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Sugar

FUNDS STILL HEAVILY SHORT WITHOUT THE SLIGHTEST CONCERN
02/03/2018

March/2018 futures sugar contract expired this week with a 742-thousand-ton delivery, which can be interpreted as slightly constructive. The two recipients are partner trading companies of the two main sugar producers in the country.

Upon receiving the delivered volume, they let the producers produce more ethanol, whose compensation is superior to that of sugar and make it possible for them to cover eventual sugar delivery commitments taken on over this period. It is a kind of option at zero cost: the behavior of the market is observed and if it continues under this current stagnation the producers strengthen ethanol production and the trading companies appoint the vessels as further down the road as possible. If the foreign market demands sugar over this period and the premiums improve, the trading companies appoint the vessels earlier.

On Tuesday, the market plummeted to the lowest levels since June last year, influenced by the interview given by Jeremy Powel, the president of the FED, the American Central Bank, suggesting that the American interest rates will evolve at a faster pace.

The market adequately interpreted that higher interests inhibit risk assets and, therefore, we saw a general decrease in the stock market and commodities.

As we know, the funds hold a huge operation of long-short which consists of being long in a certain asset and at the same time short at the same notional value in another asset. The funds are long energy and short softs (coffee and sugar).

If Powel effectively implements what he hints, the Brazilian real can devalue against the American currency and this can change the price matrix for sugar and ethanol in this 2018/2019 harvest.

Let’s analyze two scenarios of the real: R$3.25 (I) and R$3.40 (II) and two of the Brent Oil: US$55 per barrel (A) and US$65 per barrel (B) and how they would form (in theory) the average price of equivalent sugar in NY:

  • If (I) and (A) happen, the average price of sugar for 2018/2019 has a floor (the lowest price) of 13.80 cents per pound (estimating the parity of 67.5% of hydrous for the gas at the pump);
  • If we see (I) with (B), the average price goes up to 15.06 cents per pound;
  • If (II) with (A) happens, then the average price would be 13.67 cents per pound.
  • Finally, if we had (II) with (B), we would have an average price of 14.93 cents per pound.

Note that regardless the scenario we want to create, the minimum parity price for sugar (using 67.5%) is 13.67 cents per pound. That is, below this value, the mills will keep prioritizing ethanol production.

Early this year, we informed our clients that our price model estimated that the average closing price of the first month traded in NY would be 14.20 cents per pound and that in February it would be even worse, 13.92 cents per pound. The thing is the average price ended up being 13.98 and 13.58 cents per pound, respectively. A 1.5-2.5% difference only. What will March bring us?

The MB Associates forecast is that the GDP will grow by 3.5% in 2018. Two questions have a straight impact on the market: what will the increase in light vehicles sales be this year (the fleet grew by almost two million vehicles in 2017, the expectation this year is 2.2 million) and what will the increase in the consumption of equivalent gas fuel this year be, taking into consideration that it grows above the GDP? A feasible number points to almost two million tons of equivalent sugar which should be diverted to the production of ethanol.

The funds increased their short positions: 164,000 lots. We estimate that the average price of these positions is around 13.84 cents per pound, showing a profit of US$75 million.

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Have a nice weekend.

 

Arnaldo Luiz Corrêa

 

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