Hancock Timberland Investor Brazil January 2019

As Jair Bolsonaro moved towards his October victory in the second-round of the presidential election, Brazil’s equity benchmark index, the Ibovespa rebounded. Rising from a low-point in June of 69815, the Ibovespa gained 17 percent by early August as Bolsonaro rose in the polls. Following Bolsonaro’ s victory with 55 percent of the votes in the second round, the Ibovespa rallied, gaining an additional 10 percent by early November. Subsequently, the Ibovespa has traded in a relatively tight range, averaging 87551 in December and early January, which is a modest improvement (4 percent) over the average sustained in the first 5 months of 2018, prior to the mid-year correction. Financial as well as currency markets (see Figure 3, on page 3) have uniformly reacted positively to the new administration and are hopeful that Bolsonaro’ s actions will reflect his rhetoric. President Bolsonaro and his economic team have set as goals achieving a balanced primary budget in their first year, and his economic advisor, Paulo Guedes, has repeatedly stressed the need for privatization of government assets and pension reform. A divided congress represents formidable hurdles to the implementation of Bolsonaro’ s economic reform programs. Bolsonaro will have the authority to cut discretionary spending (outlays not mandated by legislation), privatize some state assets and reduce the public payroll, but any serious changes to the pension system will need constitutional amendments requiring the support of 60 percent of the members of both houses of congress.1 Markets will be able to better assess the resolve of the new administration to address Brazil’s fiscal deficiencies and reduce the structural impediments to growth as the budgeting process for 2020 gets underway in April, and whether it incorporates targets for a smaller primary deficit and more constrained growth in spending.

Hancock Timberland Investor Brazil January 2019

New President Boost Ibovespa Daily Index Values

Oct 8: BN-Brazilian Stocks, Currency Surge as Bolsonaro takes Commanding Lead

Oct 29: BN-Brazil Assets Climb after Bolsonaro Renews Pledge to Fix Economy

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Bloomberg, January 4, 2019

1Latin America Economies, Capital Economics, 4th, December 2018

Hancock Timberland Investor Brazil January 2019 2

Third quarter economic growth rose 1.3 percent year-on–year, up from 1.0 percent year-on-year in the second

quarter, and a positive 0.8 percent quarter-over-quarter from the second quarter. Consumer spending growth and

exports drove third quarter growth, after industries recovered from the disruptions caused by the truck

drivers’ strike in late May.2 With the end of election uncertainty, the outlook for growth in Brazil is positive.

Growth Again Figure 1: Third Quarter Brazil Real GDP (Percent)

Inflation Ticks Upward While Borrowing Costs Remain Historically Low Figure 2: Quarterly Brazil Interest Rates and Inflation (Percent per year)

Sources: IBGE, Macrobond as of September 2018

Economic Indicators September 30, 2018

Note: IPCA measures consumer price inflation. Selic rate is the benchmark overnight

bank rate calculated from daily rates for a quarterly average

Brazil inflation picked up sharply in the third quarter, averaging 4.4 percent, a full 1.0 percent increase from second quarter’s average of 3.3 percent. Inflation is still well below the five year average for the period of 2013 – 2017 of 7 percent. Brazil’s Central Bank (RCB) referred to underlying inflation as now being at “appropriate” rather than at “low” levels during a September 19 meeting. At this same meeting, the Selic benchmark interest rate was left unchanged at 6.5%, the fourth consecutive decision to hold rates unchanged.3 Given the recent movements in the foreign-exchange market and the potential impacts of the weaker currency on inflation expectations, a possible tightening cycle may be brought forward, and start earlier than proffered for 2019.

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

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Current Quarter (Year over year) Lagging 4 Quarter Annualized

0%

5%

10%

15%

20%

25%

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2010Q1

2011Q1

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Selic IPCA

2Latin America Data Response, Capital Economics , 30th November, 2018

Sources: IBGE, Macrobond as of September 2018 3.Trading Economics, December 2018 https://tradingeconomics.com/brazil/interest-rate

Hancock Timberland Investor Brazil January 2019 3

Foreign direct investment (FDI) into Brazil moved sharply lower in the second quarter to $US 10.1 billion, down 35

percent from the previous quarter, and now 54 percent below the cyclical peak of $US 21.8 billion reached in the

fourth quarter of 2015. Despite lingering economic and political uncertainty, the country’s sheer size makes it a

persistent destination for FDI.

Foreign Investment Drops Sharply Figure 4: Quarterly Foreign Direct Investment – Net Capital Flows (USD Millions)

The BRL weakened sharply in the third quarter against the USD (-10 percent) on strength in the USD and

tightening financial conditions in the U.S. The BRL weakened against the Chinese Yuan (-3 percent) and the

Euro (-7 percent). Post-election in Brazil, the BRL has regained about half of the pre-election depreciation

experienced in the third quarter and has stabilized near 3.8 BRL/USD.

BRL Weakens on Pre-election Uncertainity Figure 3: Quarterly Brazil FX

Economic Indicators September 30, 2018

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$25,000

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Brasil México

Source: OECD as of September 2018 Note: FDI reports lag one quarter

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0.50

0.60

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3.00

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5.00

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BR

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BRL per USD BRL per EUR BRL per CNY BRL per ARS

Source: Macrobond as of September 2018

Hancock Timberland Investor Brazil January 2019 4

Brazil exported 4.9 million metric tons of forest products in the third quarter of 2018, a 7 percent drop in total forest products exports from second quarter, moving further from first quarter’s record volumes. Exports of Brazil’s dominant forest product—market pulp—contracted third quarter, falling 10 percent from second quarter. The impacts of May’s nation-wide trucker’s strike still lingers in production schedules by many pulp and paper producers in the country.7 Lumber exports from Brazil were also lower third quarter, down 1 percent from second quarter. Wood panel exports were the exception, where volumes increased 20 thousand metric tons over second quarter, or 4 percent. The remainder of 2018 looks promising for Brazil forest product demand and exports due to the relative weakness of the BRL and the strength in global markets for market pulp and solid wood products.

Steel production rose to 8.9 million metric tons in the third quarter from 8.6 million metric tons in the second quarter, which is the first quarter in 2018 where steel production has grown. Steel net exports in the third quarter fell 19 percent from second quarter, while steel (apparent) consumption in Brazil moved upwards 19 percent. New trade tariffs on imported steel into the U.S. went into effect on June 1. Brazil was exempt from the broad based 25 percent tariff up to a defined quota, which varies by specific steel products5. Despite these new trade tariffs, the United States continues to be the largest market for Brazil’s exports—at 2.8 million metric tons or 41 percent of year-to-date total exports.6

Sources: Brazil Ministry of Industry, Foreign Trade and Services, September 2018

Steel Production Rises on Increased Domestic Consumption Figure 5: Quarterly Brazil Steel Production, Exports and Domestic Production (Million MT)

Pulp Export Volumes Move off Record Volumes Figure 6: Quarterly Brazil Forest Product Exports (Million MT)

Economic Indicators September 30, 2018

7https://technology.risiinfo.com/logistics-35

2005

T1

2 006

T1

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T1

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T1

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T1

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T1

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0

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10Net Exports Steel Production Apparent Consumption

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1

2

3

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5

6

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2011Q1

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Celulose Paper Products Lumber Panels

Sources: Brazil Ministry of Industry, Foreign Trade and Services, September 2018

5http://agenciabrasil.ebc.com.br/en/economia/noticia/2018-07/brazil-steel-exports-us-rise-after-tariffs 6United States Dept. of Commerce, Global Steel Trade Monitor, September 2018

Hancock Timberland Investor Brazil January 2019 5

U.S. West Coast Sawtimber Price Move off Recent Highs

Figure 8: Quarterly Sawtimber Stumpage Prices for Timber (USD/m3)

Prices for Bleached Eucalyptus Kraft Pulp (BEKP) turned sideways third quarter, reversing a six quarter rising trend, as third quarter prices averaged a record $USD 1,240 tonne. Southern Bleached Softwood Kraft (SBSK) pulp prices continued to set new highs in the third quarter of 2018, with SBSK prices (in USD) up 7.8 percent. The expanding restrictions in China on recovered paper imports has boosted global demand for market pulp and are supporting record price levels8. Even with record pulp prices, pine pulpwood delivered prices in the U.S. South moved lower (1.0 percent) compared to the prior quarter, as southern pulp mills tap into the growing supplies of manufacturing residuals made available from expanding production at the region’s lumber mills. Eucalyptus delivered pulpwood prices in Brazil moved lower again third quarter—falling by 7.2 percent from the previous quarter (in USD), largely due to the downward movement in the BRL relative to the USD.

In the third quarter, pine sawtimber prices (in USD) in Brazil rose 1 percent from second quarter prices and

down 2.0 percent from third quarter prices a year ago, due to the sharp devaluation of the BRL. Measured in

BRL, pine sawtimber prices in Brazil moved upward 0.5 percent from last quarter9. Pine sawlog demand in Brazil

is up due to the favorable export values in USD of Brazil’s lumber and panels shipped to the U.S. Prices for softwood sawtimber in the U.S. West Coast turned down

thrid quarter from second quarter recorded levels. U.S. West Coast prices are still 19 percent above prices thrid

quarter of last year. The price of southern pine sawtimber in the U.S. South moved down slightly, -0.2

percent, from last quarter, now –0.3 percent from prices last year. Finnish softwood sawtimber prices slowed

from last quarter’s price increases, down –0.7 percent from second quarter, still 11 percent above third quarter of last year.

Sources: STCP, Timber-Mart South, RISI as of September 2018

Economic Indicators September 30, 2018

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ulp

woo

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Ma

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ulp

SBSK Market Pulp (USA) BEKP Market Pulp (Brazil)Southern Pine Pulpwood (USA) Eucalyptus Pulpwood (Brazil)

BEKP Market Pulp Prices Turn Lower Figure 7: Quarterly Prices for Market Pulp and Pulpwood (USD/MT)

Sources: Hawkins Wright, STCP, and Timber Mart-South as of September 2018

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Brazil U.S. South U.S. West Coast Finland

9STCP Wood Price Outlook September/October 2018

8RISI World Pulp and Recovered Paper Forecast, 2017

Hancock Timberland Investor Brazil January 2019 6

Disclosures

Hancock Natural Resource Group Research Team

Court Washburn Managing Director and Chief Investment Officer cwashburn@hnrg.com Keith Balter Director of Economic Research kbalter@hnrg.com

Mary Ellen Aronow Associate Director, Forest Economics maronow@hnrg.com Daniel Serna Senior Agricultural Economist dserna@hnrg.com

Elizabeth Shestakova Economic Research Analyst eshestakova@hnrg.com Weiyi Zhang Natural Resource Economist wzhang@hnrg.com

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