Itaú BBA - Higher Agricultural Prices

Commodities Monthly Report

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Higher Agricultural Prices

March 12, 2014

Unfavorable weather in Brazil is driving agricultural commodity prices upward.

•  Unfavorable weather in Brazil is driving agricultural commodity prices upward. Expecting a smaller harvest in the country, we increased our forecasts for year-end sugar and coffee prices. Soybean and grain prices are expected remain higher until the next crop is harvested in the northern hemisphere.

•  The crisis in Ukraine is affecting several commodities, particularly crude oil, natural gas, corn, wheat, palladium and gold.

Commodity prices rise again due to unfavorable weather. The Itaú Commodity Index (ICI) has climbed 0.5% since mid-February, once again driven by higher prices for agricultural commodities (10.3%) on renewed concern over agricultural production in Brazil. Meanwhile, the Metals sub-index fell 8.8% (-13.9% year to date), and the Energy sub-index (crude oil and natural gas) dropped 0.8%. Hence, we upped our forecast for the ICI in 2014 to -3.0% yoy (previous call: -5.2% yoy), given the worse supply outlook in soft commodities. Our estimates for the Metals and Energy sub-indices are unchanged.

The crisis in Ukraine is behind the recent price action in several commodities, and this factor will continue to drive prices until the players involved reach a peaceful solution. An increase in the probability of escalation is bullish for several commodities. First, Russia is a key global exporter of crude oil and natural gas (in particular, to Europe). Second, both Russia and Ukraine are big grain exporters, therefore the conflict increases hedge demand for corn and wheat. Finally, some metals are also affected. Russia is a key global supplier of palladium, while gold (and other precious metals) may rise due to its safe-haven status.

Agricultural commodities rise as multiple weather shocks worsen the supply outlook. The big news since our previous report is excessive rainfall in the Center-West region of Brazil, which delays the soybean harvest and the planting of corn’s second crop. Furthermore, the drought that scorched the South and Southeast regions through mid-February is causing downward revisions in estimates (as well as higher prices) for coffee, sugarcane, corn and soybean crops. The impact on corn and soybeans may be counterbalanced by the next crop in the northern hemisphere, so we have kept our year-end forecasts unchanged. On the other hand, smaller output in Brazil may have a lasting effect on global balances for coffee and sugar. We thus revised upward our forecast for the Agricultural ICI in 2014, to 9.5% yoy from 4.9% yoy, due to higher prices for these two commodities.

Metal prices held to a downward trend. The drop in prices is consistent with weaker fundamentals, but the short-term dynamics may include a overshooting due to concerns about China’s Banking sector. Our unchanged year-end forecasts imply a 4.8% increase from current levels over the remainder of the year.

Mixed performance in energy-related commodities. WTI prices have traded sideways since mid-February, still affected by the combination of marginally lower oil production in the U.S. and increased outflow capacity from the Cushing region of in the central United States. Meanwhile, Brent prices continue to slide. The fundamentals suggest a drop throughout 2014, but the crisis in Ukraine is increasing the “geopolitical risk” implied for prices. We are maintaining our year-end forecasts for both Brent (USD 105/bbl) and WTI (USD 101/bbl) prices, assuming the conflict is resolved sometime in the next few months without a lasting effect on the commodities market.

Agriculture: lower output and new risks

Prices for major agricultural commodities have risen since mid-February: coffee (47.0%), sugar (15.2%), wheat (10.8%), corn (8.5%), soybeans (5.6%) and cotton (4.7%). Unfavorable weather in Brazil is behind the rise in prices. The drought in January and mid-February in the Southeast and South affected coffee, sugar and corn prices, and excessive rainfall in the Center-West partly explains the performance of soybeans and corn in international markets. The crisis in Ukraine, the severe winter in the U.S. and strong buying by the Chinese also help to explain recent performance.

Excessive rainfall in the Center-West worsens expectations for soybean supply and increases risk for the second corn crop. Soybeans were only slightly affected, relatively speaking, by the drought in Brazil through mid-February. However, excessive rainfall in the Center-West is reducing expectations for the 2013-14 crop. Consensus was in the range of 88-92 million tons but is now at 85-88 million tons. Our current forecast stands at 85.5 million tons. Rainfall also increased risks for corn supply, as delays in planting the winter crop intensify frost risk and the expected rainfall volume during grain development is reduced.

Higher prices for grains and soybeans until the next crop from the northern hemisphere hits the market. The combination of upward drivers should support corn, wheat and soybean prices at high levels until 3Q14. From 4Q14 onwards, short-term drivers lose momentum and prices will depend on the next harvest in the northern hemisphere. Meanwhile, we expect crops commensurate with long-term yield trends, and some migration of the planted area from corn to soybeans in the U.S. We thus maintain our year-end price-per-bushel forecasts for corn, soybeans and wheat unchanged, at USD 5.0, USD 12.2 and USD 6.8, respectively.

Upward revision in sugar and coffee prices. Lower production in Brazil will probably cause deficits in the global balance for these two commodities. The low price-elasticity of demand for both products requires sharp increases in prices to rebalance supply and demand. Coffee went through the biggest revision, in the magnitude of 91.3%, to USD 2.20/lb from USD 1.15/lb by year-end. The revision for sugar was more modest, at 6.0%, to USD 0.195/lb from USD 0.184/lb. The revision for sugar was smaller for three reasons: 1) our forecasts (and market expectations in some quarters) had already assumed a transition from a surplus to a deficit during the year; 2) global stocks are at high levels; and 3) Brazil’s ability to adjust the ethanol-sugar mix cushions price movements. Still, some uncertainty still lingers over the size of crop losses for coffee and sugarcane, and the required adjustment in prices could be greater than expected.

Artur Manoel Passos



* The Itaú Commodity Index is a proprietary index composed of commodity prices, measured in U.S. dollars and traded in international exchanges, which are relevant to global production. Its sub-indexes are Metals, Energy and Agriculture

** The ICI-Inflation is a proprietary index composed of commodity prices, measured in U.S. dollars and traded in international exchanges, which are relevant to inflation in Brazil (IPCA). Its sub-indexes are Food, Industrial and Energy.

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