The sugar futures market in NY closed the week erratically on Friday, with July/2016 closing at 19.76 cents per pound, only a 6-point appreciation against the previous week, after having reached 20.15 cents per pound – the highest quote since October, 2013. The other months closed with positive and negative variations, with March/2017 standing out, which is the most worrisome thing, for it reflects the off-season in the Center-South, which went up almost 5 dollars per ton.
The market exuberance is starting to worry the participants due to its irrationality right now taking into account that in less than two months, we have had a 538-point appreciation in the futures market (20.15-14.77). The values increased by 36%. The margin call account makes us worried because of the ripple effect it creates. Let’s assume Brazil exports 25 million tons of sugar this crop year. Almost 83% of this value, according to the model developed by Archer Consulting, was fixed at 14.11 cents per pound on average up until late April. That is, 20.7 million tons are fixed. We exported a total of 3.5 million tons in April and May. In theory, at this moment, we have 17.2 million tons fixed and not yet shipped and whose estimated margin call is US$125 per ton, totaling US$2.1 billion which came out of the pockets of the commercial companies.
This volume of resources bleeds the cash flow and the trading companies are forced to curtail pricing for the open contracts with the mills feeding the high trend. In addition, in order to decrease the impact of margin calls on the cash flow, several companies bought calls (long options). Well, the sellers of these short calls do it to pocket time-value, taking advantage of high volatilities (in two months they increased more than 5 percentage points) and zero the delta (directional risk) buying futures, feeding the high trend even further. This cycle seems to be happening right now.
The irrationality (in my opinion temporary) can drive up quotes which also count on stop orders (purchase orders which are triggered by the short ones aiming at putting a stop to a loss, limiting a loss to a certain level). It’s taking a toll on our pockets. Markets go overboard on high and low trends.
Regardless of what happens, we believe that late this year – in the last quarter – we will see March/2017 strengthening even further (our model believes in 22.77 cents per pound). Of course, a strong profit taking should occur before this. That’s why the funds have broken a new long position record. Now they are almost at 325,000 contracts. It’s reasonable to think that at some point they should want to pocket this huge amount of money they are making. The question is to know how, when and with what magnitude this profit taking will happen. If find it very hard for the market to be able to at least shift back to levels it was at two months ago, that is, below 15 cents per pound. It takes a universe of potential avid buyers to have this lost chance back.
A strategy that might turn out to be interesting to get profitability is the put spread purchase with a call sale.
Our weekly comments are independent and reflect our careful analysis of the market fundamentals. Our goal is to spread the culture of risk management in the agribusiness and make our clients and readers see the importance of this topic with absolute discipline.
To exemplify the importance of the discipline in dealing with risk management, allow us to refer you to the comment in 2015, more precisely the week closed on December 18. The title of the comment was “2016 CAN BE A GOOD YEAR FOR THE MILLS”.
At that time, we urged the mills to fix their prices for May/2017, which was settling the equivalent to R$1,530 per ton (the dollar was trading at R$3.9464) and we claimed that if “the political crisis gets worked out and the country gets its foreing credibility back, the dollar can go back to the 3.5000 level. And we added that “if the company doesn’t feel comfortable, it can buy calls at an exercise price close to the balance levels, taking part in an eventual rally ( sudden price hike) which can happen to the price in dollars”.
If, at that point, the mill had fixed its price in real and bought a 19-cent-per-pound call for May/2017, today’s settlement would be at R$1,660 (with the obtained gain from the call purchase). On Friday, May/2017 closed at 19.09 cents per pound and the NDF for the same period is at R$3.7655, that is, a settlement equivalent to R$1,650 per ton. Only a R$10 per ton difference in an analysis made 180 days ago, which is still consistent though the market has gone up more than 30% in dollars. Discipline is the name of the game.
Put it 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
If you want to get our weekly comments on sugar straight through your e-mail, just register on our site by logging onto https://archerconsulting.com.br/cadastro/.
Have a nice weekend.
Arnaldo Luiz Corrêa
