Itaú BBA - Increased Supply and Mixed Performance

Commodities Monthly Report

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Increased Supply and Mixed Performance

December 3, 2012

We are revising our year-end forecasts for the Itaú Commodity Index (ICI) downward.

Stabilizing growth in China and geopolitical risks also affected commodity prices.

Given lower prices than we expected in November and a better crop-supply outlook, we are revising our year-end forecasts for the Itaú Commodity Index (ICI) downward. We now expect an increase of 13.7% in 2012 (previously 19.2%) and a decline of 4.1% in 2013 (previously -7.7%).

Commodity prices remained flat in November after falling 4.2% in October, with mixed performance across the groups. Agricultural prices fell 2.4% in November, driven by a better supply outlook. Base metal and energy prices rose 4.0% and 1.7%, respectively. Despite better supply prospects for copper and oil, prices were affected by renewed signs of stabilizing growth in China. Oil prices were also affected by increased geopolitical risks in the Middle East.
 

Agriculture prices fell 2.4% mom in November, extending losses for the third straight month. Prices were negatively affected by improvements in the supply outlook, with higher soybean yield in the U.S. and better weather conditions in South America. Taking these facts into account, we are reducing our 2012 year-end soybean forecast to 1450 cents/bushel (from 1750), and corn forecast to 770 cents/bushel (from 850).

Sugar No. 11 Futures prices have remained between $0.19/lb and $0.20/lb since mid-October. Given the lack of relevant data since our last report, we maintain our view that sugar prices will remain around $0.20/lb throughout 2013.

In the cattle sector, the U.S. placements in feedlots remained weak in October, reinforcing a scenario of lower beef supply (and lower feed-grain demand) in 2013.

Despite expectations of a sizable surplus in the cotton global balance, future prices are expected to increase in 2013. This reflects a relative deficit in cotton to meet requirements for NYB-ICE futures contracts. We expect cotton No. 2 future contracts to reach 77 cents/ lb by the end of 2013.

Geopolitical risk led oil prices to rebound in November, even in the context of looser global balance in 4Q12. Following the ceasefire that ended the latest round of violence in the Gaza Strip, we expect the tension over Iran’s nuclear program to return to the media and sustain high prices, offsetting sector fundamentals and worries about the fiscal cliff in the U.S. We continue to forecast crude prices at $112/bbl by the end of 2012 and at $115/bbl by the end of 2013.

Finally, prices for base metals rebounded mildly in November. Besides China’s signs of stabilizing growth, its stockpiling purchase of aluminum and zinc also contributed to the movement. Iron ore spot prices are close to iron ore contract prices for 4Q12 and should remain around current levels of $120/ton for a while. The global copper balance is approaching a surplus, with production increasing and demand growth decelerating.

Weather: Better Conditions in South America

November was marked by better weather conditions for agricultural production in South America. Above-average rains in Mato Grosso, Mato Grosso do Sul, Goiás and Western Bahia offset lack of rains in October. Meanwhile, lower rain in Argentina and Rio Grande do Sul offset excess rains in the previous month. São Paulo received more rain in November, but still below average. Recent rains in Paraná were not enough to bring precipitation to the seasonal average, but that state, unlike others, received a fair amount of rain in the previous month.

Crop planting is advancing at a reasonable pace, but is still slightly behind schedule. It is important for both soybeans and the corn crop that there is rain when the plant is pollinating and generating the grains, a phase that is expected to take place between the second half of December and January.

Given the current neutral conditions in the Pacific Ocean (no El Niño or La Niña), our best estimate is to expect average rains during this sensitive period. This should lead to crops that are close to current forecasts from USDA and CONAB. However, the standard deviation is high and risks remain.

Agriculture: Better Supply Outlook Led to New Decline in Prices

Agriculture prices fell 2.4% mom in November, extending losses for the third straight month. Prices were negatively affected by improvements in the supply outlook, with higher soybean yield in the U.S. and better weather conditions in South America.

In order to accommodate the better supply outlook and November prices, we are reducing our 2012 year-end soybean forecast to 1500 cents/bushel (from 1750), and corn forecast to 800 cents/bushel (from 850). Given lower global inventories, prices would be heavily affected by another crop loss in South America.
 

The USDA’s November report (World Agricultural Supply Demand Estimate, or WASDE) revised ending stocks for the three main agricultural commodities (corn, soy and wheat) upward. The largest adjustment was to the soybean balance, increasing the U.S. yield for 2012-13 crop by 3.9%.

The WASDE revised beginning stocks and the U.S. production upward, leading the supply (beginning stocks + production) for the 2012-13 crop year to increase by 1.4%, to 323.6 million tons from 319 million tons. The adjustment to the supply was divided between greater demand (mainly from China) and higher ending stocks. A looser global balance is probably the main reason for the 7% fall in soybean prices in November. The estimate for Brazil was maintained at 81 million tons, within the range of the CONAB (Brazil’s food supply agency) 2012-13 forecasts. The estimate for Argentina was also unchanged, at 55 million tons. Both forecasts are consistent with average weather conditions and estimated planted areas.
 

Corn prices fell 1.0% mom in November to 748 cents/bushel, well above prices before the U.S. drought became a reality (between 600 and 700 cents/bushel). The WASDE made small adjustments to the global balance. Supply for the 2012-13 crop increased by 0.1%, (1.2 million tons), from higher beginning stocks and higher production in the U.S. The adjustment to the supply was divided between higher global demand (0.5 million tons) and higher ending stocks (0.7 million tons). Despite the improvement, ending stocks are low if compared with previous years. The current ending stock estimate (60 million tons) is less than half the average from the last three years. As expected, estimates from Brazil and Argentina were kept at 70 and 28 million tons, respectively.

Finally, the WASDE revised downward the wheat supply for the 2012-13 crop year. However, the downward revision to wheat production was lower than expected and lower than the revision to demand, leading to higher ending stocks for the commodity in both the U.S. and the rest of the world. The estimate for the Brazilian crop (5 million tons) may still not reflect CONAB’s last revision to 4.4 million tons from 5 million tons.
 

Another risk for global supply is the current condition of winter wheat in the U.S. According to the USDA, only 33% of the U.S. winter wheat was rated good or excellent as of November 23, 20 percentage points below the last-5-years average and the worst condition since tracking of data began in 1985. Under favorable winter climate conditions, quality may improve during the dormancy period (December to February). Nevertheless, this indicator is a risk to the USDA’s current estimate of a 13% increase in the 2012-13 crop compared with the previous season.

Beef: October Data in the U.S. Reinforces Lower Supply Scenario in 2013

High feed-grain costs are leading to lower cattle placements in feedlots. In the U.S., placements in feedlots remained weak in October, down 12.8% yoy according to the USDA. In Brazil, a private study (Rally da Pecuária 2012) has estimated lower-than-expected cattle placements in feedlots throughout 2012 (6% vs. 18% expected) and a flat number for 2013. A flat number of placements in Brazil suggests a lower beef supply, given the trend of pastureland being converted to crop production and reducing the area available for extensive cattle farming.
 

The consolidation of low cattle placements in feedlots suggests lower demand for grain feed and a lower beef supply for 2013, and reinforces a scenario of higher cattle and beef prices next year.

Cotton: Stocks and Prices To Increase in 2013

The USDA'’s November report estimates a loose global balance in the 2012-13 crop year. Even in a scenario of 6% lower global production and 3% greater demand, there is still a sizable surplus, leading to another year of stock increases.

Looking back, cotton prices fell 18 % in May and have remained at a lower level since then, averaging 71 cents/ lb in November. We expect prices on the benchmark contract quoted on ICE at NY to increase to 77 cents/ lb throughout 2013, even with the fundamentals mentioned above. This should happen due to a quality premium on the contract, which specifies delivery of U.S.-grown cotton of exchange-grade quality.
 

In Brazil, one of the major exporters, the  USDA estimates a production decrease of 25.3% and a lower crop than CONAB, which expects  the  total cotton crop for  2012-13 to range between  1.5  and  1.6 million tons, while the USDA is below the  range  at 1.4 million tons (we expect 1.5 million tons). CONAB’s average forecast also points to a fall of  23.8%  in the cotton planted area, mostly  lost to soybeans, a result of the higher margins for producers.

Metals: Prices Increasing on Chinese Growth Stabilization

The base-metals price index increased about 4.0% in November, partially reversing the strong fall in October. This month, among the base metals, aluminum prices increased 11.0%, zinc 10.7%, lead 8.5%, nickel 9.1% and copper, which had the weakest performance, rose 2.8%. Besides China’s signs of growth stabilization, its stockpiling purchase of aluminum and zinc also contributed to the price increases.

Iron ore spot prices averaged $120.35/ton in November and were up 5.6% compared with the October average, partly affected by strong Chinese imports. At the moment, spot prices are close to iron ore price contracts for the quarter ($122/ton). Iron ore prices are compatible with the current sector fundamentals and are likely to remain at this level for a while.

Copper future prices fell in the beginning of November, but recovered during the second half. However, when comparing the November average with the previous month, we see a sharp decline of about 4.3% due to high prices in the first half of October. The copper balance for August, released in November by the International Copper Study Group (ICSG), highlights a decline in the global deficit, caused by increases in production amid demand-growth deceleration. Chinese copper imports, a significant part of demand, were up 26% yoy through October, but are decelerating. In this scenario, we expect copper prices to decrease throughout 2013 due to a combination of supply recovery and weak global growth.
 

Energy: Geopolitical Risk Offsets Looser Global Balance and Worries about the Fiscal Cliff

Brent crude prices rebounded to $111/bbl after falling from $115/bbl in mid-October to $105. Despite a looser global supply-demand balance in 4Q12, geopolitical risks and the fiscal cliff in the U.S. are expected to be the main drivers for prices in the short term. We expect the tension over Iran’s nuclear program to return to the media and sustain high prices, offsetting sector fundamentals and worries about the fiscal cliff in the U.S. We continue to forecast crude prices at $112/bbl by the end of 2012 and at $115/bbl by the end of 2013.

The International Energy Agency’s (IEA) last Oil Market Report again revises its forecasts for the global oil balance towards a larger surplus. Global demand for 4Q12 was revised downward again, reflecting the impact of Hurricane Sandy on the U.S. and lower estimates for Europe. Global supply rose by 0.8 mb/d in October compared with the previous month, as greater supply from the Americas and the North Sea offset a slight decline in OPEC production. This decline in supply from OPEC came despite a rebound in imports from Iran, increasing 300 kb/d in October and reversing a downtrend that had been in place since January.

IEA has also released its Annual Energy Outlook. The highlight is the outlook for lower oil-import requirements from the U.S., with rising unconventional oil and biofuel production in an environment of flat demand. IEA estimated production costs for unconventional oil supplies in the range of $40-100/bbl. If oil prices fall much below current levels or transport constraints and cost inflation raise production costs, investment decisions on new projects could be postponed, lowering supply growth.

Artur Manoel Passos

Economist

** 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.



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