Those who have made it through this horror-ridden week are still picking up the pieces. We hadn’t witnessed a tsunami of such magnitude in a long time. It brought together the world coronavirus pandemic and the collapse of the energy market caused by Saudi Arabia and led all the risk assets, stocks, commodities, and so forth to a fast-melting and to an unprecedented value loss. Luckily, today the windows of the trading companies are armored. Had that been in 1929…
It’s a Hitchcock movie scene, like in The Birds. Instead of voracious crows, the leading actors of this global massacre are the starving Cygnus Atratus, the famous black swans. I don’t know if these birds have the same bad habit of pigeons that go for people’s heads when they fly, but symbolically the feeling of most traders is that they have been viciously hit by the black swans.
What went down during the week was frightening. The sugar futures market in NY closed Friday with March/2020 at 11.68 cents per pound, a steep 134-point fall against the previous Friday, or 29.50 dollars per ton equivalent, a little more than R$7 per bag of 50 Kg.
Since the high occurred on February 12, the market has plummeted from 15.90 to 11.68 cents per pound, that is, it has shrunk by 26.7% within only 22 days of trading session. It was the greatest percentage fall over a 22-day period since 2011 when the market dove from 28.07 to 20.47 cents per pound. It’s important to point out that after the brutal fall that occurred on May 6, 2011, the market bounced back up to 25 cents a month later and soon zeroed out the loss reaching above 30 cents per pound – will history repeat itself? Let’s wait and see.
There are some traders who closely follow Professor Nassim Taleb’s doctrine, which ensures money-making by betting on events that look unlikely. Whenever I have a loophole for this approach, I try to convince the companies that protecting themselves against these unexpected events should be part of the risk manager’s routine. It’s comforting to go through troubled times like last week’s knowing that you will make it out of it unscathed because considerable insurance is on the table, but very few people share this way of thinking.
Here’s an example. On February 12, when July was hitting 15.05 cents per pound, if someone offered to spend US$50,000 to buy a put option of an exercise price of 12 cents per pound, yesterday he would have settled this position at almost US$1.6 million. This value would cover the total accumulated fall of the market equivalent to 20 thousand tons. And how about spending US$100,000 now buying a call of an exercise price of 16 cents per pound maturing in October or oil?
If you’re reading this, I know you are thinking, “Ah, but looking back, it is easy. I want to see you decide on this on the spur of the moment”. I agree 100%. Nobody would complain about buying an out-of-the money call if it came to it, but most people would frown upon spending money on protection against a down market. It works like that because we are used to always looking in the same direction. We’re not used to tackling the unlikely. And we don’t always make money out of doing the same old thing. It takes creativity.
RBOB gas was the commodity that has dropped the most this month – 39.7% – followed by Brent oil with a 31.3%-fall, WTI oil with 28.6% and sugar with 17.4%. WTI reached the low equivalent to R$147.08 per barrel. This was the lowest price in real since September/2017 when it hit R$146.50 per barrel. The devalued real makes the difference because then it was at 3.1000.
With the dollar closing at R$4.8163 on Friday, May in NY settles the equivalent to R$1,292 per FOB Santos ton. This value is way above the production cost of the overwhelming majority of the mills with good management. It’s slightly below the average price of fixation of the mills for the 2020/2021 harvest and it’s practically the same as the average of the daily NY closings over the last six months. As for the hydrous price equivalent to sugar in NY, it is R$2.1750 per liter, ex-mill, with taxes, pretty close behind the R$2.180 per liter traded on Friday, according to BioAgência.
Oil will have great difficulty fighting back due to oversupply, smaller consumption perspective, which should make the mills increase the load of sugar production. Our estimate – yet to be finished – should point to a sugar mix above 42.5%. The situation might get better, but nobody has the slightest idea about what can happen over the next months.
The funds have reduced the long position from 108,500 to 51,000 contracts. As this number covers the period until last Tuesday, the reduction might have been greater.
A disheartened trader asks a bunch of likewise worried friends what he should do in a scenario of such dark clouds. The best answer he heard was, “check into a hospital, undergo induced coma and wake up in 60 days; whatever you do now will go wrong.” I don’t know if he followed his interlocutor’s suggestion, but he should have.
There are only two spots left for the XXXIII Intensive Course on Futures, Options and Derivatives which will be held on March 24, 25 and 26 at the Hotel Wall Street, on Rua Itapeva, in São Paulo, SP. Join the extensive list of more than 1,800 professionals who have already taken and enjoyed it!
Have a nice weekend.
Arnaldo Luiz Corrêa
