Itaú BBA - Weaker U.S. dollar, stronger commodity prices

Commodities Monthly Report

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Weaker U.S. dollar, stronger commodity prices

March 30, 2016

We have raised our price forecasts for base metals and agricultural commodities, after incorporating the weaker dollar

For the full report, see enclosed file

•  Commodity prices rose in March, driven by a favorable macro environment (less risk aversion and a weaker USD). Crude oil and iron ore outperformed for specific reasons.

•  We have raised our YE16 price forecasts for base metals and agricultural commodities, after incorporating the weaker dollar.

•  We expect oil prices to continue to climb, reaching USD 55/bbl by year-end.

The Itaú Commodity Index (ICI) rose by 8% in March, with all three of its components posting gains: agricultural commodities (7%), metals (3%) and oil-related commodities (14%). The overall increase was a consequence of the more favorable macroeconomic environment, with less risk aversion and a weaker dollar.

Oil and iron ore prices outperformed the ICI due to idiosyncratic factors. Oil prices remained above USD 40/bbl despite ongoing stock-building. We believe that this resilience was caused by investors anticipating the end of the oversupply, as oil and gas investment remains very weak and weekly crude oil production in the U.S. continues to fall. Iron ore prices rose at the beginning of March, reaching USD 55-60/ton amid a short-term squeeze in China that is likely to fade soon.

We have raised our YE16 price forecasts for sugar (+7%), coffee (+7%) and base metals (2%), taking into account a weaker USD. The net effect is a gain of 0.7 pp in the ICI by the end of the year.

We expect oil prices (Brent) to rise to USD 55/bbl by YE16. The adjustment in the energy sector is underway. Investments have fallen sharply since late 2014, and this will affect production more intensely in 3Q16. Lower U.S. supply will offset higher exports from Iran, likely balancing the global market by mid-2016.

Conversely, iron ore prices are likely to decline as the restocking cycle fades. We project that the global iron-ore surplus will widen in 2016, with stable global supply (higher production in Australia offsetting environment-related slowdowns in Brazil and capacity cuts in China) and declining global demand. Therefore, we are maintaining our forecast for iron ore prices of USD 42/ton at year-end 2016.

The combination of higher oil prices, lower iron-ore prices, and stable agricultural-commodity and base‑metal prices implies that the ICI will rise by 11% by year-end from its current levels in our base-case scenario.

Oil: Additional signs that excess supply will disappear in 2016

Oil prices continued to rise in March, climbing to USD 40/bbl. Excess supply persists, as is reflected in the U.S. Department of Energy’s weekly inventory figures. However, the weekly data also show that total production is falling (see chart), reinforcing our expectation that the excess will disappear in 2016.

The adjustment will not be caused by OPEC/Russia coordination. Saudi Arabia and Russia have agreed to freeze production at January levels, and Qatar and Venezuela have promised to adhere to the deal’s terms. The agreement, set to be ratified at an April meeting, effectively reduces the risk of further production increases by some OPEC members, but we doubt that it will be extended to countries that are likely to expand their output (Iran and Iraq). The geopolitical conflict between Saudi Arabia and Iran also lowers the odds of a broad agreement.

We expect prices to continue to rise as excess supply disappears from the market by mid-2016. According to our estimates, the global balance will shift from a seasonally-adjusted surplus of 2.2 mbpd in 4Q15 to a deficit of 0.2 mbpd in 3Q16, even without any coordinated action by OPEC. In its March report, the International Energy Agency revised its supply and demand scenario, which is now closer to ours.

This transition will likely be caused by falling U.S. output offsetting rising exports from Iran following the end of sanctions, without significant shocks affecting demand or the remaining supply. We assume that: i) demand will remain on a path that is consistent with global growth and the price declines seen over the past two years; ii) the other OPEC members will sustain their current production levels; and iii) the rest of the world will follow the trend seen in recent years, with production not yet reacting to falling prices (and declining investment).

Our YE16 forecast for Brent crude stands at USD 55/bbl. 

Agriculture: Risks of La Niña in late 2016 lift soybean prices

Weather forecasts indicate that the El Niño pattern will weaken over the course of 2Q16. In Brazil, this is favorable for the winter corn crop, but it may hinder the beginning of sugarcane crushing.

For the rest of the year, models suggest that the most likely scenario is a transition to a La Niña weather pattern. This pattern would affect the next crop in the Southern Hemisphere, raising the risk of drought in Southern Brazil and nearby countries (Argentina, Paraguay and Uruguay).

International soybean prices went up sharply in March, while corn and wheat prices were stable.

Risks related to the arrival of La Niña in 2H16 may explain the outperformance of soybean prices during the month. Crop losses in South America would have a greater effect on the global supply of soybeans than on that of corn (very concentrated in the U.S.) or wheat (well distributed around the world). This risk likely lifted soybean prices despite high short-term inventories and the favorable outlook for the current crop in South America.

The market is awaiting reports on planting intentions and quarterly inventories in the United States. So far, the planted area is not expected to shrink, even though prices are below total production costs. The reason for this expectation is that the share of the cost related to “fair” compensation for the land does not affect decisions as to whether or not to plant.

We maintain our YE16 price forecasts for corn (USD 3.75/bushel), soybeans (USD 8.8/bushel) and wheat (USD 5.15/bushel).

International sugar and coffee contracts rose sharply in March, driven by a weaker USD (and more specifically by the appreciation in the BRL). Sugar contracts due in July increased to USD 0.158/lb from USD 0.142/lb, while coffee contracts climbed to USD 1.30/lb from USD 1.18/lb.

We expect sugar prices to fall. The increase in sugar production in Brazil in the next crop will likely be enough to reduce the deficit in the global market. We expect the adjustment in Brazil, along with high global inventories, to lead to a drop in prices.

The outlook for the global coffee balance points to a neutral environment for international prices.

We are incorporating a weaker USD into our price forecasts for sugar and coffee. We have revised our 2H16 estimate for average sugar prices to USD 0.1555/lb from USD 0.1422/lb and our 2H16 estimate for average coffee prices to USD 1.33/lb from USD 1.22/lb.


Artur Manoel Passos
Ivan Lasaro


For the full report, see enclosed file

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