Itaú BBA - A correction, not a new downward trend

Commodities Monthly Report

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A correction, not a new downward trend

May 11, 2017

We believe the recent declines in metal and energy prices are a correction and not the start of a new downward trend.

For the full report, see enclosed file

• Commodity prices fell sharply in April, driven by metal and energy prices. We believe the declines in both groups are a correction and not the start of a new downward trend in commodities prices.

• We expect the ICI to gain 2% from its current level by the end of 2017. The increase will mainly stem from higher oil and agricultural prices.

The Itaú Commodity Index (ICI) fell by 5.3% in April driven by metal and energy prices indexes. The former plummeted 12% led by a 22% drop in iron ore price. Meanwhile the latter declined 6% with a correction in oil prices.

We believe the declines in both groups are a correction from previous excess and not the start of a new downward trend in commodities prices.

Firmer global growth limits declines in metal prices. The downside risks to improvement in global manufacturing cycle seem limited at the moment, even with a slowdown in China. If the global Manufacturing PMIs remain close to its current levels metal prices are unlikely to enter a downward trend. This is consistent with our forecast of a 6% decline in the ICI Metals from its current level, with iron ore prices falling to USD 55/mt by the end of the year.

The extension of OPEC’s deal and the decline in U.S. inventories (although from high levels) should provide support to oil prices.  We estimate that the market has reached a small deficit in 1Q17. Even with the extension of OPEC’s deal, we believe the deficit will continue during the year. We maintain our yearend Brent forecast of USD 54/bbl (WTI: USD 52/bbl). 

Finally, the ICI agricultural have remained broadly stable over the same period. Sugar and coffee prices dropped by 8.6% and 2.5%, respectively, due to weaker BRL and better outlook for the sugar 2018/19 crop year. On the other hand, soy and wheat increased 2.8% and 3.7%, respectively.

We expect the ICI to gain 2% from its current level by the end of 2017. The increase will mainly stem from higher oil and agricultural prices.

Metals: China concerns impact iron-ore and copper prices

Iron ore prices declined 30% since the end of February; this movement might reflect sector-specific factors and renewed concerns over the Chinese economy. Indeed, iron ore inventories in China remain at high levels and might explain the recent fall in iron ore prices. We also expect supply increases in 2017, from both big producers and non-traditional players, in response to the current higher-price scenario (vs. the average for 2016).

Copper prices have recently lost some momentum, also driven by a combination of micro factors and China concerns. LME inventory data showed a significant build up in copper inventory in its last print. However, weaker refined supply will likely result in a tighter market for the months ahead, supporting prices at high levels.

Looking ahead, we expect a slowdown in China in 2H17 to continue to impact metals prices. It is important to note, however, that even though year-over-year GDP figures will worsen in 2H17, for commodities it is the demand level that matters most. And, relative to supply, Chinese demand is expected to retreat to a lesser extent through 2017.

We forecast a 6% decline in the ICI Metals from its current level. In particular, we see iron ore prices falling to USD 55/mt and copper to remain stable at USD 5600/t by the end of the year.

Oil: OPEC meeting and declining U.S. inventories to support prices

Brent and WTI prices have dropped by 6.8% and 8.4%, respectively, since the end of March, trading at levels not seen since before OPEC’s November agreement.  The latest movement in prices can be related to high U.S inventories, a follow through from bearish markets for iron ore and copper as well as some withdrawal in technical positioning.

After the recent fall, the upcoming OPEC meeting (May 25th) and the decline in U.S. inventories (albeit from high levels) should provide support to oil prices. In addition, the current decline in oil prices is creating less balance sheet concerns than the fall in 2015/16, implying limited impact for the global economy.

We estimate that the market has reached a small deficit in 1Q17. Given the impressive compliance so far and the expectation of a 6 month extension of the deal at OPEC’s meeting on May 25th, we believe the deficit will continue during the year.

We maintain our YE17 Brent forecast of USD 54/bbl (WTI: USD 52/bbl), a level that would allow for additional production by U.S. producers to partly offset the measures taken by the cartel.

Grains: U.S. producers shifting to Soybean from Corn

Soybean, corn and wheat prices have dropped by 0.8%, 1.0% and 0.5%, respectively, since the end of March.

U.S. farmers shifting to soybean from corn, as expected. According to U.S. planting intentions report, the planted area for soybean will increase 7% yoy. The increase comes at the expense of corn and wheat. Planted area for the two products will decrease 4% and 7%, respectively, from 2016. The shift is consistent with relative prices.

We maintain our YE17 price forecasts for corn (USD 3.75/bushel), soybeans (USD 9.5/bushel) and wheat (USD 4.8/bushel).U.S. farmers shifting to soybean from corn, as expected.

The probability of El Niño-like weather anomaly was slightly reduced but remains our base case. For the U.S. crop production, an El Niño by 2017H2 increases risk of excessive rainfall, possibly delaying/jeopardizing the harvest.

Sugar/Coffee: Lower prices

International contracts for raw sugar and coffee have dropped by 8.2% and 4.5%, respectively, since the end of March.

The recent retreat in sugar prices might be explained by currency pass-through and market technicalities. The BRL appreciation since January and an attempt to anticipate excess supply conditions market (shift from deficit to surplus) have pushed prices lower.

Sugar price levels prevailing in Brazil still keep local mills producing more sugar at the expense of ethanol. However, as sugar prices touch ethanol`s level, the mills may start producing more ethanol than sugar, balancing the supply and rising sugar prices.

We maintain our coffee and sugar price forecasts at USD 1.40/lb and USD 0.18/lb, respectively, in 2017


 

Paula Yamaguti

Laura Pitta


 

For the full report, see enclosed file


 

 



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