Itaú BBA - Fundamentals support prices

Commodities Monthly Report

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Fundamentals support prices

July 6, 2016

Lower supply and demand growth continue to contribute to the rise in commodities

For the full report, see enclosed file

• Positive fundamentals (with lower supply and robust demand growth) continue to contribute to the rise in commodity prices.

• We revised our soybean and sugar forecasts upward for YE 2016, incorporating an outlook for lower supply.

• We slightly reduced our oil forecasts (Brent crude to USD 52 per barrel by the end of 2016, from USD 55 previously), incorporating the impact of the referendum in the UK (Brexit): lower global growth and a stronger dollar. 

Commodity prices advanced in June (3%, according to our Itaú Commodities Index – ICI), reaching an 18% expansion in the year. Metals posted the best performance for the month, up by 8%. Energy commodities advanced 4% and agricultural commodities closed the month flat from the end of the previous month.

The outcome of the referendum in the UK shows that oil is more affected by macroeconomic shocks in developed countries than metals or agricultural commodities. The ICI-energy fell by 4.1% on June 24, while the ICI-agriculture and ICI-metals dropped 1.0% and 1.3%, respectively. All components recovered in the following days, along with other risk assets.

We revised some of our forecasts for agricultural prices upward and our oil scenario for YE16 downward; metal forecasts remained unchanged. The adjustment in agricultural commodities takes into account crop failures in Brazil and planted acreage reviews in the U.S., factors that reinforce the outlook for falling inventories in the 2016/17 crop year. We adjusted the forecasts for Brent crude to USD 52/bbl (from USD 55/bbl) due to lower growth in advanced economies and the strengthening dollar that followed the Brexit result.

Our scenario is consistent with the ICI remaining constant at current levels ( agricultural and oil prices up by 3%, but metals down by 9%).

Oil: Brexit doesn’t change the equilibrium between USD 50 and USD 60/bbl

Oil prices have been volatile since the result of the United Kingdom referendum. The movements reflect uncertainties about growth and the exchange-rate adjustment in developed countries. Both have a higher impact on energy prices than on other commodities.

Despite the volatility, oil remains close to USD 50 per barrel, reflecting the advances in the sector’s adjustment.

At this price level, there are (very) incipient signs of reaction by U.S. producers. The number of oil-drilling rigs increased in the second half of July, and production increased in one of the two weeks. The movement is small and does not prevent the aggregate drop in production, but it shows that a number of projects/wells have been resumed and are turning profits.

Despite the lack of a relevant reaction so far, we believe that prices between USD 50 and USD 60 could lead to some recovery in U.S. investment (in unfinished wells) and can stabilize the market. The Brexit’s impact on the global economy will not change this equilibrium. We believe that the market consensus has been moving in the direction of this view.

We slightly reduced our price forecasts for YE16 (Brent: to USD 52 per barrel from USD 55, WTI: to USD 50 per barrel from USD 52). The revision incorporates a stronger dollar and some growth reduction in developed countries. Along with high inventories, lower demand reduces the investment necessary to balance the market, which is consistent with slightly lower prices.

Grains: weather and surprises in planted acreage in the U.S. increase volatility

Corn and wheat prices fell by 11% and 7% in June, respectively, while soybeans rose 9%.  

The month of June was marked by two surprises. 

The first was the prospect of a heat wave in the U.S. Midwest (which did not materialize), which caused a temporary increase in the three commodities.

The second was USDA’s planted-acreage review, which did not show the expected migration of planted acreage from corn to soybeans since the planting intention report. Soybean prices rose while corn (and wheat) fell after the report, which was released on the last day of the month.

This latest estimate also indicated that the combined planted acreage for corn and soybeans in the U.S. will be the largest in history (see chart). Hence, the prices observed in 2Q16 are sufficient to continue the expansion of supply. In our view, unfavorable weather is necessary for additional increases.

We raised our forecasts for soybean prices from USD 11.0 per bushel by the end of 2016, from USD 10, incorporating the smaller planted area in the U.S. and the prospect of some area reduction in the next Brazilian crop (shifted to corn and soybeans). We maintain our forecasts for corn and wheat at USD 4.0 and USD 5.1 per bushel, respectively.

Our scenario assumes a transition to La Niña only at the end of the year, affecting the next crop in the southern hemisphere, but with no impact on the current U.S. crop. We also consider weather conditions close to the seasonal pattern in the current U.S. crop.

The domestic balance of corn in Brazil, tight after breaks in the winter crop and a large volume of exports in the beginning of the year, will likely undergo a two-phase adjustment. The first adjustment is taking place with the start of the winter crop, some cancellation of contracted exports and larger-than-usual imports from Argentina. This "phase" led the premium in domestic prices (Esalq in Campinas compared to Chicago prices) to fall by half (to BRL 10.0 per bag from up to BRL 20.0). The rest of the adjustment will likely occur only with the harvest of the next summer crop (chart).

Sugar: even higher prices

International contracts for raw sugar continued to rise in June. The contract maturing in October rose 15% to USD 0.2078 per pound and is already up by 39% this year.

This upward movement also reflects the change in the global balance, which shows a deficit after five years of excess supply. We estimate a deficit of 9.7 million tons in the 2015/16 crop year (April-March) and forecast a deficit of 3.5 million tons in 2016/17, with a rebalancing taking place only in 2017/18.

The correlation between sugar and the Brazilian currency is no longer meaningful when the global balance turns into a deficit. With Brazilian mills’ capacity to switch production (between sugar and ethanol), ethanol prices in Brazil act as a floor for sugar prices – thus the correlation.

We again increased our year-end price forecast, to USD 0.185 per pound from USD 0.175. The information is similar to last month’s (when we increased it to USD 0.175), but recent developments suggest that the market will demand higher prices given the current deficit.

The bias for the scenario remains tilted upward, given the current prices (USD 0.20 per pound). However, the excess of long positions by hedge funds may have exaggerated the movement, and a correction is likely soon. It is also possible that the market is still underestimating the capacity to change the mix (sugar vs. ethanol) in Brazil.


Artur Manoel Passos
Ivan Lasaro


For the full report, see enclosed file

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