Itaú BBA - Gains in agricultural and oil prices are consistent with fundamentals

Commodities Monthly Report

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Gains in agricultural and oil prices are consistent with fundamentals

June 8, 2016

Iron ore prices have fallen since late April. We expect the slide to continue.

For the full report, see enclosed file

• Iron ore prices have fallen since late April because excess short-term demand has receded, as have expectations of an economic rebound in China. We expect the slide to continue.

•  We have increased our YE16 forecast for sugar prices by 15%, to USD 0.175/lb, and we expect a much lower correlation with the Brazilian currency going forward, given the likelihood of falling global inventories.

•  The main risks to the scenario are tilted to the upside for agricultural prices and to the downside for metals prices. For oil prices, the risks are balanced between upside factors (a faster adjustment) and downside factors (an early return of supply disruptions).


The Itaú Commodity Index diverged from its upward trend in May, dropping by 1.3%, dragged down by falling prices for iron ore (-26%) and base metals (-7%). The decline in non-precious-metals prices is in line with a repricing move in response to dampened expectations of a pickup in economic growth in China, following disappointing economic figures in April. In addition, iron ore prices had increased earlier due to a short-term squeeze that is already fading.

Oil and agricultural prices sustained their upward trend in May due to better fundamentals, notwithstanding a stronger USD (see chart). The ICI-Agriculture and ICI-Energy sub-indexes climbed by 5% and 3%, respectively. In both cases, the supply and demand balance is moving toward a deficit after two to three years of excess supply.

Higher price forecasts for sugar and lower estimates for base metals. We have raised our price forecast for sugar by 15%, as we believe that falling inventories will break the correlation between the commodity and the BRL, keeping international sugar prices far above the ethanol equivalent in Brazil. On the other hand, we have lowered our YE16 price forecast for base metals by 1%.

Our YE16 price estimates remain the same for Brent crude (USD 55/bbl) and iron ore (USD 42/t). 

Our forecasts imply a gain of 4% for the aggregate ICI by year-end from end of May levels. Our scenario for YE16 assumes additional gains in energy prices (11%), stable agricultural prices and falling metal prices (-2%), compared with late-May levels.

Upside risks for agricultural prices, neutral risks for oil and additional downside risks for metals. Despite recent upward revisions in our price forecasts for corn, soybeans and sugar, prices may go even higher in response to the slide in inventories. Risks for metals prices are still tilted downward, given the excess supply and concerns about China. Finally, we see balanced risks for oil prices.

Oil: Adjustment continues, propelled by output disruptions

Oil prices have been on the rise since late April. In addition to the adjustment in the U.S., where output is still falling and investments have not resumed (see chart), output disruptions in Canada, Nigeria and Libya have further restricted supply. Even with a new output increase in Iran, global excess supply continued to shrink during the quarter.

OPEC’s biannual meeting in June ended without an agreement, and the decision had little impact on prices. This outcome was expected, given the lack of cooperation between Saudi Arabia and Iran and the fact that prices have been climbing even without a coordinated adjustment in production.

In our view, prices will continue to rise as excess supply vanishes by mid-2016. Our YE16 scenario for Brent stands at USD 55/bbl. A quick output rebound in several countries could temporarily drive prices downward, however. The discussion going forward is likely to involve the response of shale oil production: what price of oil would be needed, how long a rebound would take to develop and how intense it would be.

Grains: Upside risks

Corn and soybean prices continued to rise in May. Futures contracts for year-end delivery of corn and soybeans climbed by 3% and 5% during the month, respectively, and extended their gains in early June. Wheat prices also increased, but underperformed peer commodities, in line with the still-loose global balance.

The gains in grain prices are being driven by the prospect of falling inventories (even under normal weather conditions) and by the risk of an earlier arrival of La Niña. Expectations of falling inventories were reinforced by the first estimate released by the U.S. Department of Agriculture for the global balance in 2016-17. Furthermore, the market has been pricing in risks of a quicker transition to a La Niña weather pattern, which would affect crops in the United States.

Our scenario assumes a transition to La Niña only toward the end of the year, affecting the next crop in the Southern Hemisphere but having no impact on the current U.S. crop.

Thus, we maintain our YE16 price forecasts for corn (USD 4.0/bushel), soybeans (USD 10.0/bushel) and wheat (USD 5.10/bushel), with prices falling from current levels as the risks associated with an early La Niña do not materialize.

However, we see upside for prices if the La Niña risks do materialize or if the market demands higher prices to adapt to lower inventories.

Sugar: A break in the correlation with the Brazilian currency

International contracts for raw sugar soared in May, gaining 8% (to USD 0.175 from USD 0.161/lb), and extended their gains in early June. 

The upward move reflects ongoing changes in the global balance, which is shifting to a deficit after five years of excess supply. We forecast a deficit of 9.7 million tons in the 2015-16 crop year and a deficit of 4.9 million tons in the 2016-17 crop year (April-March).

The correlation between sugar prices and the BRL ceases to be relevant when the global balance shifts to a deficit. The table below shows the correlation between daily fluctuations in sugar prices (due in July and October) and the Brazilian currency over the past five years, while the subsequent graph shows equivalent producer prices. The data in the table show no BRL-sugar correlation in 2016, while the graph suggests that the correlation with the exchange rate is strongest exactly when the market has excess supply. Given the capacity of Brazilian mills to switch production between sugar and ethanol, ethanol prices in Brazil act as a floor on sugar prices, resulting in the observed correlation pattern.

We have increased our YE16 sugar price forecasts by 15%, to USD 0.175/lb, incorporating the transition to a deficit and the break in the correlation with the Brazilian real.

We still see upside risks to sugar prices, given current prices (USD 0.19/lb). However, an excess of long positions by hedge funds may have magnified the move, and a correction may take place soon. It is also possible that the market is still underestimating the possibility of mix changes in Brazilian production (i.e., sugar vs. ethanol).


Artur Manoel Passos
Ivan Lasaro


For the full report, see enclosed file

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