The sugar futures market in NY witnessed yet another price record this week – traded at 19.92 cents per pound this time around on Thursday, the highest level since the fire that occurred at the Copersucar terminal in Santos in October 2013. In addition, a similar level had been traded at in December 2012. However, the values seen in real per ton also reached the highest level in history, hitting R$1,550 per ton this Friday.
New York closed at 19.70 cents per pound for July/2016 with a more than 20-dollar-per ton appreciation, which practically repeated itself along the curve up until October/2017. The non-indexed funds still keep an extremely high long position – over 315,000 contracts – based on the businesses done up until last Tuesday. Since the market appreciated 70 points from Tuesday to the last session of the week, it is reasonable that the funds are still at a longer position.
The higher the height, the more painful the fall can be. The funds must be rubbing their hands in order to pocket almost 2 billion dollars, which we estimate must be the unrealized profit of the record position, which amounts to 16 million tons of sugar. If they decide to pocket the money, we can see a flood of 200-300 points of correction.
The recent high pattern where the market swung almost 600 points (130 dollars per ton) between the 14.00 low and the 19.92 high cents per pound over the last 60 sessions, representing 42% of appreciation, repeated itself in July/2011 when the market, over the same period of time, appreciated more than 55% when traded at 31.68 cents per pound after the 20.40 cents per pound low. After this hike, the market performed strongly.
The market is going to need good news that can validate and consolidate the current levels. We cannot forget that the commodity markets stress out in situations connected to supply and demand and this seems to be the case now. The current price levels were expected for this year’s last quarter, reflecting on the next maturity, which is March/2017. As it always happens, the market anticipated this appreciation fed by the rains which cut the crushing short, by the fear that the Center-South would crush the volume the market expected (half of the consulting companies point to 622 million tons) and strengthened by the huge long position by the non-indexed funds. However, the forecast is that the sun will shine again on the sugarcane fields and crushing will come back strong.
We become blind when we fall in love. That is why it is good to use reason when analyzing the numbers so that we will not fall in love with the market. When we look at the future dollar curve for May/2017 on, that is, already thinking about sugar pricing for export for the 2017/2018 harvest, we see that the average values are close to R$1,600-R$1,650 per ton. The average production cost in the Center-South, according to the Archer Consulting model, is R$46.68 per bag ex-mill, that is, equivalent to 15 cents per FOB pound free of financial cost. This is similar to a more than 30%-margin over the FOB cost – such great profitability in commodities encourages more production.
A trader has commented that a price around 500 dollars per ton would be extremely appealing for Europe. Does this mean NY should have a 22-cent-per pound ceiling? Can the market go up any higher? It sure can, especially if we list the potential factors that can spur this movement.
With such huge profitability, an interesting suggestion is to buy the 18/15-cent-per pound put spread and sell the 22.50-cent-per pound call. This way, if market expires between 18 and 22 , the mill fixes at the market level; if it expires over 22, it is fixed at 22 cents per pound; if it expires below 18, it is fixed at 18 down to the limit of 15 cents per pound. If the market is below this level, it will be fixed at market level plus a 300-point premium.
We have seen this movie before and although the bulls are rightly very excited, from a risk management perspective it is very prudent for the mill to look at the EBITDA level it wants to go for and then set up the levels of exercise price that best fit that goal.
The market should break the 20-cent-per pound, but we can’t afford to wait for the moment when we hit the eye of the flying fly without trying to protect ourselves so that the stockholder is guaranteed to have a minimum profitability.
ICE has increased the margin to be deposited in the exchange to assure operations. Some funds can be forced to liquidate their positions partially to fit into the cash flow.
Put it down on your calendar – registrations for the 26th Intensive Course on Futures, Options and Agricultural Derivatives to be held on September 27. 28 and 29, 2016 from 9:00 am to 5:00 pm in São Paulo, SP are open. For further information, contact priscilla@archerconsulting.com.br.
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Have a nice weekend.
Arnaldo Luiz Corrêa
