Itaú BBA - We expect a partial reversal of the price declines

Commodities Monthly Report

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We expect a partial reversal of the price declines

January 14, 2016

The partial recovery in prices is likely to be a consequence of supply cuts.

For the full report, see enclosed file

• Notwithstanding the recent declines, we forecast a partial recovery of international commodity prices by YE16. Our scenario assumes an aggregate price increase of 27% from mid-January levels, led by a 74% rise in crude oil prices.

• Our view is based on three assumptions: an adjustment of the oil market in 2H16, lower future supply of commodities in China and a waning of “China risk” to around the levels seen in 4Q15.

Commodity prices have continued to slide since late November, falling by 11% over this period according to the Itaú Commodity Index (ICI). The first driver behind the price drop was excess oil supply, reinforced by a lack of coordination with OPEC, which pushed Brent crude down by 33% and affected the other commodities as well. A second driver was growing concerns over China, which affected assets more closely related to its economy.

Breaking down our commodity price index by its components, the ICI-Energy has dropped by 27% and the ICI-Metals has slipped by 5% since late November. The ICI-Agriculture remained stable, once again outperforming the other commodity groups.

Looking ahead, we forecast a partial recovery of commodity prices, expecting a 27% increase in commodity prices by YE16 compared with mid-January levels (led by a 74% hike in crude prices). Our scenario is based on three assumptions:

  1. Additional capex cuts will take place in the oil industry, reducing future supply and leveling the global balance in 2H16, even as exports from Iran increase.

  2. The “China riskpriced into global assets will return to 4Q15 levels. In our view, the Chinese government is able and willing to address the market’s concerns.

  3. China will reduce excess capacity in many industries, removing supply by closing unprofitable mines and plants. This adjustment is being discussed by the government, and if executed will support international prices for iron ore, copper, aluminum and coal.

Current prices reflect risks for metal and oil prices caused by fears of lower-than-expected economic growth in China or a slower reduction in oil output.

On the other hand, upside risks prevail for agricultural prices, due to the risk of unfavorable weather as the El Niño cycle concludes.

Oil: Short-term weakness followed by a recovery starting in the middle of 2016

Oil prices have continued to decline since late November, with Brent and WTI hitting USD 30/bbl and falling below the lows recorded at the height of the subprime mortgage crisis in 2008-09.

Excess supply continues to affect prices. With higher supply from OPEC compared with last year and stable non-OPEC output, the market remains unbalanced and inventories are high.

Furthermore, a lower probability of a cut in OPEC production is now being priced in. The OPEC meeting on December 4 ended without any agreement to adjust production. Meanwhile, the likelihood of a coordinated production cut continues to recede. Deteriorating relations between Iran and Saudi Arabia are further obstructing a return to the active stance the cartel used to take.

We have lowered our 1H16 forecast for Brent crude to USD 37/bbl, on average, from USD 44/bbl. The waning of concerns about China may support a rebound to USD 35/bbl, but prices are unlikely to increase significantly as long as the inventory buildup persists.

Although oil prices are set to be even lower in the short term, we are maintaining our YE16 estimate of USD 55/bbl. In our view, the prices seen in the market over the past 18 months are prompting capex reductions, which will likely lead to a decline in non-OPEC production as early as 2016. This decline and a new round of growth in global demand should be enough to balance the market.

Grains: Recent stability, but El Niño still carries risks

International prices (first due date) for corn, soybeans and wheat have been largely unaffected by the slide in oil prices or by rising concerns about China. Since the end of November, corn prices have fallen by 1.9%, soybean prices have remained flat and wheat prices have risen by 3.9%.

Overall, the outlook for these three commodities remains the same: a relatively loose global balance in 2016, with the main risk factor being the duration and intensity of El Niño. The USDA has revised downward its estimates for corn and soybean ending stocks, but the supply-demand balance remains loose.

Below-average rainfall in the northern part of Mato Grosso state in Brazil is also a risk for the soybean crop, but Brazil is still expected to deliver more than 100 million tons.

We maintain our YE16 price forecasts for corn (USD 4.0/bushel), soybeans (USD 8.8/bushel) and wheat (USD 5.3/ bushel).

Sugar: 4Q15 hike is affirmed

International sugar prices remained close to USD 0.15/lb in December. The contract with the first due date in New York is trading at USD 0.147/lb, having stayed around this level for the past month.

Sugar is still trading at a substantial premium to hydrous ethanol in Brazil. This situation favors more intense usage of the sugarcane crop to produce sugar, but excess rainfall in the Center-South region toward the end of the harvest period is preventing any material reaction of this sort.

We maintain our supply and demand estimates for sugar, expecting average international prices of USD 0.143/lb in 2016, in line with the futures curve. This price level takes into account the likelihood of a deficit in the current crop-year, after five successive crops that led to global surpluses in the sugar market.

Coffee: Neutral balance amid upward and downward drivers

International coffee prices (first due date in New York, arabica) have remained between USD 1.15/lb and USD 1.26/lb, showing little reaction to the currency depreciations in the major producing countries.

We maintain our YE16 coffee price forecast at USD 1.28/lb, in line with the futures curve. In our view, this projection strikes a good balance between downward drivers (favorable weather in Brazil and higher prices in local currency for the biggest producers) and upward drivers (the risk of crop losses in Central America).


Artur Manoel Passos

Ivan Lasaro


For the full report, see enclosed file

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