Itaú BBA - Have prices reached the bottom?

Commodities Monthly Report

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Have prices reached the bottom?

December 3, 2015

Driven in part by an adjustment in the oil market in 2H16, we forecast a small recovery in commodity prices in 2016

For the full report, see enclosed file

• We forecast a slight recovery in commodity prices in 2016, driven by oil and its indirect impact on other commodities.

• Three factors support our scenario: adjustment in the oil market in 2H16, capacity cuts in China and still-robust growth in demand for agricultural commodities.

• We revised our price forecasts downward for metals (incorporating the recent drop) and soybeans (greater supply from Argentina).

Commodity prices fell further in November, as the Itaú Commodity Index (ICI) dropped 6.4% during the month.

We revised our 2016 price forecasts downward for metals and soybeans. The revision for metals incorporates the recent drop and the absence of factors to drive a recovery. The revision for soybeans was caused by and outlook for greater supply of the product due to new policies in Argentina. The net effect is a drop of 2.2 percentage points in our YE16 forecast for the ICI.

Our scenario assumes a 10.5% increase from current levels by YE16, driven by a partial recovery in oil prices. The increase is small compared with the overall decline since 2012, but it may be enough to improve the terms of trade for commodity exporters and ease deflationary pressures in advanced economies (and China).

After three years of declines, what factors led us to forecast a partial recovery in 2016? 

First, the drop in oil prices will cause additional reduction in fixed investments in the industry, reinforcing the outlook for a decline in supply leading the market to equilibrium in 2H16. A rebound in oil prices affects costs (and prices) of metals and agricultural commodities.

Second, China will likely continue to reduce excess capacity, removing supply from the market.

Finally, demand for agricultural commodities continues to grow strongly, and weather issues may resurface after two favorable years in aggregate terms.

Recent developments: The demand factor explains divergence between agricultural commodities, metals and energy

The drop in commodity prices in November is still a reflection of excess supply for several products and of the spillover effect of lower oil prices on overall production and transportation costs. Metal and energy prices fell more sharply (-8.9% and -7.6%, respectively), while the ICI-Agriculture index did not drop as much (-3.5%).

Recent performance extends the pattern seen throughout the year. Metal prices dropped more steeply (-32%) than energy (-20%) and agricultural prices (-11%).

In our view, differences in demand patterns are behind the divergence among the components. While supply growth is common to these commodities, their demand patterns are different.

The drop in commodity prices in November is still a reflection of excess supply for several products and of the spillover effect of lower oil prices on overall production and transportation costs. Metal and energy prices fell more sharply (-8.9% and -7.6%, respectively), while the ICI-Agriculture index did not drop as much (-3.5%).

Recent performance extends the pattern seen throughout the year. Metal prices dropped more steeply (-32%) than energy (-20%) and agricultural prices (-11%).

In our view, differences in demand patterns are behind the divergence among the components. While supply growth is common to these commodities, their demand patterns are different.

Demand for metals, which is more deeply correlated with the cycle in infrastructure investments, shows a sharper deceleration, influenced by the economic slowdown in China.

Demand growth for agricultural commodities, which is structurally correlated with household income in emerging countries, remains robust. Importantly, the slowdown in Chinese GDP is not affecting household income levels. Meanwhile, the pickup in economic growth in India affects segments of the population whose income is highly sensitive to food consumption.

Oil demonstrates a halfway case in terms of demand. Consumption growth is partially explained by the investment cycle and partially by growing income in emerging countries.

Oil: Equilibrium in 2016?

Oil prices declined again in November, with Brent sliding to USD 45/bbl and WTI to USD 43/bbl.

Price weakness is a consequence of excess suply. With OPEC output greater than last year and stability in aggregate production ex-OPEC, the market remains unbalanced, as OECD inventories are 300 million bbl above the seasonal pattern.

Without a coordinated reaction by OPEC, prices will remain under pressure until mid-2016, when a new cycle of investment reductions in the industry may finally lead to equilibrium.

In our scenario, excess supply will last until 2H16, sustaining the downward pressure on prices in 1H16. We expect Brent prices to fall further, to USD 42/bbl by the end of 1Q16.

We forecast a recovery starting in 2Q16, with Brent reaching USD 55/bbl by YE16, as an adjustment in supply (through a reduction in investments) and further increases in demand balance the market.

We continue to see balanced risks in the scenario, with storage bottlenecks possibly leading to further price drops and the geopolitical situation possibly leading to sharp price increases. Reasonable scenarios may drive prices down to USD 30/bbl or up to USD 90/bbl.

Metals: Further declines reinforce challenging scenario

Metal prices hit new lows in November, reinforcing a challenging scenario going forward. Iron ore prices fell to USD 44/ton from USD 50/ton, while copper prices slid to USD 4,550/ton from USD 5,110/ton, with both approaching their respective five-year lows. Prices for aluminum, lead and zinc — products whose demand is also associated with consumer-related industries — remained relatively stable. All in all, our metals index is down by 32% year to date.

We revised our forecasts downward for metal prices in 2016. Our new estimates incorporate a worse short-term outlook and a modest recovery due to an unfavorable situation for global demand and growing efficiency gains for the main global producers — particularly for the commodities that are most affected by the economic rebalancing in China, such as iron ore and copper.

Adjusted YE16 forecasts:

- Iron ore: reduced to USD 42/ton from USD 50/ton

- Copper: reduced to USD 5,000 from USD 5,150/ton

- Aluminum: maintained at USD 1,550/ton

- Zinc: maintained at USD 1,800/ton

- Nickel: reduced to USD 9,000 from USD 9,450/ton

- Lead: maintained at USD 1,700/ton

- Tin: reduced to USD 14,065/ton from USD 14,300/ton

Grains: Duration and intensity of El Niño will set the tone for 2016

International prices (first due date) for corn, soybeans and wheat fell again in November, by 4.3%, 1.7% and 6.2%, respectively.

The global balance for 2016 remains relatively loose, with high inventories for the three commodities and expected excess supply of soybeans and wheat.

We maintained our YE16 forecasts for corn (USD 4.0/bushel) and wheat (USD 5.3/bushel) but lowered our call for soybeans, to USD 8.8/bushel from USD 9.1/bushel, because of expected greater availability of inventories from Argentina.

The main risk factor for 2016 is the duration and intensity of El Niño. Two months ago, the weather pattern was expected to wane during 2Q16, but the median of the latest forecasts suggest that El Niño will only end in 3Q16.

Our price scenario is consistent with the impact of insufficient rainfall in Northeastern Brazil and in Oceania, but without aggregate crop losses thanks to excess rainfall in Southern Brazil and Argentina, and no problems with the next crop in the Northern Hemisphere. 

If El Niño affects planting of the next crop in the  Northern Hemisphere (due to a drought in Asia or excess rainfall in the U.S.), the scenario will change and agricultural prices may rise despite high inventories.

Sugar: Accommodation at a higher level

International sugar contracts remained close to USD 0.15/lb in November. The futures contract with the first due date is trading around $0.149/lb in New York, much higher than the USD 0.104/lb low seen in mid-August.

Sugar still trades at a high premium over hydrous ethanol in Brazil. In principle, this situation favors increased usage of sugarcane crops for sugar production, but excess rainfall in the final period of the harvest in the Center-South region prevents a relevant adjustment.

We maintained our international price forecast at USD 0.149/lb (2016 average), after having incorporated last month the current deficit in the crop-year and the expectation that prices will likely remain high to encourage greater production going forward.

Coffee: Neutral balance amid upward and downward drivers

International coffee prices (first due date in New York, Arabica) remained between USD 1.12/lb and USD 1.22/lb, showing little reaction to exchange-rate depreciation in major countries.

Our YE16 forecast for coffee stands at USD 1.28/lb, close to the futures curve. This level seems to provide a good balance between downward drivers (favorable weather in Brazil and higher prices denominated in local currency in the biggest producers) and upward drivers (risk of crop losses in Central America).


 

Artur Manoel Passos

Pedro Schneider

Ivan Lasaro


 

For the full report, see enclosed file


 


 



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