Itaú BBA - Rally still on (for now)

Commodities Monthly Report

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Rally still on (for now)

February 8, 2017

Commodity prices extended 4Q16 gains year-to-date ,but we expect our commodity index to fall 7% from current levels in 2017.

For the full report, see enclosed file

• Commodity prices extended 4Q16 gains in 2017, driven by strong global economic activity, a weaker USD and renewed discipline among producers. 

• We expect our commodity index to fall 7% from current levels in 2017 due to a slowdown in China (by mid-year) and supply responses to current prices, particularly in oil (U.S. shale producers) and iron ore. 

The Itaú Commodity Index (ICI) has risen by 1% in 2017; extending 4Q16 gains as global economic activity keeps up the strong pace, the USD weakens and producers show renewed discipline.

Metal prices advanced further. The macro background and supply-related concerns in nickel (closure of mines in the Philippines) and copper (risk of strikes in Chile) supported prices.

Oil prices have fallen 3% in 2017, as signs that OPEC members are complying with its deal were offset by increasing drilling activity in the U.S. Uncertainty over the new U.S. presidency is also neutral for prices: worse relations between the U.S. and OPEC countries increase risks of non-compliance, but may also increase the ‘geopolitical risk’ component implied in oil prices.

The ICI-agricultural rose 5% year to date, helped from a weaker USD, a recovery of sugar and coffee prices from a technical undershooting, and floods affecting crops in Argentina (and delaying harvest in Brazil). Despite the floods in South America, crop conditions are consistent with a stronger summer crop than last year, particularly in Brazil. Looking forward, the Pacific Ocean is set to remain neutral (no El Niño nor La Niña patterns) until 3Q17. Given earlier expectations of La Niña, neutrality implies lower risks for Brazil’s winter corn crop and the next crop in the U.S.

Looking ahead, we expect the ICI to drop 7% from its current level by the end of 2017. This is because we expect a slowdown in China in 2H17 to lower metal prices. Moreover, we expect U.S. shale oil producers to expand their output, and increase in the iron ore supply (both traditional and exotic players) to pressure prices during the year.

Oil: New U.S. foreign policy not clearly bullish or bearish for prices

Supply cuts seem to be advancing in line with OPEC’s announcement. The first estimates put OPEC’s supply around 32.3 mbd in January, 0.8 mbd below December and 0.3 mbd above the supply target. Approximately 0.2 mbd of the above-quota figure came from stronger supply from Nigeria and Libya, both of which are exempt from production quotas.

Despite the almost full compliance with the deal, Brent prices have remained between USD 55/bbl and USD 57/bbl in 2017, and WTI prices ranged around USD 54/bbl over the same period.

The reason is that U.S. shale producers are increasing drilling activity at the same time, reinforcing expectations of a partial rebound in U.S. crude production through 2017.

In addition, increasing uncertainty over the U.S. approach to Middle-East countries is now neutral to prices, in contrast to the past when increasing tension with Iran would increase the ‘geopolitical risk’ premium to oil prices. This is because current prices depend on compliance with OPEC’s deal. Rising tension with Iran or with other OPEC countries increases risks of an early deal break-up, a scenario that leads to lower prices.

We maintain our YE17 Brent forecast of USD 54/bbl (WTI: USD 52/bbl), a level that would allow for additional production by U.S. producers to partly offset the measures taken by the cartel.

Grains: Prices remain well behaved

Corn, soybean and wheat prices have risen by 5%, 5% and 6%, respectively, since late December. Nonetheless, corn and wheat have traded within a narrow range since mid-September, while soybean prices have trended upward over the same period.

Prices are still well behaved, regardless of concerns about floods in South America delaying the harvest in Brazil and affecting crops in Argentina more severely. Despite these concerns, we expect the summer crop to be stronger than in 2016, particularly in Brazil. In addition, external demand remains strong in the U.S. and in China, which seems to be anticipating consumption, preventing global surpluses and thus, lower prices. 

Our scenario is that prices for these three commodities will remain range-bound and close to current levels until year-end. Our YE17 forecasts are:

  • Corn: USD 3.6/bushel
  • Soybeans: USD 10/bushel
  • Wheat: USD 4.4/bushel

Our scenario assumes that the Pacific Ocean is set to remain neutral until 3Q17. The shift of the base-case scenario from La Niña to neutrality (no El Niño or La Niña patterns) implies lower risks for the next crop in the Northern Hemisphere and the winter corn crop in Brazil.

Sugar/Coffee: Higherprices, despite bearish news

International contracts for raw sugar and coffee have risen since the end of 2016. 

Sugar prices have risen by 6% to USD 0.209/lb, driven by a weaker BRL and concerns that India might need to reduce the 40% import duty currently in place, due to dry weather.

Meanwhile, coffee prices have risen by 4% over the same period, to USD 1.45/lb, despite some bearish news. Good rain dispersion in Brazil’s Arabica coffee-growing area reduced supply concerns and reinforced a constructive view of the summer crop. Also, hedge funds’ net-long positions have stabilized after the build-up seen since the beginning of the year.

Overall, the recent developments were consistent with our base scenario. We forecast coffee prices at USD 1.40/lb by YE17, and sugar prices to average USD 0.2022/lb in 2017. 


Artur Manoel Passos, CFA


For the full report, see enclosed file


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