Some time ago we commented on how appealing the NY spreads were. We said we didn’t understand how the discount between two trading months, in this case May/2015 against October/2015, which at some point reached 17% equivalent a year, didn’t appeal to end consumers given that the carry cost for them should be a lot lower than what the market was showing. So, it would make a lot of sense for the buyers/consumers to anticipate the purchase of their needed raw material in the following months, since the cost to carry it shown in NY, incorporating the financial and storage costs, was surely a lot higher than it would actually cost them.
With this possible perspective opening up back then – considering that the strategy had been drawn up/implemented in January and February – we can try to understand the details of the decision-making process of a record sugar delivery. As for last week’s specific case, there is no buyer/end consumer, but a trading company which anticipated and took the advantage offered by the market. The spread for May/July, for example, traded at 11% a year on average over the mentioned period, but it reached 13%. May/October, over the same period, was at 12% on average, but went up to 17%. Not to mention what can be added as far as value goes by using options to make this edge increase, though taking the chance of more manageable risks.
In short, what is the worst scenario for the trading company who took delivery: redeliver sugar in July or in October whose total cost for it, taking into account the average spread for May/July or May/October, even if on the respective redeliveries the new receiver nominates the vessels close to deadline, will be largely compensated for by the money cost difference vis-à-vis the spread it got on the market. Of course to simplify reasoning, we assume the receiving trading company has flexibility in the books which allow it to relocate several origins to several destinations.
On the other hand, the gain opportunities for the Asian trading company are really huge. The immediate nomination of several vessels right in the first week of delivery gives some signs to the market and, mainly, to those who might have promised to deliver sugar without having it yet. The premium for immediate shipping is at 15 points and any problems with production rate, or truck drivers’ strike, or any other exogenous factors will affect the premium way before affecting the futures market and then, once again, the trading company will count its huge profits.
Conversations here in NY next week should be really exciting, with busy schedules due to the several crowded events this year. Moods are evidently still low, especially because of the serious financial problems which affect all sorts of mills. Little money and the urgent need to renew loans and get new cash will influence premium/discount trading for export. I see little risk for failure to receive such large amount of sugar. Even the funds are indirectly supporting the operation: the low volume they are sold at (it could be zero), after having covered a good part of their short position again, which must have made them millions of dollars in profit, don’t seem to encourage them to keep a short position at current levels. If they have to go back to the market at the level they recently had, they will certainly go for a long position.
As a friend of mine from São Carlos would say, “if there is a combination of events”, that is, if all these factors happen at the same time, then we could see the market at much higher levels than today’s.
The futures market in NY closed this Friday with July at 13.42 cents per pound, a 51-point high in the week, or about 11 dollars per ton. The other months in the exchange closed with positive variations between 29 and 59 points, or between 6 to 13 dollars per ton. However, it is worth noting that the closing in real per ton was 919 FOB Santos.
The good performance of hydrous ethanol should reinforce the arbitrage between sugar and ethanol in a calculation, if much favorable to the latter, and following the loan constrictions mentioned above can decrease sugar supply even further than what was previously assumed by the market. As a reader said this week, “we will have 75 interesting days ahead of us”.
Those who have come to NY for the sugar week have a safe trip, enjoy the good events and do great businesses. Cheers!
Arnaldo Luiz Corrêa
