Itaú BBA - No recovery in sight

Commodities Monthly Report

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No recovery in sight

April 7, 2015

Commodities resumed a downward trend in March, dragged by falling prices for crude oil and iron ore.

• Commodities resumed a downward trend in March, dragged by falling prices for crude oil and iron ore.

• We cut our year-end forecasts for oil (to USD 65/bbl from USD 70/bbl) and iron ore (to USD 52.5/ton from USD 63/ton), as we acknowledged slower adjustments in supply. Notwithstanding these revisions, we see downside risks to our estimates.

• Among agricultural commodities, we lowered our forecasts for soybeans (outlook for oversupply in the 2015/16 crop year) and sugar (international prices are consistent with parity in relation to ethanol prices in Brazil)

Commodity prices resumed a downward trend starting in early March, and the Itaú Commodity Index (ICI) dropped 4.6% during the period. The move was driven by falling prices for iron ore and oil, but all index components have slid since late February: Agriculture (-1.3%), Metals (-9.8%) and Energy (-4.3%).

We lowered our year-end forecasts for the ICI by 5.5 p.p. in 2015 and by 2.2 p.p. in 2016, following revisions in our estimates for crude oil, iron ore, soybeans and sugar. We expect prices to rise 8.1% from current levels by the end of the year and to go up another 6.9% in 2016. Most of the expected hike for the index is related to a partial recovery in crude prices.

Oil prices fell in March amid signs of oversupply in the market continuing for a while longer. Brent crude fell to USD 58.0/bbl from USD 63.0/bbl in early March. Notwithstanding a few signs of investment cuts, U.S. output sustained the upward trend of recent months. Furthermore, the likelihood of coordinated action to reduce supply in the short term (by OPEC or Russia) gets smaller and smaller. Finally, global demand does not signal a significant reaction to low prices. All in all, we see the oversupply situation lasting until the first half of 2016 – or six months longer than in our previous assessment.

With an oversupply for a longer period of time, Brent crude will take longer to rebound to USD 70.0/bbl, so we cut our forecast to USD 65.0/bbl from USD 70.0/bbl.

Iron ore prices fell sharply in March (to USD 50/ton from USD 63/ton), dragged by slow demand growth, increases in low-cost production and a lack of reaction from high-cost producers.

We lowered our forecast for iron ore to USD 52.5/ton from USD 63.0/ton. Going forward, we do not expect stimuli in China to translate into more demand for this commodity, and the trend of increased production in Brazil and Australia will continue to pressure the market for some time. Without any reasons to expect an increase, we read the March slide as another sign of a downward movement in the supply curve, with cost-cutting efforts leading to a reduction in equilibrium prices.

Notwithstanding these revisions, we see downside risks to our estimates for iron ore and crude. If high-cost producers continue to resist production cuts, prices for both commodities may fall further in the near term. Crude prices may also be affected by developments toward a definitive nuclear pact between Iran and the P5+1 (a possible increase in Iranian exports as soon as this year) or by bottlenecks in global storage capacity.

In aggregate terms, agricultural commodity prices have also slipped since the end of February, due to declines for soybeans and sugar. We lowered our forecasts for both commodities. We acknowledge a continuing oversupply of soybeans in the 2015/16 crop year. The new scenario for sugar incorporates our scenario for the Brazilian currency and parity with ethanol prices in Brazil.

Grains: Outlook for oversupply of soybeans and wheat in the 2015/16 crop year; equilibrium only for corn

International contracts for corn, soybeans and wheat were virtually stable throughout March (see chart).

The 2014/15 crop year was marked by oversupply of these three commodities and by falling prices. The U.S. Department of Agriculture forecasts the oversupply of corn, soybeans and wheat at 1.3%, 7.4% and 1.4% of global output, respectively. Oversupply explains why prices for the three commodities are approximately 25% lower than in the beginning of 2014.

Since the reports on planting intentions and quarterly inventories in the U.S. have been released, all eyes now are on the 2015/16 crop year. Although the report signaled an upward trend for soybeans and a downward trend for corn, fundamentals now point to an outperformance of corn prices and risks of additional declines for wheat and soybeans.

Corn oversupply may end in the 2015/16 crop year. The report on planting intentions suggests a reduction of 1.5% in the planted area, compared with the 2014/15 crop. With a smaller planted area and normalization in yields, the next U.S. crop may be smaller than the current one by 16 million metric tons. This adjustment would be enough to eliminate the oversupply in the global balance (13.2 million tons in the 2014/15 crop year).

We maintain our year-end estimates for corn at USD 4.25/bushel in 2015 and USD 4.5/bushel in 2016.

Soybeans: In the absence of a weather event, the market is headed to more oversupply in the 2015/16 crop year. The report on planting intentions points to a larger planted area in the U.S. Even with a return to average yields in the nation (following unusually favorable conditions in the 2014/15 crop year), the U.S. crop would still be more than 100 million tons. In other words, output would fall by 8 million tons at most. With no prospects of reductions in the planted area in other producers, the adjustment in the U.S. would be insufficient to normalize the global balance.

Given the outlook for further oversupply in the global balance, we reduced our year-end forecasts for soybeans to USD 9.5/bushel, from USD 10.0/bushel in 2015, and to USD 10.0/bushel, from USD 10.5/bushel in 2016.

Outlook for wheat oversupply in the next crop year. The report on planting intentions indicated a smaller area in the U.S. However, the expected output in the country in a scenario of normalized yields would be larger than last year, when weather conditions were adverse. Such larger production would exacerbate the oversupply seen in the 2014/15 crop year.

We maintain our year-end forecasts for wheat at USD 5.4/bushel in 2015 and USD 5.8/bushel in 2016. 

Sugar/coffee: Favorable rainfall and weakness in the Brazilian currency pressure prices down

International sugar contracts continued to slide, falling more than 10% since the end of February. Favorable weather in Brazil and depreciation in the real are behind the movement.

We updated our forecast for sugar prices to USD 0.144/lb. from USD 0.158/lb. by the end of 2015. The estimate contemplates our scenario for the exchange rate (3.10 Brazilian reais per U.S. dollar by year-end) and considers that international sugar prices will have parity with ethanol prices in Brazil.

Coffee prices have been relatively stable since early March, and did not rebound from the drop seen in the previous month. As is the case for sugar, international coffee prices are negatively affected by depreciation in the Brazilian real. However, there is a lot of uncertainty surrounding the crop and our perception (in line with futures contracts) seems to accurately reflect the current outlook for fundamentals. Our forecast for international prices (Arabica coffee) stands at USD 1.5/lb. by year-end.


Artur Manoel Passos

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