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Sugar

WEAKNESS AHEAD
07/08/2020

Receives weekly comments from the market







 

“In a time of universal deceit, telling
the truth is a revolutionary act.”
 
 Attributed to George Orwell (1903-1950)
British writer and journalist

 

The sugar market in NY closed out the week pretty much unchanged for the two first maturities – October/2020 at 12.63 cents per pound and March/2020 at 13.25 cents per pound. The real was what made the difference when it devalued by about 4% in the week against the dollar, improving prices by about 65 real per ton for 2020/2021, R$58 per ton for 2021/2022 and R$44 per ton for 2022/2023.

The drop in the value of the real made the future contracts with longer maturities experience a drop of almost two dollars per ton for the 2021/2022 harvest and about 4-5 dollars per ton for the 2022/2023 harvest. The price curve in NY is clearly descending and skewed due to the real.

The values in real per ton now obtained by the mills in sugar pricing for the 2022/2023 harvest due to a possible appreciation of the Brazilian currency, following the curve of the Focus bulletin, would only have same value in real per ton – keeping everything else unchanged – if NY went up 120 points. Not fixing prices now can be a huge mistake for the mills.  

For the prices in real per ton now obtained to be seen as bad, the market would need to go through a perfect storm that would push the sugar price in NY to much higher levels, that is, exogenous factors that are beyond our scope right now and that we cannot protect ourselves from. So, if the current values of the 2022/2923 harvest – R$1.450 Santos FOB on average adjusted to present value – are disturbing, it’s worth buying an out-of-the-money call to protect from a possible sharp market rise and also, even more importantly, as cash flow hedge for possible margin calls.

It’s worth noting once more that in 2010, in the week of the sugar gala dinner in NY, the market hit 13 cents per pound and many guests heard from renowned gurus that the market was clearly moving toward 10 cents per pound. Just seven weeks later, it was at 18.40 cents per pound. And it doubled in price (26.33 cents per pound) before it hit 100 sessions after the dinner.

But many readers will say that the picture is pretty different now. The dollar was just at R$1.7500 (when many mills took out huge loans in dollars, but this is another story). The values in real per ton obtained by the mills were hardly reaching R$1,000 per ton, but actually, this period represents the highest level (in adjusted values by the IGPM – General Market Price Index) ever seen this century.

At current price levels it makes sense for India to see an excellent opportunity to unload its sugar on the foreign market. The lowest price in that country after deducting the export subsidy is about 12.50-13.00 cents per pound.

The position of the principals released today by the CFTC shows that the non-indexed funds were long by 148,308 lots, an increase of 54,043 lots in a week. The numbers are based on Tuesday’s position.

I have a bearish view on this position of the funds, because they added 54,000 lots to their purchases to move the market just 77 points (the two previous Tuesdays’ closings). This represents 35,000 tons to move a little point! The question is: when they decide to get out of the position (selling) or roll over the position, who will give them liquidity buying sugar in the midst of a pandemic, dwindling economy, and shrinking consumption? There is a lot to think about that. Four weeks ago, we said that in our opinion the position of the funds is vulnerable. Now, we think that it is fragile. The producers in Brazil and Central America are thankful and must have taken advantage of the recent high prices.

Life is not easy for the commodity companies. In less than a month the news agencies announced that two large banks of world access have stopped new commercial financing involving commodities. The trend has been for banks to just stop operating with commodities closing their trading desks. This is a crisis that has been dragging on for more than two decades. On the sugar market, for instance, we can list at least 20 trading companies that traded the commodity, buying sugar from mills in the Center-South, in the second half of the 1990’s. Today, this number has been reduced by at least 2/3.

Sugar is a product that is traded in large volumes, needs logistical efficiency, demands capital intensive which usually finances the two ends (buyer and seller, mill and refinery), demands close attention to spreads traded on the futures market, requires careful fundamentalist analysis and a skilled team with market intelligence to help with the management of the basis and directional book. Not to mention the creativity and preparation of the derivatives required by the clients and the risk management of the Greeks (delta, gamma, volatility). Too much work for slim margins.

On the other side, looking at all this, are the bank commodity desks that frown on the size of the risk of their clients’ operation in their numerous and sophisticated tentacles, and question themselves whether it’s worth lending money under this scenario of continuous risk. The Darwinian evolution is/was present on the commodity market in Brazil and many companies (trading companies, coffee exporters, mills, processors, among others) are going to be/were left behind. It’s an ongoing process.

Registrations for the online and live 34th Intensive Course on Futures, Options and Derivatives – Agricultural Commodities are open. Classes will be held in the first two weeks of September. Click on https://youtu.be/YyoR2BcpyI8 for further information. Spots are limited and you can pay in up to 10 installments.

Have a nice weekend everybody.

 

Arnaldo Luiz Corrêa

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Receives weekly comments from the market