Itaú BBA - Stronger Agricultural Supply Reduces Price Forecast

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Stronger Agricultural Supply Reduces Price Forecast

July 7, 2014

The Itaú Commodity Index (ICI) has fallen 1.6% since the end of May.

We revised our forecasts downward for agricultural commodities, in the face of several surprises in terms of supply.

Metal prices climbed in June, driven by better sentiment towards China. We expect prices to advance some more by year-end.

• Conflicts in Iraq impacted crude oil prices. We project lower geopolitical risk and lower prices ahead.

The Itaú Commodity Index (ICI) has fallen 1.6% since the end of May. Rising metal and oil-related prices were not enough to offset plummeting agricultural prices, driven by better supply outlook in soybean, corn, cotton and coffee.

The ICI-Agriculture index has dropped 9.4% since the end of May, influenced by the rollover of futures contracts and by a better supply outlook. Except for sugar, all the commodities we follow posted price declines in the period. Most of the surprises came from the U.S., as favorable weather conditions reinforced expectations for high yields in the 2014-15 crop. The latest report by the U.S. Department of Agriculture (USDA) showed that corn inventories and soybean planted area are much higher than expected. In the rest of the world, there are signs that the El Niño weather pattern will not cause losses for grain crops in Asia. Additionally, analysts are revising their estimates upward for coffee production in Brazil.

Downward revision in forecasts for agricultural prices. The abovementioned supply adjustments will lead to a looser supply-demand balance in the 2014-15 crop year for corn, soybean, cotton and coffee. Hence, we are revising our year-end forecasts downward for these commodities. Wheat prices are also affected due to their correlation with corn prices. This combination of changes leads the ICI-Agricultural index to a level 8.4% lower (by December 2014) than our previous scenario and 2.3% above current levels.

Following the revision in agricultural prices, our year-end forecasts for the ICI were also revised downward and now point to a 4% yoy drop in 2014 (previous scenario: -1.4%) and a gain of 2.4% in 2015 (previous scenario: 1.6%). This forecast implies that the ICI will go down 1.0% from current levels.

Higher prices for energy-related commodities due to the conflict in Iraq. The ICI-Energy index climbed as much as 4.3% between May 30 and June 23, as rebels took over cities and marched toward Baghdad. Since then, the index retreated 3.1%, as the Iraqi government received support from Russia, Iran and the U.S. and managed to interrupt the advance. Despite the decline from recent highs, we believe crude is pricing in above-average geopolitical risk. With external support, we expect the Iraqi government to be able to defend oil-related infrastructure and the geopolitical risk to recede. We maintain our year-end price forecasts, considering a 3.7% drop in the ICI-Energy index from current levels.

Metal prices have risen since the end of May (4.2%, according to the ICI-Metals), as iron ore and base metals recovered from recent lows. This partial rebound is explained by improved perception of China. We believe that iron ore prices are not sustainable at USD 90 per metric ton in the current environment. Our year-end forecasts are unchanged and imply an additional increase of 0.7% for the ICI-Metals, driven by higher iron ore prices (we expect USD 101 per ton by year-end, or 4.5% above early-July prices).

Grains/soybeans: downward revision in price forecasts

Many surprises improved the supply outlook for the next crop year, leading agricultural commodities to fall further in June, except for sugar.

Most of the surprises came from the U.S., as favorable weather conditions reinforced expectations for high yields in the 2014-15 crop for corn, soybeans and cotton. Weekly assessments by the USDA showed that the quality of crops of these commodities is better than historical average, which is consistent with high yields. Additionally, the USDA report showed that corn inventories and soybean planted area are much higher than anticipated, supporting the scenario for surpluses in the balance between supply and demand in both products.

Lower risk for corn and wheat crops in the rest of the world. Recent conditions in the Pacific Ocean suggest that El Niño will not be intense enough to cause losses in grain crops in Asia (particularly in China and India). Weather conditions are favorable in Europe.

Downward revision in forecasts for corn, soybeans and wheat. The abovementioned changes in the supply outlook will lead to looser balances between supply and demand during the 2014-15 crop year. We have thus revised our forecasts downward for international prices per bushel for corn (to USD 4.50 from USD 5.00), soybeans (to USD 11.5 from USD 12.2) and wheat (to USD 6.0 from USD 6.8).  

Coffee: equilibrium at lower prices

Conditions for Brazil’s coffee crop are being reassessed. Consensus is still pointing to losses from the 2014-15 crop, but concerns involving a lasting shock on yields have eased. We are thus revising our year-end forecast downward, to USD 1.80/lb from USD 2.20/lb. This number still implies a strong increase from levels seen at the end of 2013, but it also suggests that the market is reaching equilibrium at a lower price level.

Sugar: higher prices ahead

Sugar prices have traded with no clear trend, as the outlook for lower supply is offset by weak demand. Sugar prices (contract due in October 2014) are still fluctuating between USD 0.175/lb and USD 0.185/lb, without a clear direction. As for fundamentals, the supply outlook does not evolve in the same way as for other agricultural commodities and is still being revised downward. Weak demand has prevented prices from going up.

Deteriorating outlook for sugar production in Brazil. The dry weather in the Southeast region continues to prompt downward revisions in estimates for the sugarcane crop in Brazil. With lower-than-average rainfall in the main producing regions, sugarcane plants are not able to recover from the intense drought experienced during the summer. After incorporating recent developments, we are revising our forecast for the sugarcane crop in the Center-South to 560 million from 570 million tons and maintaining our call for Total Recoverable Sugar (ATR) at 132 kg per ton of sugarcane. Assuming that 44.5% of the crop will be turned into sugar (vs. 45.4% in the 2013-14 crop year), production in the Center-South will reach 31.3 million tons of sugar, or 3.0 million less than in the previous crop.

Lower-than-average rainfall in the monsoon season suggests lower yields in India and Thailand. Rainfall during the monsoon is below seasonal patterns. El Niño suggests that this situation will continue in the coming months, probably reducing crop yields in India and Thailand.

We still expect higher prices. The outlook for lower yields in these three countries further justifies a transition from a surplus to a deficit in the global balance for 2014. Therefore, we continue to expect increases in international sugar prices, to USD 0.195/lb for the contract due in March 2015.

Artur Manoel Passos



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