CREDIT SQUEEZE Despite improving demand, there are still factors at play to curb real price improvement. A slew of unfolding economic crises throughout the year in 2010 dictated the volatility in crude prices. The first event was a credit problem in Dubai which caused oil to break from the eighties to below $70. The massive building boom in Dubai, including man-made islands and construction of the world’s tallest building, ground to a halt as a credit squeeze raised fears of another economic collapse that might spread across the Middle East. Obviously a break in oil prices might cause even more economic pain across the region and instead of exporting oil, the Middle East might export economic gloom. The gloom which would result from a Dubai default would be far reaching indeed. What happened in 2010, was that Dubai (and by default, the price of oil) got bailed out when the United Arab Emirates (UAE) coughed up a $10 billion rescue plan to help Dubai’s sovereign wealth fund restructure. Oil rallied again as the bailout helped create the impression that Dubai was a small problem in the larger scheme of things.

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EURO PRICE DEFLATION The U.S. Federal Reserve Board (Fed) had repeatedly warned the European Union (EU) to protect their economies by printing more money but it didn’t happen. The Europeans have a strong reservation against printing money based on their pre-WWII history. As the Euro remained strong in the year just ended, the spread widened between the Euro and the U.S. dollar, creating deflationary pressures in Europe. In fact, the combination of their weaker European economy and the strength of the Euro currency made it hard for some EU members to pay their debts. Several countries had not been as fiscally responsible as others, and the next thing you know, there was a crisis in Greece. Greece’s fiscal responsibility and debt imbalance first led to a selloff in oil, and next to the infamous “Flash Crash” that steered crude oil to its low of 2010 in the $64 area. That was a short-lived break in oil prices, because then the EU broke every rule they had in the book; despite a treaty that vowed that they would not bail out any members’ bad debts, they did so. Fear of contagion to their neighbors, now known as the acronym “PIIGS” – Portugal, Italy, Ireland and Spain – forced the EU to act. Just as easy as one, two, three, the EU printed cash, hoping the PIIGS’ debt problems could just gradually fade away. And, once again, it was a major intervention that stopped a free-fall in oil. Oil did rebound, but supplies increased to record highs in the face of weakening demand. By the middle of 2010, oil demand went into a major malaise. The U.S. Energy Information Agency had to scale back its optimistic prediction for 2010 and 2011 as the economy sputtered. Oil prices started trending down into the low seventies and looked as if they were going to continue their fall. That was, until they got the boost of a lifetime when the Fed signaled once again that it would print more money. Oil prices then took off on an incredible bullish journey, hitting a two-year price target high of $88.63. The Fed tried to defeat oil deflation expectations and the oil bulls triumphantly called for a straight shot up to $100. We did not hit that $100 level in 2010, and we may not in 2011 if the dollar rebounds. A WORD OR TWO ABOUT THE OTHER ENERGY COMPLEX MARKETS

Source: Short-term Energy Outlook, June 2010

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Natural gas has been in a decline for about a year, but that is not to say consumers have benefitted from the lower prices. We are now apparently in a stability zone with unleaded gas prices. There was some upward movement in Q3 of 2010, but only back to the spring prices. Diesel fuel continues to trade in a range. The U.S. has unused production Source: EIA, AEO2009 facilities and no new refineries on the drawing board. U.S. demand has stabilized and world demand is projected to continue to grow modestly. The retail price is not cheap and is well off of all-time highs. The problem is that consumer income is flat, so there will be issues with paying higher prices. Upside targets in the oil complex products are all-time highs, but with current economic conditions, that kind of elevated pricing would be disastrous.

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G R A I NS OUTLOOK
by Tim Hannagan [email protected] 800-935-6487
OVERACHING THEMES FOR GRAINS • Funds will continue as mega-buyers in futures • Battle between corn and beans to secure acres • Ethanol and bio-fuel demand • Continued increase in global demand for grains and oilseeds

Look for grains to exceed the highs of 2010 before the 2011 U.S. harvest begins. Ending stocks of both corn and soybeans were dangerously low as the spring planting season of 2010 got underway. Price strength will occur in each grain to ensure each has enough acres being produced, so that we don’t run out, even in the event of a growing season drought. Farmers will plant only the grains in strong export demand – corn, beans and spring wheat – at the expense of hayfields, alfalfa and oats, which have little export market demand at this time. Oats may be the biggest loser with acreage under 3 million acres from 4.5 million acres only a few years ago, creating the tightest of all grain inventories and the potential for a substantial supply-side rally. In terms of fundamentals, the foundation we have is very similar to the supply and demand ratio we have seen for the past two to three years. U.S. grain prices are poised to rally going into the planting season in order to win additional acreage away from competing crops. Another bullish fundamental that persists is the growing world bio fuel demand – corn to make ethanol and soyoil, which is also an ingredient in bio fuel. This occurs in tandem with ever-expanding food needs in emerging markets – Asia primarily, and China in particular. MEGA-FUNDS AND THEIR INTENTIONS I think one of the biggest forces on pricing in 2011 will be the mega-funds. Since the historic high grain moves of 2008, there has been a change in the roster of grain market movers and shakers. Before then, control was levied by large individual traders and some agricultural trading funds wielding $5 million to $10 million; commercial exporting and processing companies controlled the more seasonal trends. Now, outside investors – funds – have a far greater role, as they have benefitted from regulatory changes. New laws allow money from stock trading companies to trade commodities, once considered too risky. These monies used to sit in massive, billion-dollar, conservative, stocks through managed accounts. These funds hold monies from teacher, auto and private company pension funds. Practically overnight, we’ve seen the funds go from $5 million to $10 million ag-minded funds to $50 billion to $100 billion trend-following and index funds. These index funds were given hedge account status with no trading limits on positions held. They can only be long the market, leaving selling as only a profittaking result. Since these new fund monies originated from the stock market mindset, it is easy for the money managers to keep buying just like years of stock buying has trained them. They know little of fundamentals of commodities, and they don’t care. They never take physical delivery of the product. Therefore, their strategy is 90 percent technical. The pattern is to aggressively buy the first half of the month and sell only on bursts of profits before month-end. Many funds have clauses in their contracts that allow them to pay handsome bonuses on profits taken before month-end. This makes for an easy decision. There is much talk of restricting these funds and limiting the position size they can hold. Don’t think that is likely. A large portion of the fund monies comes in from foreign trading entities. The fear

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of regulators is that trading restrictions would drive monies away from U.S. exchanges to newly-formed exchanges in other countries. The U.S. exchanges also are reluctant to push for trading limits, as soaring open interest and daily trading volume continue to bring in exorbitant amounts of capital through exchange fees. Additionally, the government regulatory agency in charge of commodities, once underfunded and under managed, now sees regulatory fees per trade bringing in monies and enhanced power and control. These massive trading funds are not going away. They are getting better organized and expanding. Total managed fund monies at the end of October 2010 totaled $340 billion, double the amount that drove prices of grains to historic highs in 2008. A new agricultural grain fund out of China begins trading in early 2011, and it manages $50 billion. That and similar-sized new funds will overbuy every event in the market this year. ETHANOL UPDATE Our country is resolved to expand ethanol production with mandates for future energy supplies in place. Current estimates indicate about 40 percent of the U.S. corn crop for the 2010-2011 crop year – somewhere in the neighborhood of 5 billion bushels or just a bit more – are projected to be used in ethanol. A movement by anti-ethanol senators to end all ethanol subsidies and tax breaks is afoot. This end to subsidies is inevitable. The initial reaction would be bearish, then back to neutral and long-term bullish. We no longer need subsidies to encourage ethanol production and usage. We no longer pay private entities to build ethanol plants – businesses and individuals are doing it at their own expense, gladly. Ethanol has arrived, and not just domestically. The business of ethanol production will do far better without government involvement and now is in the strong hands of rural corn growers and ethanol plant managers with solid hedging and marketing skills. This is evolution from 2009 and before, when many ethanol plants owned by entities in the green movement went bankrupt. WORLD FOOD SUPPLY AND LIVESTOCK FEED DEMAND China, the world’s most populous nation, has mandated a more protein-rich diet for its citizens. China intends to increase hog and chicken populations for meat protein. Their feed corn and soy meal comes mainly from the U.S. but also other world sources. Their strategic grain reserves were sharply depleted after a poor 2010 growing season, in spite of their collective appetite being whetted for ever more soybeans that yield high-protein, tasty soy oil for cooking. Improvement in family incomes is also a demand consideration. It is projected that 40 million Chinese again this year will move from a poverty class to middle-class status. China has 22 percent of the world’s population and only 7 percent of the world’s plantable land. This keeps their import needs on an upward curve. In fact, the U.S. is a major supplier of corn to China, but the world’s number two corn exporter, Argentina, is an important back-up. Adding a more protein-rich diet through added meat is a trend echoing across Asia, and increasingly across Europe, where bread used to be their diet staple. China is busily trying to stockpile reserves so it doesn’t get caught short of inventory, especially if there is a price spike to record highs similar to the one in 2008. China plans to spend $3 billion in storage facilities for storing some 40 percent of their grain imports. India plans to create 15 million metric tons of storage space along with similar numbers from key European Union nations. The most curious and potentially bullish plan stems from Brazil planning a partnership with Argentina and other South American producers of grains and oilseeds to deal jointly with buyers in Asia and elsewhere. This cartel would combine to supply about half of the world’s exportable soybean production and it would be among the top three corn exporters. Cartels traditionally control distribution of inventory and manipulate prices. South America has been known to store other commodities in the past such as sugar and coffee. When supplies are ample, they increase storage to create an artificial tightness and when supplies

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tighten they hold back inventory for higher prices before selling. Regardless of intent, for a cartel to succeed, it needs the power of inventory and this looks to further tighten world stocks. PRICE PROJECTIONS REVISITED In last year’s report (PFGBEST Research Outlook 2010, published in December, 2009), I projected July corn futures to trade to the $5.25 to $5.60 level. They reached $5.28 in late September, then the high of the year at $6.00. I wrote July soybeans would trade to $11.75 to $12.25, prices hit and exceeded in October. July wheat was pegged in our summary to trade to $6.75 to $7.10 and it hit $6.75 July 31 and the high of the year came at $8.70. These projections beat the industry in accuracy. They were by far the most bullish of all analysts surveyed for a Reuters report last January. That is why my report here features more general insight into why I feel grains will reach new highs again this year. Weekly updates are posted online with plenty of ongoing price projections: http://www.PFGBEST.com/services/research/blogs/grain-report.asp.

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L I V E S T O CK OUTLOOK
by Robert Short [email protected] 800-280-4566
OVERARCHING THEMES FOR THE LIVESTOCK AND MEATS COMPLEX • Feed costs should keep livestock herd expansion in check • Cash hogs again to see seasonal highs in spring or summer

• Consumers’ ability to purchase will determine whether 2011 sees new all-time highs in retail beef prices • Cattle futures to again see seasonal, annual Q4 highs in 2011 Most data suggests beef production will decline marginally – about 2.5 percent – in 2011, with pork production up 1.5 percent. Overall, look for total red meat supplies to remain steady, and in line with the markets of 2010. HOGS: SUMMARY OF 2010 MARKET FACTORS After negative hog returns in 2008 and 2009, when the average reported loss was about $20 per head, U.S. producers elected not to increase pork production in 2010. For the first six months of 2010, pork imports into the U.S. were up one percent, and domestic exports increased 7.9 percent. Imports of Canadian feeder pigs for the first six months of 2010 were down 15 percent from 2009 levels. USDA reported on July 1 that cold storage stocks declined 53 percent from 2009 to 413 million pounds. Prices for wholesale pork rose 40 percent from 2009, even though per-capita pork consumption was the lowest since 1997. Consumers were reluctant to pay the higher prices and that is what diminished consumption. Cash hog prices made seasonal, late-spring highs of $55 to $57 the third week in May, 2010. What followed was a normal seasonal break in prices but it was a month or two earlier than usual in 2010. The higher-than-normal price and economic weakness was the reason for the price break coming earlier in the year – consumers exhibited reluctance to pay record high retail prices for their chops, roasts, loins and bacon. Export bookings were also lighter than anticipated during the late spring and early summer. Third quarter 2010 pork exports tumbled to 952 million pounds, off 5.4 percent from 2009. At the same time, Q3 hog imports into the U.S. increased 15 percent from the year before. The combined influence of lower exports and higher imports from July through September 2010 saw pork prices erode 12 percent versus the normal seasonal dip of seven percent. As others have reported in their annual sector summaries, the competitive U.S. dollar, and fasterrecovering world economies versus the U.S. economy, contributed to export reductions and lower hog prices for the latter part of 2010. Fourth quarter 2010 hog pricing continued to decline to the $44 - $47 area. Much of this weakness is blamed on higher hog weights, up some five pounds a head from 2009 weights, attributed to improved new-crop feed corn quality. HOGS: 2011 MARKET CONDITIONS Pork production for 2011 is anticipated to rise very slightly (1-1/2 percent) to 22.6 billion pounds. This small increase is based on expectations of a minimal year-over-year increase in farrowings, litter rates

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and increases in dressed weights due to higher feed costs. USDA forecasts pork exports for 2011 at 4.7 billion pounds, a 4.6 percent rise from 2010, while swine imports from Canada are anticipated to increase just 2.5 percent in 2011. The USDA looks for Q1 pork production in 2011 to come in at about 5610 billion pounds – more or less unchanged from the same period in 2010. Its estimate for Q2 pork production is 5410 billion pounds or a mere two percent above 2010. If corn prices go above $6 in 2011, pork margins could be squeezed enough to keep producers from expanding Q4 production. Hog expansion usually starts five quarters after a return to profitability. With the second quarter 2010 giving producers their first profits in over two years, this model would indicate Q3 2011 hog kills will exceed 2010 levels. Higher feed costs would keep this from happening. Assuming 2011 pork production rises a tad (1-1/2 percent), exports at 21 percent of production, Canadian swine imports not more than two to three percent more than 2010, and continued consumer acceptance of high-priced pork, the normal seasonal trends will apply in cash hogs – prices will decline to annual lows in Q4. Look for a cash hog rise into the middle of February followed by a modest selloff into April before making summer highs. PRICE PROJECTIONS FOR CASH HOGS In Q1, cash hog prices in 2011 should average between $51 and $53. Pricing will vary from $54 to $57 in Q2 and Q3, before breaking to the low $50 area for the last quarter. With current break-evens for hog producers of $50 per head, 2011 should be a profitable year. CATTLE: SUMMARY OF 2010 The U.S. beef harvest rose a modest 2.3 percent in 2010 from 2009. Dressed cattle weights were a bit lower most of the year, and production ended up to be fractionally more for the year (up 0.3 percent) at 25.7 billion pounds. Beef sales for 2010 were running a third higher than 2009 levels at this writing. The increased exports/decreased imports took roughly 500 million pounds of beef production away from the consumer market. That 500-million-pound figure represents approximately one week of U.S. beef production. Per-capital beef consumption during 2010 declined about three percent from 2009 and 2011 will show a further decline of one to two percent from 2010 levels, to 57.8 pounds. High feed pricing is causing the nation’s cattle herd to continue to contract. Beef’s market share has declined from about 34 percent of total red meat consumed in the U.S. in 1990 to a projected 28 percent in 2011. Finished cattle prices averaged $92 in 2007 and 2008 but fell to $83 in 2009 because of recession fears. It appears 2010 average steer prices in Nebraska for the first three quarters (last data available) averaged $93.75. It is possible that when the data is complete, it could show $95, which would topple the record high of $94.27 from 2008. Steer price increases in 2010 centered on two influences – consumers seemed to pay up for high-priced retail beef; and, the cattle feeding industry kept forward sales extremely current. With futures at a discount to cash, it became easy for cattle feedlots to sell their cattle and thereby cover their hedges for a nice profit. As cash cattle prices advanced, beef packers had to price boxed beef higher. In the chain of events, grocers paid up for boxes, and had to raise prices to their retail consumer. Retail beef prices now average $4.37 a pound. This is an all-time high and 14 percent above the 5-year average of $3.84 a pound. At the present time it appears retailers are happy with their narrowing beef profit margin, and beef consumers continue to buy high-priced beef.

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STRONG FUNDAMENTALS IN PLACE FOR 2011 IN BEEF High feed prices will keep cattle prices strong for years to come. We will continue to see the numbers of cows slaughtered at high levels compared to the demand base. Importantly, heifers will be a higherthan-normal percent of daily slaughter. If heifer retention does not begin in 2011 or at least by 2012, we can expect beef production to be steady or decrease through the next several years. U.S. beef production is presently forecast at 25.1 billion pounds for 2011. This would be a 600 millionpound reduction from 2010 (down 2.3 percent.) Exports are forecast at 2.2 billion pounds, 300 million pounds less than in 2010. Beef and veal imports are forecast at 2.8 billion pounds with exports of 2.2 billion pounds. This gives us a beef trade deficit of 600 million pounds. The U.S. generally runs a deficit in this, and the forecast for 2011 year shows one of the smallest deficits in the past ten years. Beef exports will show the first decline, year-on-year, since 2004, and this decline comes from a tightening domestic supply, not lack of international interest. USDA is forecasting a 590 million pound reduction in 2011 beef tonnage and a 430 million pound increase in pork production. CATTLE AND BEEF PRICE PROJECTIONS Commercial beef production will increase approximately 2.6 percent from Q1 to Q2 but that could be bullish, since the normal 5-year average is more like eight percent. Assuming consumer disposable income allows continued high-priced retail consumption and the corn market can stay under $6.25 per bushel, cattle prices should stay between $96 and $99 during Q1. Prices through Q2 should average $99 to $103. Then, for Q3, a normal seasonal decline would project pricing between $95 and $98. The last quarter of 2011, I foresee a seasonal increase to between $97 and $102 barring extraneous developments. Expect the cattle futures market to remain volatile as traders watch beef retail demand, feed pricing and stock indices.

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S O F TS OUTLOOK
by Robin Rosenberg [email protected] 800-611-6974
OVERARCHING THEMES FOR SOFTS • Increasing demand as world population and wealth expands • Weather in growing regions is always a wild card The bull moves in the soft commodities could very well just be getting started. We are entering a time unlike any we have witnessed in the past. The increase in demand for these commodities from the world’s mushrooming middle classes along with a steady increase in the world’s overall population are straining Mother Earth’s ability to provide more of these physical commodities. COFFEE Coffee drinking is on the increase everywhere in the world, and consumers are purchasing high quality coffee. Price is not a deterrent. Many coffee producing countries have or will be allocating large amounts of government capital to increase production and consumption. Brazil is the world’s largest coffee producer. Here is the kicker: 50 percent of Brazil’s crop is of poor quality. Coffee prices have risen 50 percent in 2010. I would not be surprised in the least if coffee futures rise to the $3-a-pound level in 2011! COCOA The main crop harvests are taking place at this moment. Weather conditions in cocoa growing areas could not have been much better. Bountiful supplies have been expected and priced in, and that is what we got. With all of this supply, we have a cocoa market that continues to exhibit price strength. Although supplies are abundant, it is reported that any cocoa for sale is being bought up as soon as it is available. Cocoa prices are affected greatly by macroeconomic conditions. Chocolate is a luxury item and it is among the first grocery items to be axed when money is tight. Demand, however, looks to be greater than supply. This scenario can only play out one way. Look for higher cocoa prices in 2011, as long as the entire world economy is not in a downspin. COTTON Cotton has been in one rip-snorting bull market! Opening at $75.90 per cwt in 2010, cotton futures traded as high as $157.23 during the year. Although the cotton contract we trade is 100 percent U.S. grown, worldwide production affects our market. The 2010 U.S. cotton crop was a bin buster. Other global producers were not so lucky. Major flooding damaged the cotton crops of China, India and

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Pakistan. The U.S. made up the difference. We have exported 85 percent of the USDA’s export estimate in a marketing season that began October 1, 2010. If exports continue at this torrid pace, domestic supplies of cotton will run out before the 2011 crop is harvested. The last USDA inventory report was bullish, as U.S. cotton stocks were lowered by 200,000 bales. Higher cotton prices in 2011 are in the cards! SUGAR Sugar production this season was expected to bring a surplus, following the supply deficit in 2009. In February of 2010, sugar reached a high of 30.40 cents per pound. A break of mammoth proportions followed. Sugar traded as low as 13 cents in May! Then, the first hints relating to the overall world crop size began to surface. As the growing season progressed, several catastrophic weather events took hold. Drought, and fires related to drought, took place in the Russian sugar beet regions. Heavy rains caused flooding in China, India and Pakistan, damaging large sugar acreages. Needless to say, the surplus flipped and became a deficit. This pushed sugar prices to a 20-year high. Nothing short of a banner growing season worldwide will pressure current prices. POSSIBLE SURPRISES FOR 2011 THAT COULD BE OF CRITICAL IMPACT A large increase in supply would see the softs reverse and head lower. The amount of tillable acreage is limited. Mother Nature, once again, is the wild card. Weather conditions will make or break a crop. The La Nina phenomena present in the equatorial Pacific Ocean can negatively affect tropical commodity production; drought or heavy rains could again wreak havoc on all soft commodity crops.

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PFGBEST Research respects the input and dialogue that we have built with our customers! Please feel free to call any analyst here to discuss the markets, to open an account, to help create a particular trading strategy, or to learn more about their evolving market outlooks and summaries. These research analysts and others, along with a variety of daily market commentaries, can be accessed at www.pfgbest.com/research. To increase our two-way communications with experienced and new investors and traders, PFGBEST offers a series of webinars including routine market outlooks. You can view archived webinars on the topic of your choice, or participate in live educational events all year long. Log on to www.pfgbest.com/webinar. To learn more about PFGBEST managed commodity futures and forex accounts designed for portfolio diversification, our staff of professional trading advisors will help customize your portfolio and craft your trading strategy. Call 888.706.0124.

800.333.5673 www.pfgbe st.com

The outlooks provided herein represent the professional opinions of the PFGBEST Research analysts and should not be construed as statements of fact. There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products. Past performance is not indicative of future results.

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