Itaú BBA - Metal Prices to Stay at Low Levels

Commodities Monthly Report

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Metal Prices to Stay at Low Levels

May 2, 2013

Commodity prices declined in April, led by disappointing global activity and U.S.-dollar appreciation.

  • Commodity prices declined in April, led by disappointing global activity and U.S.-dollar appreciation.
  • Base metals: Disappointing growth in China and rising output are consistent with lower prices throughout the year.
  • Unfavorable weather in the U.S. creates risks to corn planting.

The Itaú Commodity Index fell 4.0% in April, driven by deterioration in the global scenario and idiosyncratic shocks. Regarding the global scenario, economic growth in China in 1Q13 disappointed expectations, prompting downward revisions in estimates for growth in 2013 (on our part as well). Furthermore, the U.S. dollar continued to strengthen against other currencies. The main shocks were: i) unwinding of long positions in gold and other precious metals, hurting other asset classes including base metals and energy commodities; ii) the delay in corn planting in the U.S.; and iii) the reduction in operational capacity at oil refineries, causing crude demand to retreat in the short term.

What are the changes in our year-end forecasts?

The main adjustment was a downward revision in price estimates for base metals. Slower growth in China and higher output are consistent with lower prices throughout the year. Hence, we are cutting our estimate for the ICI Metals sub-index by 10%, moving to --4.2% yoy from +5.1% yoy. This revision does not affect our scenario for iron ore, as inventory replenishment in China offsets demand signals from economic activity. Thus, we still expect prices to fall to $125.0/ton by December, from an average of $137.70 in April.

We expect crude oil prices to rebound from a recent drop. Notwithstanding a sharp decline in crude prices, driven by a combination of worsening macro prospects and a looser balance in the sector in the short term, we are lifting our year-end estimates for the ICI Energy sub-index to a gain of 3.7% yoy from a gain of 2.6%. The adjustment reflects lower natural gas inventories in the U.S., leading to higher prices. Meanwhile, our forecast for Brent crude was maintained at $110.0/bbl, based on the expected recovery of operational capacity in refineries, as well as the expectation of some impact of regional conflicts on production.

Agricultural prices and fundamentals behaved in line with our scenario, but weather conditions in the U.S. created risks. Weaker demand for grains had already been incorporated into our previous report. However, two risks must be closely watched over the next few weeks. First, corn planting in the U.S. is very late. This delay may be resolved over the coming weeks, but the crop will be more vulnerable to unfavorable weather, as planting will be concentrated in a shorter period of time. Another possibility is that difficulties in planting corn may drive farmers to switch planting to soybeans, changing the supply outlook for both commodities. Finally, the second risk is associated with bird flu in China, and its effects on demand for corn and soy meal.

Commodities vs. Macro Fundamentals: Lower prices in 2013 are consistent with economic growth below expectations and a stronger dollar.

The drop in commodity prices in 2013 is consistent with slower economic growth and a stronger dollar. The decline incommodity prices throughout 1Q13, particularly for base metals and energy, offset the increase seen in 4Q12. ICI prices are virtually stagnant (-0.6%) when considering a quarterly average. Flat prices in 1Q13 are consistent with a stronger dollar against other currencies and with lower-than-expected global growth in the period. When assessing daily price changes, one notices a strong correlation between commodity indexes and the NEER dollar. This correlation can be explained by several factors, but the most important one is that a stronger dollar increases prices for commodities denominated in other currencies, prompting a decline in demand in other countries.

Weather: Cold and Wet Conditions in the U.S. Delay Corn Planting 

Rainfall and cold spells delay corn planting in the U.S. and add risks to supply in the next crop year. Producing regions in the U.S. faced cold and wet weather in April, immediately triggering a delay in corn planting and uncertainties about the distribution of the planted area between corn and soybeans. Additionally, the potential impact of adverse weather on productivity increased, as planting is concentrated in a shorter period of time. Looking ahead, rainfall levels should remain above average, but dry periods and milder temperatures should enable planting.

Weather in Brazil should be favorable to crops in the coming months. Producing regions got above-average rainfall during the first two weeks of April. The second half of the month was characterized by no rain in the Center-West, South and Southeast. The absence of rain helped the sugarcane harvest in the Southeast and Center-West. The weather outlook for the next months is favorable: rainfall levels in line with historical patterns and well distributed over time, with a low risk of frost until winter begins.

Reservoirs: At Last, Strong Accumulation

Reservoir levels rose faster than the seasonal average for April. Above-average rainfall in Brazil during the first half of April also affected regions that produce hydroelectric power. Rainfall in regions that are relevant for electricity production stood at 127% of its seasonal historical average, driving an increase in water levels at reservoirs to 61.3% of capacity in April from 54.4% at the end of March. This hike was greater than the average for the month in the 2002-2012 period (1.9 p.p.), and was driven by seasonally high affluent natural energy (around 108% of energy generated under historical conditions) and utilization of thermal power plants.

The uncertainties ahead involve system efficiency in the dry season and consumption growth. With the expectation of rainfall close to historical patterns during the rest of the year, the main uncertainties surrounding the changes in reservoir levels for the rest of 2013 are the performance of the hydroelectric system during the “dry” season in the Southeast (leading to lower power generation by hydroelectric dams) and the evolution of energy consumption.

Grains: Delayed Corn Planting in the U.S. Creates Risks

 Since the sharp decline in prices between late March and early April, contracts for corn, soybeans and wheat advanced in the futures market.Among the factors behind  the hikes, we point out demand’s reaction to lower prices (particularly for corn), low soybean inventories in the U.S., concerns about yields in the wheat crop 2013/14, and about corn planting. Soybean prices are rising despite the pickup in shipments from Brazil to about 7 million tons in April.

We maintain our year-end price forecasts. Our estimates for corn, soybeans and wheat were maintained at 638, 1350 and 750 cents per bushel, respectively. However, corn-planting delays in the U.S. and the avian influenza in China represent risks to the scenario.

Unfavorable weather delays corn planting and increases uncertainties for the U.S. crop. Wet and cold weather in April delayed corn planting: as of April 29, 5% of the crop had been planted, vs. an average of 46% in the past six years. Less unfavorable weather is expected in the next few weeks, with less rain (though still above the historical average) and milder temperatures, enabling more planting. Our basic scenario still contemplates higher yields and planted areas for soybeans, and corn at the same level as the previous crop, so the harvests reach 91 million and 340 million tons, respectively. However, planting delays increase the likelihood of alternative scenarios. First, the delay makes planting more concentrated in a shorter period of time, increasing the effects of adverse weather conditions on crop productivity. Second, the delay may provide incentive for farmers to relocate some of the area planned for corn to soybeans, deeply affecting the supply scenario for both commodities.

The next WASDE report should provide balances, including the replenishment of global inventories during crop year 2013/14. On May 10, the U.S. Department of Agriculture will release its first report with estimates for global balances in the crop year 2013/14. Based on preliminary information, we expect surpluses for the three main soft commodities (corn, soybeans and wheat), leading to higher inventories by mid-2014.

Crude oil: Prices Likely To Rebound

Oil prices retreated in April, but are likely to rebound through 2013.Brent crude (first due date) declined sharply, to as low as $97.70/bbl on April 17, from $110.00 in the beginning of the month. Prices have recovered somewhat since then, ending April at $102.37. The steep slide may be explained by a combination of disappointment with economic activity in China in 1Q13 and a looser balancefor crude oil in the short term. Demand was negatively influenced by seasonally strong refinery maintenance. In our view, prices will rebound to about $110.00 by year-end, as operating capacity at refineries recovers and production is interrupted to a certain extent in countries experiencing significant geopolitical risk.

Although geopolitical factors did not affect prices in recent weeks, they may affect production in several nations.No progress was reported on the talks between Iran and P5+1[1], and a new sale of U.S. weapons to allies in the Middle East may get in the way of a new agreement. Attacks by organized groups pose risks to production in Iraq and Nigeria. Also, conflicts in Mali may once again hurt production in Algeria.

In the U.S., production rebounded to 7.3 mbpd on April 16 from an average of 7 mbpd in January.Notwithstanding the recovery, the WTI discount to Brent has been shrinking during the year, reaching about $8.58/bbl (2012 average: $17.5). Looking ahead, higher production and the economic slowdown may lead to a wider spread, more than offsetting the capacity increase in pipelines and other adjustments made to obtain a better grasp on domestic production.

Artur Manoel Passos


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

[1] The five permanent members of the U.N. Security Council plus Germany.



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