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Sugar

RUSSIAN ROULETTE
23/04/2021

Receives weekly comments from the market







The forecast for the sugarcane crop by a sugar trading company, which scared some participants, was all over WhatsApp groups during the week. The number released by the company showed a sharp drop in the Center-South production to 530 million tons of sugarcane, a contraction of 12.5% against the recently ended 2020/2021 crop. If this forecast should come true, it will have been the greatest drop in sugar production over the last 20 years, only being surpassed by the reduction of more than 22% in the 2000/2001 crop caused by the low sugar prices of the previous year, which made the mills drop the careful attention to the farm work and the yearly renewal of 15% of the sugarcane field due to a total lack of money.  

The news could have contributed to the performance of the futures sugar market in NY during the week. May/2021 closed out Friday at 16.95 cents per pound, appreciating 23 points, equivalent to 5.00 dollar per ton, against last week. It could have contributed, but it must not necessarily have. The market has been fed by robot trading, algorithms, among other artificial agents and the price evolution doesn’t always follow the logic of the fundamentals.

Just for you to have an idea, the hedge funds increased their long positions by 50,300 lots over the week, according to data released by the CFTC. The volume bought is equivalent to 2.56 million tons of sugar and the market went up 118 points over the period (Tuesday to Tuesday). That is, for every 100,000 tons purchased by the funds, the market went up a dollar per ton. It provided all the producers with the opportunity to fix selling prices.

In order to strengthen this bullish feeling, an experienced agronomist believes that last year’s drought and the erratic summer rains, on top of the rainfall level below the average in March and April, will contribute to an expressive break of 50 million tons in the Center-South, supporting the forecast of the mentioned trading company. The bulls are hugging each other and celebrating.

There are several points that keep puzzling me and among them are: a) If the physical market really sees that there will be a shortage of sugar in the world, why aren’t the spreads reflecting that?; b) India has already registered 5.2 million tons of sugar for export, 2/3 of that volume having already been shipped; c) Is world consumption really picking up?; d) If there is a commodity boom, will it contaminate softs too?; e) Will the excess of dollar issuance cause inflation in the United States, interest rate increase and then a bubble burst (see down below)?; f) Who will buy 220,000 lots that the funds are long if they decide to liquidate the position?; g) who will receive the sugar on next week’s delivery? Will it be the same trading company mentioned at the beginning of this comment? h) What if it delivers? Wouldn’t the report be contradicting itself?  The bears are biting their nails.

It’s clear I can be totally wrong about the trajectory that the market is taking. It won’t have been the first time. However, if the decision-making process in the mill were up to me, I would continue fixing prices for sugar for the next crops taking advantage of the profitable prices in real per ton. If there is still doubt, I would buy multiple lots of out-of-the-money calls at the exercise price of about 19 cents per pound. A synthetic put at the end of the day. Missing out on that can be a Russian roulette.

The Russian roulette is a game where participants place a single bullet in the chamber of the revolver, which is spun and closed so as they don’t know the position of the projectile in the chamber. Then, the players point the gun to their own head and pull the trigger, at the risk of dying if the bullet is in the triggered position. Statistically, the chance of success (or survival) is 83.33%.

Chances of success are many times – and especially in this instance – one-off. That is, they need to be taken advantage of at the exact moment. The fact that an event has a high chance of success doesn’t mean we can continue betting indefinitely. If you play Russian roulette even at this probabilistic advantage, you have more than a 50% chance of getting your brains shot in four rounds. By analogy, if in most cases you lose the opportunities the market shows you, you can get hurt.

==

Michael Burry, is that American physician who turned into an investor and was the one who predicted the 2008 bubble with the subprime crisis, a kind of mortgage credit created in the American real estate market focused on the borrowers who represented greater risk. It was assumed that gathering several of these individual risk credits in larger tranches, the risk would dilute and the paper currency would become more profitable.

The crisis made companies that until then were renowned on the world market, such as the investment banks Lehman Brothers (it lost 691 billion dollars), Bear Sterns, the insurance company AIG, to mention a few, disappear at the snap of a finger. Burry bet against the bubble and then the fund he was managing yielded a return of almost 500% for its shareholders in a little less than eight years. The stress of this period made Burry closed the fund as soon as he settled its successful positions. If you want to know all the history, watch the movie “The Big Short” based on the book by Michael Lewis, author mentioned in our comments numerous times.

Burry predicts that a new wave is coming up, “it will be a lot worse than the 2008 one”. One of the inconsistencies he sees is the fact that in a pandemic year the American stock market continues high, basically due to the excess of money issued (injected by the government) since the pandemic started – fiat dollars which will create inflation in dollar further ahead. He believes the stock market is going through a bubble and we are on our way toward a new collapse.

Since we don’t know what might happen, the best thing to do is protect the company against tail events that might hurt the result (as we said here in the comment a few weeks ago http://archerconsulting.com.br/artigos/artigo9772/).

Wish all this market bulls and bears a great weekend.

Arnaldo Luiz Corrêa

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Receives weekly comments from the market