Itaú BBA - Demand for Base Metals Rebounds

Commodities Monthly Report

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Demand for Base Metals Rebounds

January 4, 2013

Despite falling grain and energy prices, base metals led the Itaú Commodity Index (ICI) to increase 0.4% in December from a month ago.

Expectations of a strong harvest in South America are leading to lower grain prices.

Despite falling grain and energy prices, base metals led the Itaú Commodity Index (ICI) to increase 0.4% in December from a month ago. This slight increase was much lower than we expected (4.0%), with the surprise coming mainly from lower grain prices. Reflecting this surprise in December prices, we now expect the ICI to increase 0.8% yoy in 2013 (previous: -4.1%). The revision is mostly due to base effects.

Grain prices extended losses for the fourth month and fell 0.9% in December, negatively affected by expectations of a strong crop in South America and cancellation of soy contracts from China. We expected prices would rebound until March, driven by extremely low corn and soybean stocks. However, major consumer regions seem to be postponing imports, which will likely lead to lower prices throughout 1Q13 than our previous forecasts. We expect the ICI-Agriculture sub-index to fall 1.0% yoy in 2013, after increasing 5.6% yoy last year.

Base metal prices have held to a rising trend since mid-November and are up 6.4% on December over the previous month. This recovery is being driven by the wave of solid economic indicators from China. Taking into account a better outlook for the Chinese economy, we made upward revisions to our 2013 year-end forecasts. We expect the ICI-Base Metals sub-index to increase 5.1% yoy in 2013, after increasing 8.1% yoy last year and falling 17.3% yoy in 2011.

Meanwhile, energy prices averaged 1.1% below November’s average, influenced by less noise about Iran’s nuclear program and by concerns over the fiscal cliff in the U.S. Looking forward, we revised downward our 2013 year-end for Brent crude to $110/bbl from $115/bbl. We expect the ICI-Energy sub-index to increase 2.7% yoy in 2013, after increasing 1.7% yoy last year and falling 22.2% yoy in 2011.

Weather: Outlook Remains Favorable for Brazilian’s Crop, but Risks Remain

Overall weather conditions remained favorable for agricultural production in Brazil through December. The highlight was rainfall exceeding the seasonal average in São Paulo and the southern states (Rio Grande do Sul, Santa Catarina and Paraná). In the Center-West region, below-average rain was not enough to affect soil moisture, which remains adequate. Both regions are the most significant crop-production areas in Brazil, and recent evolution is consistent with soybean and summer corn crops close to current estimates, and well above the last crop year.

A strong crop year depends on favorable weather conditions throughout January. The concentration of the planting period over a short time span poses risks, since a larger proportion of the crop can be affected by adverse weather during a specific period. However, neutral conditions in the Pacific Ocean (no El Niño or La Niña) and a possible weak La Niña by the end of January suggest average rainfall in most producing regions.

In Argentina, heavy rain in November and December led to flooding in key farm areas. Consequently, soy and corn harvests will probably fall short of current estimates by the U.S. Department of Agriculture (USDA). Currently, it estimates crops of 55 million tons and 28 million tons for the current crop season, respectively. Nonetheless, crops should be well above last year (41 and 21 million tons, respectively).

Grains: Prices Falling Despite Lower Stocks 

Grain prices extended losses for the fourth consecutive month, with average prices falling 0.9% in December. Prices were negatively affected by renewed expectations of a strong crop in South America, cancellation of soy purchase contracts by China and an unexpected adjustment to wheat global balance for the current crop year in the USDA’s December Report. Among the three major crops, soybean outperformed corn and wheat, closing December 1.4% below November’s average. Corn and wheat prices closed December 6.7% and 7.9% below November’s average, respectively.

We expected grain prices would rebound until March, driven by extremely low corn and soybean stocks. However, major importers seem to be postponing imports, that should lead to lower prices throughout 1Q13 than our previous forecasts. For year-end 2013, our forecasts for soybean and corn prices remained at 1400 cents/bushel and 638 cents/bushel, respectively. Both forecasts assume crops a bit lower than current estimates by the USDA for the current crop year in South America (our downside bias comes from Argentina) and a recovery in the U.S. crop yields for the 2013-2014 Season.

Soybean prices fell to 1419 cents/bushel as of December 31 from an average of 1439 in November. The USDA’s December Report (World Agricultural Supply Demand Estimate, or WASDE) hardly made any adjustments, as expected. For the current season year, the adjustments were an increase of 0.2 million tons in global demand (less than 0.1%), and decreases of 0.1 million tons in global production and ending stocks. The estimate for Brazil was maintained at 81 million tons, lower than the forecasts made by CONAB (Brazil’s food supply agency). The estimate for Argentina was also unchanged, at 55 million tons. The estimate for Brazil is consistent with weather conditions and estimated planted areas. For Argentina, we expect a slightly lower crop due to unstable weather so far.

Domestic and foreign demand indicators showed a steady demand for the U.S. current soybean crop until mid-December. Domestically, average crushing data (September-November) from the National Oilseed Processor’s Association (NOPA) is 9.5% above the same period in 2011. On the foreign front, an early start and a fair pace of net export sales were interrupted by the cancellation of export contracts by China in the second half of December. This suggests that demand may react to prices above 1500 cents/bushel as the South American harvest is about to begin.

Corn prices fell to 693 cents/bushel as of December 31, from an average of 740 cents in November. The WASDE made some adjustments to non-U.S. supply and demand, but the overall adjustment was neutral. Ending stocks for the current crop year were revised to 117.6 tons from 118 million tons. The estimate for Brazil was maintained at 70 million tons, lower than CONAB’s forecasts. The estimate for Argentina was reduced to 27.5 from 28 million tons. As with soybeans, the estimate for Brazil is consistent with weather conditions and estimated planted areas. For Argentina, we expect new downward revisions due to unstable weather so far. Finally, data since our last report showed the same pattern of slackening demand for the U.S. crop.

Contrary to the weak pace of net export corn sales in the U.S., Brazilian corn exports have been very strong in 2012. Brazil exported 19.8 million tons in 2012, and exports are expected to continue throughout January of 2013. This performance was caused by a combination of factors: a record winter crop in Brazil, lower soybean exports and crop losses in the U.S. Currently, neither of these factors is expected to occur again this year, and corn exports ought to be inside the 15-18 million ton range in the 2013-2014 crop year (March-February).

Freight costs in Brazil may rise due to a new law that limits working hours of truck drivers, and lack of investment in infrastructure. Higher freight costs are partially passed on to international prices and may also widen the discount faced by domestic prices.

Sugar and Ethanol: Adjustments in Brazilian Ethanol Market May Provide a Higher Floor for Sugar Prices

Raw-sugar prices have remained between $0.19 and $0.20/lb since mid-October, trading over a narrower range than from April to September. Average prices in December were 18% lower than one year earlier, reflecting the global surplus since 2011 and the weaker (12.9%) Brazilian exchange rate. We forecast that prices will remain within the $0.19-$0.20/lb range in 2013.

The evolution of the harvest in Brazil’s center-south region showed a strong output since July, beating the previous crop estimates. The sugarcane processed until November reached 510 million tons, up 17 million tons relative to the previous crop but 46 million tons below the 2010-11 season. The harvest may continue throughout December, reaching 520-535 million tons. ATR (Total Recoverable Sugar) yields remained below those of last year and well below the historical levels. Despite the drop in sugar prices in 2012, relative prices favored sugar production over anhydrous and hydrous ethanol. The consequence was another increase in the share of sugarcane used to produce sugar, to 50% from 40% four years ago.

We expect the global surplus to continue in 2013, driven by increasing production (China, Mexico, Australia and Brazil), which will more than offset the demand growth and lower production in India and Thailand. The fundamentals therefore suggest that sugar prices will either remain around $0.19/lb or fall further. Our flat-price scenario is based on two adjustments scheduled to take place in Brazil next year. First, the government will return to a 25% (from 20%) ethanol content in gasoline next year, pressuring anhydrous ethanol prices. Although this adjustment is expected to take place in July, it may be sooner. Second, the Finance Minister has already confirmed that Petrobras will raise gasoline prices. As opposed to last year, we expect the upcoming increase to be passed through to retail prices. Given the size of the flex-fuel fleet in Brazil, higher gasoline prices will raise the floor for anhydrous ethanol. Since prices below the sugar equivalent in ethanol will likely cause mills to produce less sugar, the expected increase in ethanol prices will provide a higher floor for sugar prices.

Live Cattle: Don’t be Mad, It’ll Pass Soon

U.S. live cattle prices outperformed their Brazilian counterpart in the BM&F Bovespa following the announced confirmation of a case of latent Mad Cow disease by the World Organization for Animal Health (OIE) during the second week of December. The cow died in 2010 in Paraná, near Argentina, and showed no symptoms of the disease, which is the reason that it was not tested for Mad Cow disease earlier. Monthly average prices (first future contract) in the U.S. rose 1.0% versus November, while the BM&F fell 2.8%.

As highlighted in our previous report, cattle on feed placements in the U.S. should still be monitored. However, the November placements, reported in December, presented a better-than-expected (albeit still-low) placement environment, partly justified by the drop in soybean and corn prices. Cattle on feed placements are 5.6% below those in November 2011 and 6.7% lower year to date. On the slaughter front, while the reduction in future supply due to the slaughtering of females and young ones had decelerated, it picked up again in beginning of December, indicating that the supply normalization has not yet materialized in the U.S.

In Brazil, there were two major events in December: the 3Q12 cattle-slaughter statistics and the confirmed presence of Mad Cow Disease virus. The IBGE’s slaughter statistics for the third quarter confirmed our suspicions of higher female slaughters, following the same slaughter-rush pattern seen in the U.S. However, demand is not accompanying the higher supply. Following the announcement of Mad Cow disease, nine countries (Peru, Saudi Arabia, China, Japan, South Africa and others) partially or completely restricted their meat imports from Brazil, directly affecting the country’s exports. Daily meat exports during the week after the announcement decreased from 5.6 to 3.8 thousand tons. Nevertheless, we expect the effect to be temporary, and import bans to be removed throughout 2013.


 

In this scenario of a temporary import ban from Brazil, lower meat supply ahead, and steady demand, we expect the average Chicago price in December 2013 to be about 7.6% higher than the same period in 2012.

Base Metals: Optimism on Improved Chinese Demand

Our ICI Metals Index rose 6.4% in December against the November average. Besides the specific fundamental effects of each metal, the entire sector was permeated by a sense of optimism following the new wave of solid demand indicators from China. Among the base metals, iron and tin outperformed the others, rising 25.3% and 7%, respectively, relative to the figures at the end of November. Copper averaged $7971/ton in December, but fell sharply hitting a low of $7753/ton in December 20 and rebounding to $7912/ton by the end of the month, due to rising fiscal cliff concerns.

In December, the International Copper Study Group (ICSG) released the September copper-balance values, which broadened the copper deficit. Nevertheless, we still expect the deficit gap to close (despite steadier Chinese demand), due to a supply increase and lighter Chinese import demand. We believe copper prices will average $8000/ton by the end of 2013.

On the other hand, iron ore prices for delivery in China registered one of the strongest performances and responses to the solid Chinese demand indicators, closing at $144.9/ton on December 31. Further corroborating the price movement and signaling the higher demand, iron ore stockpiles held at the major Chinese ports dropped to the lowest levels in two years. In contrast, iron ore contract prices opened a big discount over spot prices, which are likely to remain at higher levels. We therefore expect suppliers to raise their contract prices as soon as they can. Given our belief that part of this hike will remain, we have raised our iron ore price forecast to $125/ton by December 2013.

Energy: Downward Revision in Crude-Oil Price Forecast for 2013

Brent crude prices rebounded to $111/bbl after falling to $107 in the first days of December.  Despite the perception of lower odds of a conflict between Iran and Israel, signs of improved demand are helping to keep prices well above $105/bbl. Other sources of tension in the Middle East (Iraq’s semi-autonomous Kurdistan regional government stopped oil exports, terrorists were arrested in the United Arab Emirates) are also helping to hold crude prices. Amid the signs of better demand are expectations of a growth pickup in China, a low fiscal drag in the U.S., and better-than-expected oil demand in October (according to the International Energy Agency’s (IEA) last Oil Market Report).

Looking forward, we are lowering our year-end Brent crude forecast for 2013, to $110/bbl from $115/bbl, based on three factors.

First, although the geopolitical risk may rise again, there is no longer a foreseeable trigger for increased tension in the Middle East (like the end of the elections in the U.S. last November). Conversations between Iran and the G5 + 1 (the U.S., UK, France, Germany, Russia and China) may resume in 2013, leading to fewer sanctions and higher oil exports from Iran.

Second, the adjustments for 4Q12 demand do not alter our low demand-growth expectations, consistent with a still-weak global economic performance in 2013. Meanwhile, Brent prices between $105 and $112/bbl are not expected to generate changes in OPEC’s strategy, while non-OPEC production should be able to meet a demand growth of around 0.8 mb/d.

Third, after the negative effect of two years of transportation bottlenecks on WTI[1] crude prices, in the midst of a strong production-growth environment in the U.S., investments to improve the country’s oil infrastructure are expected to bear fruit in 2013. Hence, increased capacity to transport crude oil to refineries is expected to reduce imports, contributing to a less tight global balance. The WTI discount to Brent could also fall, but would require transportation capacity growth to outpace crude production, which did not occur in 2012: WTI traded at an average $22/bbl discount to Brent, as domestic production increased by roughly 1.1 mb/d yoy, more than offsetting the infrastructure improvements.



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