Viva Brazil! - Market Analysis for Jun 8th, 2019

  • The real bounces
  • Brazilian stocks rally
  • Brazilian commodities post gains
  • Lots of upside in the Brazilian currency
  • President Bolsonaro holds the key

Brazil is the most populous nation in South America with the leading economy. With over four times as many people as Colombia, the country with the second highest population on the continent. Brazil is fifth in the world when it comes to the number of inhabitants. Brazil is also the leading economy in South America as the geography, and climate support crop growth and the crust of the earth within its borders is abundant with the many of the commodities that people all over the world require in their daily lives.

As a supermarket to the world, Brazil has a substantial influence when it comes to the path of least resistance of many commodities prices. Since the dollar is the reserve currency of the world, it is also the benchmark pricing mechanism for most raw materials. However, the cost of production within Brazil is a function of the country’s currency instrument, the real. Since labor and other local costs of extracting minerals and ore and growing crops are based on the level of the Brazilian real, a move in the currency can ripple around the world when it comes to the price consumers pay for the products from Brazil.

An example of just how influential the Brazilian real can be for commodities prices, one of the reasons that the raw materials asset class rose to all-time highs in 2011 was that the Brazilian currency traded at a high against the US dollar at $0.65095 in July 2011. Since then, it has been all downhill for the currency relationship, which has sent the prices of commodities where Brazil is the leading producer and exporter in the world lower.

While the real remains not far from its recent low, there are some signs that a recovery in the currency could be on the horizon. If the market is entering a Viva Brazil period, and the real is heading higher, many commodities prices are likely to follow, which could have significant ramifications for global inflationary pressures.

The real bounces

The trend in the Brazilian currency versus the US dollar has been bearish since 2011.

Source: CQG

The monthly chart highlights the deep decline in the currency as it fell from $0.65095 in July 2011 to a low at $0.23040 in late 2015. Corruption and scandals sent the currency to the lows. After an attempt at a recovery that took the real to $0.33 against the US dollar in early 2017, it fell to a marginally higher low at $0.23625 in September 2018, which was 63.7% below the 2011 peak. At first, it appeared that the real was heading for an even lower low, but since last September the real stabilized, and over recent months the currency remained above the low.

Source: CQG

The weekly chart shows that the Brazilian currency made another higher low at $0.24225 during the week of May 20.

Source: CQG

The daily chart illustrates that the most recent high was at $0.26010 on June 5, and was trading at the $0.2574 level on Friday, June 7, 6.3% higher than the most recent low. The real bounced off a higher low, and that has sent Brazilian stocks higher.

Brazilian stocks rally

The iShares MSCI Brazil Capped ETF product (EWZ) holds shares in many of Brazil’s leading companies.

Source: Barchart

The EWZ EFT moves from a low at $36.70 on May 17 to a high at $42.99 on June 7, a rise of over 17% in under one month. The increase in the Brazilian stock market is at least partially a function of the recovery in the currency.

Brazilian commodities post gains

Brazilian stocks have not been the only beneficiary of a stronger real. Brazil is the world’s leading producer and exporter of three soft commodities; sugarcane, Arabica coffee beans, and oranges. The rise in the currency has also had a bullish impact on futures prices in agricultural products.

Source: CQG

Nearby July sugar futures have rallied from 11.36 cents per pound on May 21 to close on June 7 at 12.50 cents, a rise of just over 10%.

Source: CQG

The price of July Arabica coffee futures moved from a low at 87.60 cents per pound on May 7, to $1.0095 per pound on June 7, an increase of over 15% in one month.  

Source: CQG

Finally, frozen concentrated orange juice futures appreciated from 90.60 cents per pound on May 6 to settle on June 7 at $1.0610, or over 17% higher.

As the Brazilian real rises against the US dollar, the cost of producing the three soft commodities increases, putting upside pressure on their prices.

Lots of upside in the Brazilian currency

Considering that the Brazilian real fell to a low, that was almost one-third its level against the dollar since 2011; there is plenty of room for a recovery rally from a long-term perspective. The recent marginal rise in the real had a magnified impact on Brazilian stocks and the three soft commodities that come from the nation. A continuation of the recovery in the currency could have an explosive effect on those markets over the coming weeks and months.

From a technical perspective, a 50% retracement of the move from the 2011 high to the 2015 low would take the real to the $0.44 level against the dollar. If that occurs, look out, because the prices of coffee, sugar, oranges, and the leading Brazilian stocks could be heading for much higher levels. When it comes to the commodities, the soft sector of the asset class has a long history of high price variance. It is not uncommon for the members of the sector to have their prices double or triple. Considering that sugar, coffee, and FCOJ futures are all a lot closer to multi-year lows than highs, the risk-reward profile of the markets is compelling if the Brazilian currency is ready for a recovery.

President Bolsonaro holds the key

Last October, Brazilians went to the voting booths and elected a far-right candidate who pledged to clean up corruption in the country. President Jair Bolsonaro has been in office since late last year, and if he succeeds in delivering on his campaign promises, the value of the real currency will likely continue to climb.

After years of corrupt governments, a pro-business leader who can improve the environment would attract foreign investment. President Bolsonaro holds the key to Brazil’s future at this point. Even a marginal improvement would likely lead to gains in the currency as the bar for success is so low.

I am bullish on the prospects of growth in Brazil, and that translates to an expectation that Brazilian shares and the prices of the commodities that come from the nation will experience appreciation. As the production cost for sugar, coffee, and oranges increases, the price in dollar terms should go along for the bullish ride. The low level of current prices limits the downside and makes the upside explosive from a risk-reward perspective. A long position in any of those commodities is a vote for Viva Brazil.