Itaú BBA - General Decline

Commodities Monthly Report

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General Decline

November 1, 2012

Fading global optimism and higher supply led to falling commodity prices.

Fading global optimism and higher supply led to falling commodity prices.

Most commodity prices fell in October, as optimism about higher monetary stimulus in the G3 lost strength. The strongest decline (7% MoM) came from the metal complex, after September’s 10.6% price increase. Energy prices also fell by 1.8%, due to both higher supply and lower demand growth prospects. Grain prices continued to fall, with markets pricing in the better-than-expected supply number in the U.S.

We are adjusting our forecasts for the Itaú Commodities Index (ICI) in order to accommodate lower year-end grain prices, given the latest better-than-expected supply numbers for the 2012/13 U.S. crop. We now expect an increase of 19.2% in 2012, from 24.6% previously and a decline of 7.6% for 2013, from -9.6% previously.

Investors continued reducing positions in the grain market, but the movement lost strength. On the fundamentals side, grain prices were negatively affected by better–than-expected supply numbers published in the USDA’s (United States Department of Agriculture) October report. With the final numbers of the U.S. crop now released, the focus should turn to the demand side of the equation and also to the progress of the South American crop.

Metal prices gave back most of the gains registered in September, as the optimism with the QE3 announcement in the U.S. faded and the stimulus package in China failed to produce higher growth forecasts. Metals demand is failing to show a meaningful recovery as expected in the beginning of the year, which, given the expected supply gains for the coming quarters, could produce a surplus in 2013. Iron ore price contracts for the quarter fell from $154 per ton to $122 per ton, a value much closer to current spot prices and consistent with the industry marginal cost.

Crude Brent prices fell back to slightly below $110 (measured by December Futures) after reaching $115/bbl by mid-October, reflecting revised expectations of a slightly looser global balance. We maintain our year-end oil price forecast at $112/bbl in 2012, and expect prices to be heavily affected by the evolution of the fiscal cliff in the U.S. and the political situation in the Middle-East. We are revising our forecast down for the end of 2013, to $115/bbl from $116/bbl, reflecting a slightly lower global growth.

Grains: Adjusting the Balance 

Grain prices fell nearly 7% MoM in September, negatively affected by high selling flows in the cash market and reduction of speculative positions. The adjustment continued in October, albeit at a slower pace, with average prices falling 1.5% MoM. With the harvest in the U.S. nearly over and an improvement in market positioning, we believe that prices will resume the upward trend in the coming months.

The USDA’s October report brought the final numbers for the 2012/2013 U.S. crop. Soybean production should be 7.5% below 2011/12 and above our forecast of a 13% decline. Corn production fell 13.4% YoY, in line with market forecasts and above our initial estimate of a 20% YoY decline. Given the better-than-expected supply numbers we revised our year end price forecasts downward. Despite these adjustments, our forecasts are still above current market prices and we maintain our call that the extremely tight balance should propel prices higher in the coming months. 

Soybean prices suffered the deepest decline among grains. Higher perceived supply of palm oil, the main substitute for soy oil in Asia, was the main reason for the correction of soybean prices, which was further stimulated by a higher supply of beans in the U.S. The USDA revised the initial stocks of soybeans in the U.S. by 1 million tons and also increased both the yield and harvested area for the 2012/13 crop. Combining both effects, the USDA forecast for total supply increased 7.2 million tons in the October report, an increase of 9.5% from the previous release. Despite the revision, supply still is 8.5% below the 2011/12 levels and demand was revised upward, more in line with our estimates of 80 million tons, maintaining year-end stocks at 4.2% of use, which is only two weeks of consumption. Given the higher-than-expected supply numbers, we decreased our year-end price forecast to 1750 cents/bushel from 1800 cents/bushel, but still above the current 1560 cents/bushel market price. A successful Brazilian crop should help to bring prices downward, starting in the first quarter of 2013. 

Corn balance adjustments were different from soybeans, but led to a similar outcome. Both initial inventories and production estimates were revised downward in the October report. Total supply estimates fell 5.44 million tons, 1.8% below September’s values and 13.3% lower than last year. While supply shrank, current demand is matching the USDA’s pessimistic forecast of an 11% YoY decline. Not only exports are running at record lows, but also domestic consumption. Cattle placement in feedlots, which are a proxy for feed corn demand in the U.S., was only 81% of the level reached in 2011 by this time of year, signaling a significant decline in demand.

We maintained our year-end corn price forecasts at 850 cents/bushel for 2012 and 638 cents/bushel for 2013, but the return should happen only in the second half of 2013, with confirmation of a good crop in the U.S. Unlike soybeans, for which Brazil and Argentina can replenish global inventories between the U.S. crops, corn exports are much more focused on the U.S.

The World Agricultural Supply Demand Estimates report (released by USDA) effectively ended the supply uncertainty about the U.S. crops; now all eyes should turn to both demand behavior and the South American crop.

Weather: South American Weather Uncertainty

Given the high international grain prices and low global inventories, South American farmers were expected to start the sowing process early. Nonetheless, climate conditions didn’t help this plan: lack of winter rains in Mato Grosso, Paraná and Mato Grosso do Sul prevented the main growers of Brazil from moving the sowing schedule up, while excess of rain in Argentina, Rio Grande do Sul and Paraguay did the same for the southern growing region.

With the normalization of weather conditions in October, plantings started and are now only slightly behind schedule. Normal rains forecasted for the next 15 days should help a healthy crop emergence. While the current normalization of conditions is good news for South American crop, climate risk still exists. Both soybeans and corn crops have two very climate-sensitive periods: one immediately after sowing, when seeds need water for germination and the second when the plant is pollinating and generating the grains.

According to our estimates, this second climate-sensitive phase will happen between the second half of December and January. Do we have any indication about the weather in this period? While meteorologists can predict with a reasonable degree of certainty the weather in the next few weeks, predictions for the next few months carry a much higher level of uncertainty. In the beginning of 2012 it was expected that El Niño was going to be active in the spring and summer of the southern hemisphere, bringing above-average rains and therefore good crop conditions. During the year, the El Niño didn’t materialize as expected, with Pacific Ocean temperatures cooling down. Current forecasts point to a neutral pattern affecting the weather during crop development. Nonetheless, the standard deviation is high.

Therefore, expect a considerable weather risk in the coming months for South American crops.

Beef: Slaughter Rush Should Lead to Lower Supply in 2013

Higher costs are hitting the cattle sector in the U.S. and Brazil. With higher feed-grain prices and lower quality of the U.S. pasture due to the drought that we have seen in the past few months, many producers are reducing their herd. This increases meat supply in the short term while reducing its availability in the future. In this scenario, we expect prices to increase more than inflation throughout 2013.

The U.S., the biggest beef producer in the world, has suffered from a severe drought that not only increased prices of grain used to feed animals in feedlots, but also damaged the quality of the pasture, bringing it to a record low (18percentage points below the five-year average) increasing the costs of the sector. In response, producers are slaughtering more cows than normal, resulting in an increase in the current meat supply. However, the lack of females results in lower herd growth, decreasing future beef supply. Furthermore, recent data from the USDA reported the lowest September cattle placements in feedlots (2 million heads) since 1996 – 19% below September 2011 and 46% below the five-year average. This suggests lower demand for grain-feed and lower beef supply for 2013, and is consistent with higher cattle and beef prices next year. However, higher pork and poultry production may offset part of the price increase.

In Brazil, even though the main portion of the production comes from extensive cattle farming, we also see input cost increasing for domestic producers. In addition, the latest data from IBGE shows a high proportion of cows and calves slaughtered to steers in 2Q12 (above 2011 and the 5-year average in the same period). This supply increase supported the low prices until August. However, record beef exports from Brazil, future stock reduction and the price increase in poultry due the grain shock give room to a scenario with a likely price increase during 2013.

Finally, as a consequence of the cow and calf slaughter in 2012, as well as the expected fall in grain prices after the next crop in South America, we expect a lower cattle supply in 2013. This may lead to higher beef and live-cattle prices throughout the year.

Sugar and Ethanol: Brazil’s Harvest to Recover Next Year

No. 11 raw-sugar prices reached almost $0.22/lb the beginning of October, but returned to levels between $0.19/lb and $0.20/lb. We expect prices to remain around $0.20/lb for a while.

Harvest evolution in Brazil’s center-south region showed a strong output in the region between October 1 and October 15. Mills in the region processed 38 million tons of sugarcane, up 14 million tons from a year earlier. Taking this data into account, we are revising upwards our crop forecast in Brazil’s center-south to 510 million tons, from 500 million tons in the previous report. ATR (Total Recoverable Sugar) yields remains lower than last year and well below historical levels.

With more than 80% of the current crop year (started April 1) processed, the focus shifts to the next season. Given the investment to renew aging plantations, expected neutral weather conditions and large planted area, we expect a crop of 550 million tons in Brazil’s center-south, with ATR yields higher than the previous two years. In this scenario, sugar and ethanol output will be considerably higher.

The government will probably return the ethanol content in gasoline to 25% (from 20%) next year (although the specific month is uncertain). If the content increases by mid-June, anhydrous ethanol will exceed 10 billion liters, 7% above the maximum annual production. The anhydrous production capacity and level of stocks will play important roles in determining whether the sector can meet the demand.

Energy: Slightly Looser Oil Global Balance in the Short Term

We forecast Brent crude prices at $112/bbl by the end of 2012. The two main drivers for prices in the short term are the fiscal cliff in the U.S. and the political situation in the Middle-East. Both drivers will be affected by the outcome of the U.S. elections. For the end of 2013, we are revising downwards our forecast to $115/bbl from $116/bbl, reflecting a slightly lower global growth.

Recently, Crude Brent prices fell back to slightly below $110 (measured by December Futures) after reaching $115/bbl by mid-October. Gasoline prices in the U.S. have fallen roughly 15% since August. This fall results not only from lower crude prices, but also from refineries completing maintenance and weak demand. Even if Crude Brent prices recover to levels around $112, gasoline prices are expected to remain lower than in August and September.

The International Energy Agency’s last Oil Market Report shows a slightly looser global balance, revising down global oil demand between 4Q12 and 2Q13 and revising oil production in 1Q13 upward. U.S. weekly data[1] have also been marginally bearish for crude prices, showing strong production (700 kb/d above the same period in 2011), high crude stockpiles and weak demand for gasoline and distillates.

Recently, there has been no progress with regard to Iran’s nuclear program or Syrian civil war. Iranian crude-oil exports fell back to an estimated 860 kb/d in September from slightly above 1000 kb/d in August. Despite this, the European Union has further tightened sanctions against both Iran and Syria. At first, Iran was willing to resume discussions to suspend its 20-percent uranium in exchange for nuclear fuel provided to a research facility. A few days later, it threatened to suspend all its crude-oil exports. This threat is not credible, as Iran would hurt its economy even more while having little impact on prices. In Syria, the recent cease-fire over a holiday backed by the U.N. failed, suggesting that the stalemated civil war will continue. Following the elections in the U.S, regardless of the outcome, we may see a tougher stance towards Iran and Syria, leading to greater geopolitical risks.

[1]Department of Energy (DOE): weekly data to October 19.

Source: Bloomberg and Itaú.

** The Itaú Commodity Index is a proprietary index composed of those commodity prices, measured in U.S. dollars and trade in international exchanges that are relevant to Brazilian consumer inflation. Its sub-indexes are Metals, Energy and Agricultural.

Giovanna Siniscalchi

Artur Manoel Passos

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