Itaú BBA - Forecasts Revised Upward Due to Geopolitical Risk

Commodities Monthly Report

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Forecasts Revised Upward Due to Geopolitical Risk

May 6, 2014

The Itaú Commodity Index (ICI) has risen 1.0% since the begnning of April

• We revised our forecasts for the Metals and Energy sub-indexes upward, assuming that the situation in Ukraine will continue to affect prices until 2015.

• Delays in corn planting in the U.S. worsen the balance of risks for grains.

• Slowing growth and stricter rules in China are leading to lower iron ore prices.

The Itaú Commodity Index (ICI) has risen 1.0% since the begnning of April, driven by higher agricultural, base metal and natural gas prices. Meanwhile, oil-related prices are stable and iron ore prices resumed the downward trend. Besides strong demand and the weather-related issues discussed in previous reports, the gains in agricultural prices can be attributed to delayed corn-planting in the U.S. (due to unfavorable weather). Renewed concerns about the situation in Ukraine are affecting not only grains, but also nickel and natural gas prices.

Divergence among the different commodity classes in 2014. The breakdown by commodity class (agricultural, metal, oil-related) shows a divergence in the year-to-date performance measured by our commodity sub-indexes. Agricultural prices have risen 18.2% YTD, due to supply losses related to unfavorable weather, strong demand (particularly for soybeans and corn) and the low price levels at year-end 2013. Oil-related prices are practically flat, dropping 0.6% YTD, with higher natural gas and WTI prices, and lower Brent prices. Finally, metal prices dropped 12.1% over the same period. The drop in iron-ore (discussed above) explains most of the performance in the metal sub-index.

We revised our year-end forecasts for the metals and energy sub-indexes upward, considering that fears of sanctions against Russia will continue to add “geopolitical risk” to prices until 2015. We now expect the ICI-metals to drop 11.8% yoy and the ICI-energy to drop 2.3% (previously -12.4% and -3.2%, respectively). The delayed corn planting in the U.S. increases the probability of a significant crop loss, but do not change the base case of yields in line with the long-term trend. Hence, we maintain our year-end forecast for the ICI-agricultural (+9.5% yoy). The adjustments in metals and energy prices cause the ICI to drop 1.4% yoy instead of 1.9%.

Growth slowdown and tighter regulation in China are leading to lower iron ore prices. Iron ore prices have fallen 21.0% year-to-date to USD105/ton, -8.1% since mid-April. The slowdown in China is consistent with a deceleration in steel-production growth, leading to an equivalent deceleration in iron ore demand. In addition, there are rumors that the authorities in China are tightening rules, to prevent iron ore imports being used only as collateral in order to obtain loans. Besides, current prices are still well above break-even costs for the main suppliers. In sum, the drop is consistent with fundamentals and we forecast an additional drop through 2014 to USD 101/ton.

Agriculture: El Niño becomes more likely

Corn prices retreated from their recent highs due to the possible window for planting corn in the U.S. Futures contracts for corn (due in July 2014) dropped 4.5% from their recent high. The slide was driven by forecasts indicating no more rainfall in producing regions in the U.S., enabling shorter delays in planting. Despite the delays that have already taken place, we maintain our year-end forecasts at USD 5.0 per bushel. The rationale is that delays hurt the balance of risks but do not change the basic scenario of crop yields, which are in line with their long-term trend. The current winter crop in Brazil is an example of delayed seeding that is evolving favorably. Although planting took place later, weather conditions have been favorable and, so far, plant development has topped expectations.

Soybean prices remain high, reflecting a tight balance in the U.S. until the next crop. Recent figures reinforce the outlook for a tight transition to the next crop-year, with low inventory levels. First of all, the pace of soybean crushing in the U.S. remains intense. Secondly, net cancelations of contracted exports have been insignificant compared with the difference between contracts and the current scenario contemplated by the U.S. Department of Agriculture. Finally, eventual planting delays would also postpone the availability of the next crop, making the transition even tighter.

Sugar and coffee prices are set to rebound. Normalization of weather conditions in producing regions in Brazil is alleviating concerns about sugarcane and coffee crops, leading to recent price declines for both commodities. Dry weather is helping the sugarcane harvest in the Center-South. However, we understand that the recent weather situation will not be enough to offset losses caused by the drought in January. We expect production in Brazil to be smaller than the market is pricing in and to lead to deficits in the global balances for both commodities. We thus continue to expect increases for coffee and sugar prices ahead, to USD 0.22/lb. and USD 0.195/lb., respectively.  

Probability of El Niño weather pattern increases; additional upside risk for sugar prices. According to the National Oceanic and Atmospheric Administration (NOAA), the probability of El Niño starting around June is higher than 50%. If the pattern materializes, there should be less rainfall in Asia and more rainfall in the Center-South region of Brazil. Sugar output would get a double whammy: higher-than-average rainfall in Brazil would hinder the sugarcane harvest, while dryer monsoons in Asia would reduce yields in the 2014/15 crop in India and Thailand, causing additional upside pressures on international sugar prices.

El Niño may also affect the other agricultural commodities, depending on its intensity and timing. Usually this weather pattern is unfavorable for agricultural production in Asia and favorable in the Americas, but that depends on its timing. If it peaks during planting or harvesting, output could be hurt even in the Americas.

Artur Manoel Passos

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