Itaú BBA - Lower Grain Surplus, Higher Geopolitical Risk

Commodities Monthly Report

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Lower Grain Surplus, Higher Geopolitical Risk

September 6, 2013

Commodity prices have risen since the beginning of August.

•         We revised our year-end forecast for soybean prices upward (to USD 13.2 per bushel, from USD 12.5), due to less-favorable weather since mid-August. 

•         Escalating conflict in Syria lifts crude-oil prices. We expect the impact to be temporary and forecast Brent crude prices at USD 110.0/bbl by year-end.

•         ICI-Inflation: our commodity index, built to gauge the impact of international prices on Brazilian inflation, suggests an end to the disinflationary contribution of commodities. 

Commodity prices have risen since the beginning of August. The Itaú Commodity Index (ICI) rose 2.4% from the beginning of August, led by: i) the outlook for downward revisions in U.S. crop forecasts, ii) higher geopolitical risk due to tensions in Syria and iii) better-than-expected economic indicators in China. The breakdown by component shows increases (since August 1) in the agricultural (1.7%), base metals (2.7%) and energy (4.0%) sub-indexes.

Forecasts for soybean prices raised due to a smaller harvested area and less-favorable weather in the U.S. Mid-August field surveys in the U.S. suggest current official estimates for corn and soybean crops will be revised downward, in line with our base scenario. Additionally, unfavorable weather conditions in the Corn Belt since mid-August may further compromise crop yields. We raised our forecast for soybean prices by year-end to USD 13.2 per bushel, from USD 12.5, due to past conditions, but weather uncertainty remains and may still affect yield forecasts throughout September. Corn prices are less affected because even the new estimates for global balance still point to a sizable surplus in the current crop year.

We expect metal prices to fall from current levels. Metals prices have risen 2.7% since the end of July (according to the ICI Metals sub-index), buoyed by restocking and better-than-expected economic indicators from China. However, we still believe that global fundamentals are consistent with lower metal prices. Our scenario is unchanged, and we still expect declines of 9.7% yoy in 2013 and 7.0% yoy in 2014. Forecasts for 2013 assume that prices will drop from current levels as the restocking cycle fades, and economic indicators show that growth in China is stabilizing rather than rebounding in the second half of 2013.

Higher geopolitical risk raises energy prices. Energy prices are up 4.0% since the end of July (according to the ICI Energy sub-index), boosted by increased geopolitical risk stemming from accusations that the Syrian government used chemical weapons, in a situation that could prompt a response from the Western powers. Even though Syria is not a significant oil producer (approximately 300 kbpd), the fact that the Syrian government is supported by Russia and Iran may lead to spillover to other Middle Eastern countries. While there is uncertainty about the next steps that Western powers will take (and about reactions from Russia and Iran), geopolitical risk will continue to sustain crude prices above fundamentals. But according to our base scenario, the effect of the Syrian situation on prices will be temporary. Hence, our forecasts for the ICI-Energy sub-index are unchanged at +6.6% yoy in 2013 and -0.8% yoy in 2014.

ICI-Inflation: our commodity index suggests an end to the disinflationary contribution of international commodity prices. In order to capture the effects of international commodity-price shocks on Brazilian inflation, the ICI-Inflation takes into consideration international commodity prices weighted according to their relevance to the consumer price index (IPCA in the Portuguese acronym). Our index suggests that the disinflationary contribution provided by commodities to internal prices has come to an end. After dropping 10.8% year-to-date, we forecast a gain of 1.5% through the end of 2013, driven by agricultural commodities.

Grains: Lower Surpluses

Outlook of smaller crop in the U.S. Two factors reduced the outlook for the U.S. crop. First, field surveys conducted in August suggest that both the harvested area and yields are below the forecasts contained in the current scenario by the U.S. Department of Agriculture, reinforcing our view that the USDA will revise its estimates for the corn and soybean crops in the U.S. downward in its two next monthly reports. Furthermore, weather conditions in August were unfavorable to supply, with dry weather and above-average temperatures in the main producing regions. A sharp increase in soybean prices followed, while corn and wheat prices were also affected.

Differences in the planting cycle and a tighter balance explain the fact that soybeans were affected more than corn.The soybean planting cycle takes place weeks after the corn planting, so the impact of less-favorable weather now is felt more intensely by soybeans. Additionally, a looser balance for corn is expected, thus there is more room to maintain a surplus scenario if crop forecasts are reduced.

Price forecasts raised for soybeans and maintained for corn and wheat. We are revising our forecast for soybean prices by year-end upward to USD 13.2 per bushel from USD 12.5, reflecting the effect of recent weather conditions on the U.S. crop. Forecasts for corn and wheat are unchanged at 550 and 680 cents per bushel, respectively. We maintained our forecasts for corn and wheat because our scenario already contemplated a downward revision in USDA estimates for the corn crop.

Crude Oil: Geopolitical Risk Is Affecting Prices Again

Prices rise, driven by the risk of escalation in the conflict in Syria. Prices for Brent crude (first due date) fluctuated between USD 106.0 and USD 110.0/bbl in early August, staying at levels that are close to current fundamentals, according to our view. But suspicions that the Syrian government used chemical weapons against civilians heightened geopolitical risks associated with the Middle East, driving prices to a level between USD 114.0 and USD 117.0/bbl. WTI crude prices were also affected, albeit less intensely: an increase between USD 1.0 and USD 2.0/bbl may be associated with the increased risk.

Syria: escalating violence, scattered rebels and possible use of chemical weapons. Started during the Arab Spring, conflicts in the nation have become more heated and are marked by low cohesion among the many rebel groups (ranging from groups associated with Al Qaeda to Kurd separatists). Signs from the U.S. government about the conflict indicate that the use of chemical weapons could lead to some kind of military intervention. With suspicions that the Syrian government used chemical weapons in mid-August, the chances of military action by Western powers have increased. Syria is not a significant oil producer (approximately 300 kbpd), but the conflict may spread to other Middle Eastern nations, considering the interests of Russia, Saudi Arabia and Iran.

The situation is more complex than in Libya. Violence escalated in both cases. In Libya, it led to military action by NATO, sanctioned by the U.N. Security Council. However, Syria is supported by Russia (a permanent member of the Security Council, with veto power) and Iran, while Libya had no significant support. Additionally, rebel groups in Syria are more fragmented than in Libya, hindering indirect support.

Base scenario: the geopolitical effect on prices will be temporary and year-end forecasts are unchanged. Uncertainties surrounding the Middle East should continue to affect oil prices (as well as precious-metal prices) in the short term, but our base scenario considers that the effect on prices will not last until the end of the year. Hence, forecasts for oil prices by year-end are unchanged at USD 110.0/bbl for Brent crude and at USD 105.0/bbl for WTI.

ICI-Inflation: Index Suggests an End to the Disinflationary Contribution of Commodities

Our index incorporates shocks from international commodity prices on inflation in Brazil. In order to capture the impact of international commodity prices on Brazilian inflation as measured by the consumer price index (IPCA), we considered international prices for 20 commodities (in U.S. dollars, next due date on futures contracts) weighted by their relevance to local inflation. Together, these commodities explain about 60% of the change in market-set prices in the IPCA and were divided into three groups:

• Food: sugar, wheat, corn, live cattle, soybeans, coffee and cocoa;

• Industrial: iron ore, copper, aluminum, cotton, nickel, gold, lead, tin and zinc;

• Energy: crude oil and natural gas.

Food: greater relevance to the IPCA. According to the new index, prices for food-related commodities (ICI-Food) account for approximately 50% of the headline index, with wheat, sugar and corn being the most significant items. Meanwhile, ICI-Industrial and ICI-Energy sub-indexes represent 21% and 26%, respectively.

We expect an advance in the ICI-Inflation index starting in September. Following a 10.8% drop in the ICI-Inflation (year-to-date), driven by favorable weather in the Northern Hemisphere in the first half and lower prices for base metals, we anticipate a gain of 1.3% by the end of 2013. The advance would be led by the ICI-Food sub-index, forecasted to climb 4.5%, as a smaller U.S. crop is priced in.

Artur Manoel Passos

Verena Paiva



* 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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