Sugar


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WORRISOME PARADOX

Weekly Comment – July 31 to August 4, 2017

The futures sugar market closed Friday with October/2017 traded at 14.14 cents per pound, a 23-point fall, or five dollars per ton against the previous week.

The market was taken aback by the so-called fat-finger, a situation where the wrong key is pressed when filling out the price of a purchase or sale order given on the market making it fluctuate violently until it goes back to the previous levels after the mistake has been absorbed. Because of that, October was trading at 13.92 cents per pound for some milliseconds. It is unbelievable that with so many sophisticated systems and algorithms, mistakes such as this are not immediately detected and controlled by the exchange.

The funds are slowly starting to buy again in the soft commodities (sugar, coffee, cocoa, cotton and orange juice) and this can bring support up to the levels of sugar price. This Friday, the release of commitments of the principal agents considered until last Tuesday, show that the funds repurchased 35,000 lots, but they are still short on sugar by about 72,000 lots or 3.6 million equivalent tons of sugar, reinforcing what we said previously.

With July’s closing, the average price on the daily closing of the futures contract in NY was 14.12 cents per pound, 4.35% above that one seen in June. Over the last eighteen years, it has been proven that the average prices seen over April-May-June-July are lower than the highest monthly average price of the year. In short, we can say with a reasonable hit probability that we have already seen the lowest price of this year, which occurred in late June: 12.53 cents per pound. 

Our model for price estimate showed that the average price in July would be 14.28 cents per pound. The market maximized the fall and, looking at early August, we want to believe that the average price this month can surprise us. The model shows that at the start of the last quarter of 2017, NY can reach the 16.56-cent-per-pound average with an eventual peak up to 18.02 cents per pound in that month. Don’t ever forget that models fail and the performance of the funds, depending on the flow, makes the market overreact in either direction.

With Congress voting for dismissing corruption case against Temer, the political instability decreases and opens up room for reforms to be approved. This favorable environment can mean a more valued real. 2018 will bring huge uncertainties because it is a presidential election year and, unless you want to be embarrassed, it is best not to make any predictions. However, with Lula behind bars (more viable hypothesis) and a weakened left wing, the possibility of our having several candidates with less than 20% of the votes, opens up a huge scope of worrisome candidates and any outcome is possible – and the world has shown that.   

Let’s imagine that a candidate who is pro-market, liberal and introduces an economic policy that is not interventionist gains strength in the presidential race next year. What would happen, in this case, with a valued real? And what if, in addition, the oil foreign market was trading between 40-45 dollars per barrel? For the sugar-alcohol sector, it would be extremely worrisome.

Strong real and weak oil would detonate ethanol price, increasing sugar supply and pressing the quotes of the community at the exchange. On the other hand, it is true that a pro-market government would bring income and consumption growth which could counter with the environment of pressured ethanol prices. It is always good to keep in mind that the consumption of fuel increases exponentially more than the GDP when it increases.

How to prepare for this possibility? Some banks and institutions must be preparing to soon offer structured operations referenced at the exchanges with this purpose. One of them can be the purchase of a put financed by the sale of a call of RBOB (in Reals) to hold a minimum value for ethanol (assuming that it trades at the parity of 70%).

The sector can face an important paradox next year. There are several operations which can be made based on the need of each mill, what cannot happen is for one to sit looking at the screen and rooting for better prices. It is a crucial moment for the companies to pay more attention to risk management. There is no salvation without it.  

Electing a modern president can bring the Brazilian economy a starry sky, but there is the possibility that heavy clouds might hover over the sector. It is safe to keep ahead of this possibility.

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Have a nice weekend.

Arnaldo Luiz Corrêa

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