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Sugar

RISKS ALL OVER THE PLACE
12/02/2021

Receives weekly comments from the market







Without any revealing change in the sugar market fundamentals, March/2021 futures contract in NY got to trade above 17 cents per pound over the week, stunning lots of traders and triggering margin calls on traders short at an exercise price around this level by the most scared operators.

It seems to us that March/2021 has been driven by robots and algorithms aiming to maximize the rollover margin of the funds that are long in March and that, with the artificial acceleration, undo the purchase of the contract maturing in March and repurchase the contract maturing in May showing a significant gain in the portfolio. The funds must have rolled over most of their positions (some just liquidated their positions and made a profit). After the work was done, March/2021 closed out exactly at the same level as last Friday’s – 16.42 cents per pound.

With the world economy severely affected by the pandemic, it’s just natural for the industrial consumers/end users to just buy their inputs hand-to-mouth. This behavior can partially explain the rush of the end users to cover their short-term needs for input. In short, lots of importers postponed their purchases and now they have to pay the price to redo stocks.

It’s said the huge sugar delivery against March/2021 that occurs at the end of this month should be between 1.0 and 1.5 million tons. The receiver should be associated with a refinery or else there is no economic sense to receive March for a possible redelivery in May.

Over the last twelve months Brazilian sugar exports have accumulated 31.1 million tons, which represent a surplus of 12.6 million tons of sugar compared to the same period last year, which Brazil dumped on the foreign market supplementing any deficit shown by their competitors.

The exported volume is a record of records and reveals an increase of 67% over a one-year period. Only from April/2020 to January/2021, assuming this period represents the 2020/2021 crop, we have already come to 28.4 million tons of exported sugar, 75% above the volume exported over the same period of 2019/2020.

We cannot turn a blind eye to the fact that the 2021/2020 crop that starts soon will again prioritize sugar production. The survey by Archer Consulting shows that the Center-South should produce 578 million tons of sugarcane, a reduction of nearly 4% against the previous crop. Our production estimate is 35.3 million tons of sugar, a reduction of three million tons compared to 2020/2021 and a smaller ethanol production, whose total should come to 27.4 million liters, almost 2 billion liters less than last year. Out of this total, we estimate 2.4 billion liters of corn ethanol.

Export sugar of the 2021/2022 crop is already fixed by more than 75% at an average price around R$1,600 per FOB ton. That is, Brazil’s sugar flow destined for the world market will continue through the next 12-15 months and it’s hard for us to see any difficulty supplying the commodity that makes it possible for the futures market of NY to be able to stay above 16 cents per pound for very long unless, of course, the algorithms and robots think otherwise.Ethanol should have a year of good profit. With the mills maximizing the sugar production and estimates for GDP growth around 2.5% and the Otto Cycle at 5%, together with a possible improvement on the post-vaccine global economy and a tight internal supply of the product, we believe that the average price for ethanol for the 2021/2022 crop will be R$2.7000 per liter with taxes, and possible sporadic peaks of R$3.0000. Those with empty tanks and cash-rich will have a blast.

We have been reiterating that sugar consumption in 2020, whose final figure has yet to be published, should be negatively surprising. It’s hard to assume that consumption could have been better than the disappointing average yearly growth of 0.46% of the last five years. To me this is the point that will show that some countries used part of their strategic stocks (so as not to import), other producing countries did the same to be able to meet foreign demand and the world has enough sugar in the system to fend off any deficit that feeds into the irrational price spike. What can go extremely wrong with this analysis?

Let’s see. The non-index funds are still long, according to a bulletin by the CFTC by 209,000 lots. The mills are pretty well hedged for this crop that starts at the equivalent to 440,000 lots, which could be on their own, or together with trading companies and financial institutions and over-the-counter operations suppliers.

If the funds decided to sell their long position, they would need to find a counterpart that needed them. Industrial consumers have been holding off on purchases, because they believe prices are artificially high. So, a massive settlement of the funds can have enough magnitude to scare, for example, 45,000 lots of puts at exercise price between 15.50 and 13.50 cents per pound. You can imagine the damage, right?

There is also the risk that the market will go up. Much is being said about the new cycle of commodities hike, the same we saw at the start of this century. Only now, especially when it comes to sugar, what we see is a lack of investment and a migration to crops that pay better (grains, for instance). However, in the yearly accumulated, neither grains nor soft commodities show encouraging enough performance to the point where we can predict a new hike cycle, but it can happen. How to protect from it?

If the funds continue adding new purchases and are adjusted by unimaginable exogenous factors right now (tail events), we can see the sales hedges being severely affected by the margin call that in an effort to mitigate the risk on the part of the hedgers makes the volatility of the calls blow up. So, we can strongly recommend the purchase of out-of-the-money calls (out-of-the-money options) at an exercise price 200/250 points above the market as cash flow protection (margin) and participation in a possible market high.

I read “Factfulness: Ten Reasons We’re Wrong about Things the World and Why Things Are Better than You Think” by Hans Rosling, a Swedish doctor who died in 2017. The book destroys wrong concepts we have been carrying over the years, deconstructing myths and changing the way we see the world, making us able to have a more realistic analysis about crisis and future opportunities. It’s recommended for all traders and decision makers.

Have a great weekend everybody.

 

Arnaldo Luiz Corrêa

 

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Receives weekly comments from the market