The futures sugar market in NY closed the first quarter of 2017 with the May/17 contract at 16.76 cents per pound, a horrible performance of a 13.59% accumulated fall in the year. It is a 500-point fall since mid-November 2016 or 700-point fall since early last October. May/17 had the top quotation of 23.10 cents per pound on September 29. Quotation today, using Friday’s dollar, reaches meager R$1,205 per ton, a melting of more than 550 real per ton of the highs seen.
Out of the commodities, in the yearly accumulated, sugar only beat orange juice which lost 18.4%. Gas dropped 11.4%, soybean oil 9%, oil 8.4%, ethanol 7,2% and soy 6.9%. Wheat, corn and cotton were exceptions and closed the quarter in positive territory.
It is difficult now to find news that can encourage the market, tired of waiting for positive numbers from India, or strong fundamentals from China or even a positive number from the Center-South harvest (smaller than 570 million tons) which would push prices up. Since none of that materialized, the bears came out onto the field.
The situation (of prices) can get even worse due to a list of factors which hover our heads:
a) stronger real lowers domestic price of gas and worsens the profitability of ethanol;
b) harvest will start;
c) funds are increasing the short position;
d) April-May-June-July are seasonally weaker months;
e) harvest numbers in the Center-South above 610 million tons of sugarcane as some consulting firms announce;
f) Europe producing more than 20 million tons of sugar;
g) surplus numbers around 3 million tons;
h) oil price on the foreign market won’t take off!
Things are not easy at all.
The sugar market lacks bullish fundamentalist news so much, that not even the cyclone which hit Australia was able to move the market over a long period of time. In Brazil, the introduction of taxes on fuel which could raise the curve of support of prices for ethanol had a breeze-like impact. For industrial consumers, however, it is a moment of great opportunity to fix input prices, though I believe sugar in real per ton still has room to fall a little further (R$1,075-1,100 per ton).
The funds have reduced their long positions close to 40,000 contracts, according to an experienced broker in NY and then, in a week where prices shrank 95 points (21 dollars per ton) in May/17 and 250 points since the delivery of 12 million tons against March/17, it becomes difficult to keep any bullish flame.
To make matters worse, the predictions we made here some weeks ago ended up coming true. Mills that had a hedge with over-the-counter operations linked to a certain level of disappearance (17 cents per pound), known as knock-out, have finally been “knocked out”. We heard that the loss comes close to US$4 or 5 million. That is, these mills, on a downstream market, lost their hedges. What can we say about these knock-outs? With such a suggestive name, you only join them if you really want to. Imagine inviting a friend to participate in a knock-out, “Come on, bro, it will be really great, we will get into the ring with a great guy called Mike Tyson”. Then it is no good complaining if you get a bloody nose.
OTC are essential tools for risk management. There are several serious companies on the market which offer their products to clients adequately, respecting their appetite for risk and warning them about limitations embedded in the structure. They all make money and there is nothing wrong with that. However, there are a few whose focus is only on profit and huge bonuses coming from the suicidal structures they offer the unwary. With these, the client is just a supporting actor and, in situations like the week that has closed, they end up putting all the supplying companies on the same counter jeopardizing the reputation of serious professionals and casting doubt on the use of future structures. That is, they are killing the market of derivatives.
The side effect of this situation is horrible balance sheets, aversion to new structures, distrust in the financial sector, default, among other things. The important thing is to know how to separate the wheat from the chaff. The mills are to blame as well. They ignore the operations of the derivatives and treat risk management as an appendix of the commercial area when it should be the leading character. They will learn through the most painful method: from the ring to the ICU (Intensive Care Unit).
Put it down on your calendar: Archer Consulting XXVIII Intensive Course on Futures, Options, and Derivatives – Agricultural Commodities (in Portuguese) will take place on September 19 (Tuesday), 20 (Wednesday) and 21 (Thursday) from 9:00 am to 5:00 pm in São Paulo, SP at the Hotel Paulista Wall Street.
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Have a great weekend.
Arnaldo Luiz Corrêa
