The sugar market in NY closed Friday at 12.52 cents per pound for March 2016, a nearly 14-dollar-per-ton painful fall in the week. NY price curve, which up until recently was inverted, is now a carry curve. When this happens, the funds liquidate long positions and then they go short. I wonder if this will happen. The cost-of-carry for some spreads is already over 8%. The futures market has felt the impact of a weak physical. Buyers will hold off on buying until the last minute. The price, whose average was R$1,329 per FOB ton in January, closed at R$170 less on Friday – that was a hard blow.
Seasonally, February is the month of the year with the highest average closing price of quotations on the futures sugar market in NY. It has been so over the last sixteen years (from 2000 to 2015). May and June, on the opposing corner, share the position of the lowest average price of the year. Over the analyzed period, only 25% of the times did March average price exceed that of February. Up until Friday’s closing, the average price for February had hit 13.07 cents per pound – an 8.5% fall in relation to the average price for January, which was 14.29 cents per pound. Our model pointed to a price recovery for early 2016 topping out at 16.16 cents per pound. Models fail, as we can see, and we come away with that old lesson which says that nobody goes bust with profit in their pockets. The prices in real were so appealing that for countless times here we recommended fixing prices for 2017/2018.
Is it a coincidence? According to analyst Marcos Masagão, from Futures Analysis (http://www.futuresanalysis.com.br), the average purchase price of the funds for March was at 13.07 cents per pound, just like the average value for this month’s closings.
The sharp fall on the oil foreign market caused a ripple effect on commodities affecting the perception the market has about the financial health of the European and Asian banks which have a heavy exposure on the energy market. Those who have invested in this sector are weathering a huge loss in the yearly accumulated – gas has melted 25%, natural gas has plummeted 22%, WTI oil has collapsed 21%. Cheap energy creates discomfort (to be nice) for the oil-reliable economies (Venezuela and Russia, for instance) and more cash in the pockets of the families in strong economies.
Paradoxically, it was thought (in other words, J.P.Morgan) the fall in the oil price would increase the income of the households bringing a 7%-boost into the economic growth. They were wrong. Cheap oil made private investment in the energy sector plummet by 50% in the United States while the income dropped 0.2%. Only four countries have a production cost below 30 dollars a barrel – Saudi Arabia, Iran, Iraq and Kuwait – although the break-even price they need to meet the country’s budget is above that. Two years ago, Saudi Arabia thought the fall in oil price would wipe out its competitors. It couldn’t imagine, however, that the United States embargo against Iran would be lifted. The world was flooded with oil. The source of this overproduction goes back to 2007/2008 when the world believed that we would never see oil below 100 dollars a barrel again. Today the world produces 96.3 million barrels a day and consumes only 94.5 million. A few months ago, the intelligence sector of a big European bank had predicted that the average oil price would be 50 dollars a barrel and average sugar price would be 14.50 cents per pound for 2016.
My feeling as far as the sugar market is concerned and in light of what is happening in the macro scenario could be illustrated as follows. Imagine a malleable tube filled with water. You keep stepping on one end of the tube while the water moves towards the opposite direction and dams in the other end of the tube. And little by little you walk over it and press it harder and harder. There will come a point where the tube won’t stand the pressure and will burst. Who in their right mind would admit that a market that for the first time in five years has presented an extraordinary deficit which goes up (depending on the source) to 7.8 million tons could be trading at the current levels?
I do not remember, in the recent past, seeing such a divergent situation in the sugar market like what we have now. Deficit increase, stock in the hands of China and India, but with a slight concrete possibility that this stock will go to the market, stagnant sugarcane production in the Center-South (see our forecast further on), hydrous increasing consumption and even so the market doesn’t respond. You see, the macro factor on the sugar market isn’t a supporting actor anymore (and, therefore, on pricing) and has become the leading actor. A lack of new money for the trading companies makes them more restrictive and selective. A sluggish physical export market decreases the business flow, so we have the same amount of cash going around less. Since the trading companies make a profit off of the turnover, a smaller turnover calls for a larger margin of contribution; therefore, the trading companies are expected to increase the discounts on the next harvest. Meanwhile, industrial consumers who buy based on the ESALQ index now want to go back on their word and sit down to discuss making the contract more flexible, if you know what I mean. Others are now seeing the huge risk there is when purchase and sale are made on different grounds. Those who sold based on the ESALQ index and have a hedge in NY are all smiles. There are some structures that can decrease these risks. We are available to fill you in on that.
Archer’s harvest estimate for the Center-South is 618.5 million tons – 34.35 million tons of sugar and 27.49 billion liters of ethanol. We are using a 43.5% mix for sugar. We believe the combination of the high financial cost, the sluggishness of the physical export market, the increase in discounts (according to what was said in the previous paragraph) and the suffocation of the cash flow will encourage mills to produce more ethanol at the start of the harvest than what was thought, mainly now that prices are depressed. We can have surprises as long as this harvest’s mix goes.
Registrations for the XXV Intensive Course on Futures, Options and Derivatives in Agricultural Commodities are open. The course will take place on March 29, 30 and 31 from 9 am to 5 pm in São Paulo. Send in a message to priscilla@archerconsulting.com.br for further information.
If you want to get our weekly comments on sugar straight through your e-mail, just register at https://archerconsulting.com.br/cadastro/.
Demarest Advogados will hold the Seminar on Capital Market and Agribusiness next Thursday, February 25. One of the important topics for those who are after new money is about structured credit for the agribusiness. For more information, log on to eventos@demares.com.br.
Have a nice weekend everybody.
Arnaldo Luiz Corrêa
