Michael Lewis, American journalist, economist, writer, NYT columnist and a great expert on the entrails of financial markets, with several books on best sellers’ list such as Moneyball, Liar’s Poker, Flash Boys, among others, recently published an amusing book where he tells the gripping story of partnership and friendship between two Israeli psychologists, Danny Kahneman (Nobel Prize winner in 2002) and Amos Tversky, whose work gave rise to the book “Thinking, Fast and Slow”.
In the book “The Undoing Project”, Michael discusses the conclusions of the two friends over several years of study about the human process of decision making, showing that the mind, when required to make choices in situations of uncertainty, is systematically wrong, undoing and deconstructing the idea that we human beings make rational decisions. We might even make them sometimes, but this does not always occur. Their work had a huge impact on several areas promoting advancements in the analyses of medical diagnoses, among others.
You, dear reader, must be asking yourself why on earth after four weeks on vacation without the weekly comment about the sugar market, in the middle of an avalanche that made the prices of the commodity melt in the NY exchange, plummeting from 15.16 cents per pound to 13.25 cents per pound, this scribe starts out the year reviewing a book. Calm down, I will get there.
Danny and Amos had already talked about algorithms decades before the market started using the term. As far as their role went, the algorithms helped to take the personal component, subjective inferences, and other filters away when it came to recruiting soldiers for the Israeli army, increasing the efficiency in the choice of professionals.
On the markets, the algorithms are used by some funds and investors to take advantage of the human weaknesses to make decisions rationally which maximize profits or losses: euphoria and panic. That is, the funds and investors use complicated mathematical formulas and deterministic and non-deterministic algorithms and operate on the market, free from the human restraints linked to fears, euphoria, and panic.
It is evident that one can make money on euphoria and panic. On euphoria, the active prices are artificially high by means of systematic buys (the bitcoin market is a recent example, sugar at 24 cents per pound in October/2015 is another one) to the point where the funds make profits of more than two billion dollars (on sugar).
On panic, which is the current sugar situation, the positions are systematically sold by the funds which increase as the panic sets in (analysis by Big Data, as a quant told me) and those who do not make rational decisions help bring down prices even further. Danny Kahneman himself saw that people when confronted with losses, start searching for risks. That is, that same company which shrugged off the market when it was at 24 cents per pound, now jumps in to fix its prices at 13 cents per pound.
Therefore, on one side we have worried traders and mills trying to survive on a market where fundamentalist news are demonstrably bearish and, on the other side, robots programmed to make the most out of two human traits which are not always constructive. But this is science fiction. Is it really, you might ask.
Well, speaking fundamentally, the idea that sugar prices were inflated in October/2015 was easily seen because the hydrous, for example, got to trade at 800 points of discount against the sugar. That is, something was terribly wrong. The advice we would give out then was to fix sugar prices along the curve in real per ton at the highest volume possible because the profit, vis-à-vis the average production cost, was extraordinary. Today, when we see that hydrous trades at 450 points of premium over sugar, the perception we have is also that there is something terribly wrong. Well, what can we do? Let’s try to look at it rationally.
No one has doubts about the expected surplus for this year – much less about the Indian production which points to 27 million tons of sugar or the increase in Thailand and EU’s production. What is discussed is how bearish the market can be. Both highs and lows get blown out of proportion. Let’s see, Friday’s closing in NY amounted to 973 real per ton. The average over the last eight years was 1,031 real per ton. The lowest value occurred in May/2010, 570 real per ton and the highest one was in October/2016, 1,762 real per ton. The lowest value mentioned above, if adjusted by the IGPM (General Market Price Index), would be 915 real per ton today, or the equivalent to NY at 12.50 cents per pound.
The thing is in 2010 there was no concern over the production of sugarcane in Brazil like there is today. The estimated production for 2018/2019 in the Center-South is 585 million tons of sugarcane with a clear low bias. ATR will definitely be smaller. That is, we have still been at a standstill since 2010/2011 with just about the same production of ATR. On the domestic consumption front, there is an increase in the sales of flex-fuel vehicles, greater demand for hydrous due to the fact that gas is more expensive and a trend that – if the GDP (Gross Domestic Product) really increases by 3% in 2018 – there will be an increase in the consumption of Otto cycle fuel by three billion liters, of which 40% is ethanol and are equal to a decrease of two million tons of sugar.
But it also happens that we started 2018 with a great volume of pending fixations on the part of the mills which were still hoping for the best and which – according to the market – ended up pouring out the pending lots over the past days. The OTC structures (the ones the kill you later) where the mills get by on less hedge than they expected and had to adjust the delta selling on the market also contributed to some degree. And, of course, last but not least, an Agriculture Minister who makes an inappropriate statement about the import tax on ethanol. Finally, there is no rational decision that will withstand so many hurdles.
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Wednesday, the 24th, is the trial of the biggest scoundrel in Brazilian history. There is a great hope that Brazil will once and for all turn this sad page of our history and definitely bury this left wing made up of gangsters that plague the country.
The book “Derivativos Agrícolas”, written by journalist Carlos Raices and me, is already available at Amazon Books, iTunes, Google Play, Kobo and Livraria Cultura. All you have to do is access the following link. Good read!
https://itunes.apple.com/br/book/derivados-agr%C3%ADcolas/id1294585521?mt=11
There are only very few spots available for the XXIX Course about Futures, Options and Derivatives on Agricultural Commodities which will take place on March 6,7 and 8 2018 in São Paulo, SP at the Hotel Wall Street. For further information: priscilla@archerconsulting.com.br
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Have a nice weekend.
Arnaldo Luiz Corrêa
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