Itaú BBA - Enjoy the party, for now

Commodities Monthly Report

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Enjoy the party, for now

January 18, 2017

Positive outlook for commodities in the short term. But we expect metal and energy prices to decline with China's slowdown.

For the full report, see enclosed file

• Commodity prices have continued to rise since late November, driven by strong global economic indicators and signs that OPEC members are complying with the deal to cut production.

• The short-term outlook may be bullish for commodity prices, given that China’s economy is likely to remain stable in 1Q17 and that the oil market may still fully adjust to the supply cut.

• Nonetheless, we expect metal and energy prices to decline throughout 2017, due to slowdown in China (particularly in metal-intensive sectors) and stronger supply.

The Itaú Commodity Index (ICI) has risen by 7% since the end of November, driven by increases in its three components – agriculture (5%), metals (5%) and energy (9%) – as global economic activity sustains a strong pace. Moreover, signs that OPEC members are complying with the deal to cut production supports the view that global oil balance shifted to a small deficit, causing Brent prices to increase by 8% since November 30 (the day the deal was announced).

Looking forward, we expect the ICI to decline by 8% in 2017. The two major drivers are the expected slowdown in China in 2H17 (which particularly affects metal prices) and a supply response from U.S. shale producers that could partially offset the cartel’s cut.

Nonetheless, both factors are likely to take some time to affect prices, and the short term may remain constructive. China’s economy is set to remain positive in 1Q17, and a few months may be needed to see the supply reaction from U.S. shale producers. Short-term prices may therefore continue to be driven by a tight market and, even after the decline, we forecast prices well above the lows registered in early 2016.

Agricultural commodities continue to trade sideways, given that the major increases since the end of November (corn, wheat and sugar) were driven by the reversal of earlier declines. We lowered our price forecasts for coffee (stronger Brazilian crop in 2017) and wheat (recognizing that the current environment of lower premium to corn will continue). Besides coffee and wheat, there were no material changes in the supply outlook, as the La Niña anomaly fades and the crops in South America advance under normal conditions.

Metals: Prices to decline in 2017 on demand slowdown and stronger supply

The ICI Metals has risen by 7.4% year to date, even after a 40% increase in 2016, on both demand and supply surprises. Global demand was stronger than expected, particularly in China, as the government shifted its focus to the short term and metal-intensive sectors accelerated (see chart). Supply was also surprising, with improved rationality from larger producers and capacity cuts in China.

However, Chinese demand growth is not sustainable. There are some signs that China’s growth in 2016 was well above its potential, and therefore not sustainable; these include excessive credit growth, an uptrend in non-food inflation, and rising house prices until September. These factors forced the government to act in 3Q16 (macro-prudential measures to cool down house prices), and will certainly become more of an issue in 2H17 after the political transition is more established.   

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).

We forecast a 16.5% YoY decline in the ICI Metals. In particular, we see iron ore prices falling to USD 55/mt by the end of the year.

Commodities vs. USD: A rare break in correlation

The negative correlation between the USD and commodity prices was broken in 2H16 (see chart), when commodity prices rose at the same time that the USD was appreciating against other currencies.

There is an economic reason for the two causality sides of the correlation. On the one hand (USD > commodities), a strong USD shifts both producer’s supply and consumer’s demand curve, leading to lower equilibrium prices in USD. On the other hand (commodities > USD), higher commodity prices raise the current account surpluses of emerging economies (that are net commodity exporters, on aggregate), leading their currencies to appreciate.  

Demand- and supply-related surprises are responsible for the divergence. We can model commodity prices as a function of the USD (changes vs. other currencies not caused by commodity prices), global demand and supply. Despite a stronger USD, global demand rose throughout 2016 (beating expectations), and several supply shocks are bullish for prices (OPEC deal, capacity cuts in China, higher supply discipline among iron ore producers, etc.).

Past data (following chart) shows three periods with a similar break: between ‘92 and ‘94, between ’99 and 2000, and in 2005. Global growth was accelerating during the latter two periods.

Oil: OPEC’s compliance, U.S. shale & global economy to drive prices

Brent prices have remained at around USD 55/bbl since the end of November, while WTI prices rose by USD 1.5/bbl to USD 52/bbl over the same period. The increase in prices was a reaction to the agreement announced by OPEC on November 30.

Supply cuts seems to be advancing in line with OPEC’s announcement on November 30. Non-OPEC members agreed to cut an additional 0.6 mbd on December 9, as signaled by OPEC a few days earlier. The participants of the coordinated cut seem to be complying with the deal, which is in our view enough lead to a small deficit in the global market in 1Q17.

Looking forward, we see three drivers for prices. Besides the global macroeconomic outlook, the market will react swiftly to signs of (non-)compliance with the deal and the pace of investments in U.S. shale.

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

Grains: Favorable weather & strong demand

Corn, soybean and wheat prices have risen by 6%, 1% and 12%, respectively,since late November. Nonetheless, corn and wheat have traded within a narrow range since mid-September, while soybean prices have trended upward over the same period.

Prices remain well behaved due to an absence of supply shocks – crops in South America are performing close to expectations, and strong external demand in the U.S. has prevented surpluses in the country to lead to lower prices. 

We lowered our YE17 wheat price forecast to USD 4.4/bushel from USD 4.7 due to our expectation of a lower premium to corn this year.

Our scenario for these three commodities is close to current levels until year-end. Our YE17 forecasts are:

  • Corn: USD 3.6/bushel
  • Soybeans: USD 10/bushel
  • Wheat: USD 4.4/bushel

Our scenario assumes that La Niña will fade throughout 1Q17 and will be followed by neutral weather. The anomaly would therefore end before affecting the next crop in the Northern Hemisphere or the winter corn crop in Brazil.

Sugar/Coffee: Lower coffee prices on stronger estimates for Brazil’s crop

International contracts for raw sugar and coffee have risen since the end of 2016, partially reversing earlier losses. Sugar prices have risen by 5%, to USD 0.2052/lb, while coffee prices have risen by 9% over the same period, to USD 1.49/lb.

Notwithstanding the recent increase, we lowered our YE17 coffee price forecast to USD 1.55/lb (from USD 1.70), following upward revisions of Brazil’s 2017 crop estimates.

We expect sugar prices to average USD 0.215/lb in 2017. We estimate a deficit of 3.6 million tons in the 2016‑17 crop year (after a deficit of 10 million in 2015‑16), followed by two consecutive years of surpluses that lead to lower prices in 2018.


Artur Manoel Passos, CFA


For the full report, see enclosed file


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