The sugar market in NY closed Friday unchanged in relation to last week. March/2016 closed at 14.28 cents per pound followed by the other trading months whose fluctuations varied from unchanged to an 8-dollar-per-ton loss over the week. The funds, according to the last data survey made last Tuesday, are long at almost 145 thousand lots equivalent to 7.4 million tons.
The physical market hasn’t kept up with the same strength as the futures and, of course, this is a point of concern. Though the funds are long and seemingly comfortable with their positions which should represent a 120-million-dollar profit not yet realized, the physical market trades at discounts still way above the cost of carry until March. That is, the trading company which received a great amount of sugar, according to market brokers, hasn’t been able to sell the product without giving huge discounts.
The number released by UNICA shows that until the first fornight of October the Center-South has already crushed 480 million tons of sugarcane divided between 25.3 million tons of sugar and 21.9 billion liters of ethanol. The accumulated amount in the harvest is 132.75 kilos of ATR per ton.
A bull market scares some mills which paradoxically would rather NY not go up so much now and “at least hold out until March”, like an executive in the sector has put it. The explanation is that over-the-counter operations whose fixed values double if a certain price level is negotiated (which has already happened) and NDF exchange operations require complementation or margin call due to the appreciation of the sugar at the commodity exchange and of the dollar against the real, respectively. So, a lot of mills and trading companies have had to spend resources to honor these commitments. Those who have been through a similar situation know how stressful it is for a company to see its cash balance being wiped out, even if it is temporarily, since the margin will be back via billing revenues down the road. But until then…
This uncomfortable situation could bring pressure onto the sales of those products the mill can turn into cash right away, that is, ethanol and sugar on the domestic market (with obvious restrictions). It’s been said on the market that some companies have partly or totally settled their over-the-counter positions because they can’t afford to keep spending money on margin. This is bad for risk management.
The sale value of a commodity depends on three strong trading pillars. The first pillar is the futures market. The ability to know when to fix or at least hedge its contracts using futures and options makes a difference. It’s extremely important for the company to know and quantify the risks involved in an operation with derivatives so as not to be caught off guard in stressful situations such as the one taking place now. The second pillar is the exchange rate. The financial and commercial departments must hold hands in order to search for the fixation goal in real for the commodity according to the budget of the company and the production cost. The third pillar is the commercial negotiation itself. Fixing exchange rate and futures doesn’t effectively translate the final sales price determined by the company, for this value will still be changed by the premium or discount the physical market trades at. That’s why the commercial contracts are equally important, even more so for those companies which don’t have an open account with the brokers to operate on futures market, since they eliminate the basis risk (the difference between the physical market and the futures market).
It’s always good to reinterate that a margin call can break a company regardless of whether it has used a good commercial strategy or not. Examples abound on the commodities market. The most famous being Metallgesellschaft (if you’re interested, look it up on Google).
Measuring risk and stressing the position to antecipate problems is the most adequate medicine. Remember when the market hit 36 cents per pound? A lot of companies which were hedged at levels lower than the market’s had to take a heavy margin call which wiped out the cash balance and credit lines. To lower this stress, they bought calls (long options) with stratospherical volatility (more than annualized 60% , which today would represent, for example, a 36-37 dollar premium per ton for a option expiring within 90 days). That is, they’ve thrown money out of the window.
Risk management is like a flight plan. It’s possible to know where the “cumulus nimbus” are so we can change courses. The hardest thing is to fly out of the storm when we’re in the middle of it running the risk of losing the spatial vision. You think the plane is going up, but actually it’s falling. Today based on NY’s closing and taking on an annualized volatility around 29%, there’s a 95% probability that the total margin call will be lower than 55 dollars per ton over the next 30 days. That is, for each 10,000 tons fixed in NY the maximum expenditure on margin call , with 95% certainty, is US$550,000. How about the other 5%? Only God knows.
Take note: the III Advanced Course on Agricultural Options will be held on November 30 (Monday), December 1 (Tuesday), December 2 (Wednesday) and December 3 (Thursday) 2015 from 7:00 pm to 11:00 pm at the “Espaço Maestro” on Rua Maestro Cardim, 1170, Paraíso, São Paulo, SP. To register or to get further information, contact priscilla@archerconsulting.com.br.
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Everybody have a nice weekend.
Arnaldo Luiz Corrêa
