Itaú BBA - Weather-Related Uncertainty

Commodities Monthly Report

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Weather-Related Uncertainty

February 11, 2014

Hot and dry weather in Brazil has led to reduced crop forecasts for coffee, sugar, corn and soybean.

•  Hot and dry weather in Brazil has led to reduced crop forecasts for coffee, sugar, corn and soybeans, in descending order of likelihood and magnitude.

•  There are higher odds of an El Niño weather pattern arriving around June, bringing more rainfall to the Americas and dry weather to Asia. If this pattern does appear, there may be a reduction in global sugar production, higher yields in the 2014-15 crop in the U.S. (corn, soybeans and wheat) and lower yields in Asia.

•  Non-precious metals remain on a downward trend, as sentiment toward emerging economies has deteriorated and economic data from the U.S. came in weaker. However, we see this as likely to be a temporary effect. Hence, we are maintaining our year-end price forecasts, assuming only a slight drop from current levels.

Higher commodity prices due to unfavorable weather. The Itaú Commodity Index (ICI) has risen by 1.7% since its recent low (on January 9), driven by higher prices for agricultural products (4.1%) and energy (3.4%), despite another decline in the metals price sub-index (-4.0%). Agricultural commodity prices were affected by sustained strong net export sales of U.S. grain and by weather conditions unfavorable to crops (snowstorms in the U.S. and very dry and hot weather in Brazil). Energy commodity prices were also affected by an especially cold winter in North America, along with further improvements in the oil-transportation infrastructure in the region. Nevertheless, we are leaving our year-end price forecasts unchanged (please refer to the table and charts at the end of this report).

Dry weather in Brazil means uncertainty about agricultural commodity prices. The recent hike in agricultural commodity prices is explained by the weather in Brazil and strong demand for U.S. corn and soybeans. The Brazilian drought is likely to last until mid-February, leaving significant upside risk for coffee and sugar prices. We do not expect international corn and soybean prices to be affected for an extended period. For soybeans, worse growing conditions in parts of Brazil are being offset by improved conditions in Argentina. For corn, the drought has delayed the seeding of the winter crop in Brazil, decreasing expected yields and increasing the risk associated with possible frosts. However, the surplus in the global balance should prevent international prices from being significantly affected by a smaller Brazilian crop; only domestic prices are likely to rise. All things considered, we are maintaining our year-end price forecasts for agricultural commodities, but we see more upside to our estimates for sugar and coffee prices, which are currently at USD 0.184/lb. and USD 1.15/lb., respectively.

Metal prices fall amid new (but likely temporary) concerns; our year-end forecasts are unchanged. The ICI Metals sub-index has already fallen by 7.6% year-to-date, driven by lower prices for iron ore (-11.4%), aluminum (-5.5%) and copper (-3.6%). This performance may be attributed to renewed concerns about China and other emerging markets and to a series of weak economic data releases in the United States. However, we expect the perceived risk about Chinese growth to subside to the levels seen in late 2013, and in our view, the weakness in U.S. figures is temporary. Hence, we are maintaining our year-end price forecasts, which assume a milder drop in prices for the remainder of the year (-2.4% from current levels).

A more constructive environment for WTI prices. WTI crude prices have climbed by 8.2% since January 9, boosted by slightly lower output in the U.S. and improved capacity to move oil from the Cushing hub. Meanwhile, Brent prices keep falling in response to lower geopolitical risks and the prospect of a looser balance in 2014. Hence, the narrowing WTI discount to Brent is consistent with the fundamentals. Given the fundamentals and the current evolution being in line with our scenario, our year-end forecasts for Brent (USD 105/bbl) and WTI (USD 101/bbl) prices remain unchanged.

Agricultural commodities: weather-related risks and mixed reactions

Prices for the main agricultural commodities rose in February, with gains for coffee (8.8%), wheat (5.2%), soybeans (3.3%), corn (2.1%), cotton (1.8%) and sugar (0.6%). Two points mentioned in our previous report partly explain this move. First, the pace of purchases of corn and soybeans produced in the U.S. remains strong, driving prices up. Second, there is a risk that the winter weather in the U.S. was severe enough to affect its wheat crop.

New risks: a dry start to the year in Brazil and the likelihood of El Niño in June. Following a long period of near-normal weather conditions in terms of agricultural production, two climate anomalies have brought uncertainty to the markets. The first is the dry and hot weather that has prevailed in Brazil since late December and is expected to last until late February. The second is the prediction by several weather models of the arrival of an El Niño pattern by June.

The dry weather in Brazil could affect coffee, sugarcane, corn and soybean plantations, in descending order of likelihood and magnitude. The coffee crop is the most vulnerable. As the global balance is near equilibrium and price-demand elasticity is low, we see strong upside risk to our price estimates. Our year-end price forecast (USD 1.15/lb.) is likely to be revised when new information becomes available. The potential impact of the drought on the sugarcane crop is also large, but rainfall in March and April could lead to a partial recovery. The summer soybean and corn crops could also be affected, but the critical period for plant development has already passed. Corn prices may be affected by a delay in planting the winter crop, as such postponements reduce expected yields and increase the risk of losses due to weather events (frosts, for instance). On the other hand, the same weather phenomenon which led to a drought in Brazil has led to more rainfall in producing regions in Argentina, which should partly offset lower Brazilian production of corn and soybeans.

The arrival of an El Niño weather pattern around June would bring more rainfall to the Americas and less to Asia. Hence, conditions for the 2014-15 crop in the U.S. would be better (increasing expected corn and soybean yields), but the harvests of these commodities in China and India would be hurt. Sugar output would be doubly hurt: rainfall above seasonal levels in Brazil would hinder the sugarcane harvest, while dryer-than-usual monsoons would reduce yields in the 2014-15 crop in India and Thailand. Hence, we see significant upside risks to our year-end sugar price forecast (USD 0.184/lb).

The evolution in weather conditions does not support changes in our year-end forecasts for international corn, soybean and wheat prices. The negative impact of weather conditions on Brazil’s corn and soybean summer crops is being partly offset by improved conditions in Argentina. The second corn crop in Brazil may be deeply affected, but the surplus of this commodity in the global balance is so large that international prices will probably be unaffected, limiting any price shock to the domestic market. Regarding wheat, the risk that the severe U.S. winter has affected the crop has already deterred us from making any downward revisions in forecasts since our last report. We will wait for new information on the quality of the U.S. winter wheat crop before revising our estimates. Our year-end price forecasts for corn, soybeans and wheat remain at USD 5.0/lb, USD 12.2/lb and USD 6.8/lb, respectively.

Artur Manoel Passos




* The Itaú Commodity Index is a proprietary index composed of commodity prices, measured in U.S. dollars and traded in international exchanges, which are relevant to global production. Its sub-indexes are Metals, Energy and Agriculture

** The ICI-Inflation is a proprietary index composed of commodity prices, measured in U.S. dollars and traded in international exchanges, which are relevant to inflation in Brazil (IPCA). Its sub-indexes are Food, Industrial and Energy.

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