We have been reiterating for some time now the long-awaited recovery of sugar prices on the world market. Our arguments, which have been discussed here for several times, were founded on the finding of the decrease in the sugar availability produced in the Center-South, due to the fact that the mills have favored ethanol production in this harvest, which today pays more than 200 points above NY, sugar equivalent.
The fact that the ATR production is 5.34 kilos per ton below the production seen last year, with a huge chance of worsening through this harvest, has also corroborated this perception (better prices). In the building of the constructive argument supported here so many times, two recent events that hit the market weren’t taken into account because they were part of what we can call hidden risks, that is, those exceptionalities nobody had seen coming.
On one hand, there is the turmoil on the world market of commodities after the declaration of Trade War between the two greatest economies of the world, the USA and China, which brought down the commodities prices creating an exodus of investors to less risky assets. On the other hand, there is the startling Argentina’s default declaration which contaminated the currencies of the emerging countries and clearly infected the bloodstream of the Brazilian currency.
This year’s last quarter hasn’t gotten here yet, but it is coming up with smaller recovery power than that previously predicted. And we find a lot of similarities between the behavior of the sugar futures market and coffee, two soft commodities that seem to belong to the group the non-index hedge funds have chosen to stay short at as a counterpart (diluting risks) of the commodities where they are long (mainly energy).
So, in the accumulated of the year, the soft commodities have suffered great losses: cotton fell by 18%, orange juice 17%, cocoa 8%, sugar 7%, and coffee 5%. Energy commodities, conversely, enjoy substantial gains: WTI oil 21.5%, gas 17% and Brent oil 10%.
As for sugar, one can see that any sluggish price recovery on NY futures market is enough for the funds to add on more short contracts to the point that today they are – based on the number found on Tuesday and released on Friday by CFTC – at a global position of 181 thousand contracts (equivalent to 9.2 million tons of uncovered sugar). It is believed that with movement there has been since Wednesday, the short position of the funds is a record. Sugar swings at the mercy of the funds, algorithms, robots and high frequency traders – forget about fundamentals.
Markets doomed to a restrict and boring price range for a long time, as the sugar market in NY has been for months, attract option sellers, calls and puts, pressuring the premium and bringing down volatility. That’s what happens to sugar options nowadays.
Volatility is pretty low: about 20% yearly, which shows sellers just want to capture the premiums because they don’t believe in price range changes and, therefore, trust they don’t run any risk of being exercised. That’s easy money. Based on this rationale, more people sell and push volatility down. On the other hand, if volatility drops is because there is no interest in buying put or call, which means the market is happy to be within this boring range. Nobody wants to buy calls because they don’t believe the market will be strong enough to go up, nor puts because nobody believes the market can fall any further.
The scenario for September, which only starts on Tuesday because Monday is a holiday in the USA and the exchanges will be closed, promises a dose of more volatility. Some mills can feel pressured for not having fixed their export contracts yet and can be forced to do so at the last minute.
An executive has admitted “throwing in the towel”; he says he has waited for an improvement on sugar prices in NY until now to decide how to direct the sugarcane for crushing. He wisely decided to go with ethanol. Some mills have done a wash-out of their sugar contracts, paying a penalty which compensated for the gain they would get directing sugar originally intended for sugar production for ethanol.
Rolling commercial open contracts of sugar delivery, which should have prices fixed against October in the NY exchange, over to March makes the operation too expensive and increases the risk if prices don’t move. The October/March spread shows a cost of 25% per year, that is, rolling over seems to be prohibitive.
Our bet is that October should have a great delivery. It makes perfect sense for those who will receive sugar to keep it for up to five months, taking advantage of the whopping discount of 25% per year and betting that from now until February next year the fundamentals will overlap. The fact that the downward risk is limited (more competitive ethanol, low demand for puts, smaller ATR, less sugar availability, and so on) validates the strategy.
The sugar recipient’s potential for gain can dissipate (I don’t believe that), but if, conversely, it comes with all the constructive news mentioned in parentheses in the previous paragraph, even with the worsening of the number to be published by UNICA, the same exceptionality seen recently can send us to a breeding site for black swans.
NY closed at 11.14 cents per pound – a significant fall in the accumulated of the month. My 17 loyal readers must be getting their email ready to pick on me for having said that staying short at 12 cents per pound was crazy.
Have a nice weekend.
Arnaldo Luiz Corrêa
