The sugar market continues to follow a path of agony which has gone beyond 10 cents per pound and is headed now toward 9 cents, consistent with the world crisis caused by the coronavirus, the melting of the oil price on the world market inaugurating negative prices and the sharp depreciation of the real (which has reached 5.7480 on Friday) driven by the political tension generated by president Jair Bolsonaro’s inability.
NY closed the week with May/2020 adjusted to 9.68 cents per pound, a 69-point fall in the week, equivalent to a little more than 15 dollars per ton. As we said here two weeks ago, sugar would have a lot of difficulties keeping above 10 cents per pound due to the problematic world scenario. We thought it could bounce back in the following weeks, but the situation has gotten worse.
The non-index funds increased the short position and now they have 65,000 contracts. Brazil, if it exports 21-23 million tons of sugar this harvest, might still have to set between 70 and 90 thousand contracts.
There seems to be little doubt we will have a substantial increase in sugar production for this harvest. Our number for the Center-South is 35.8 million tons of sugar, but some analysts put this volume close to 38 million tons of sugar.
If we argue that placing this huge volume on the international market is extremely complex, it would be reasonable enough to admit that we should have a substantial delivery of sugar against July/2020 (which expires on June 30) and October (which expires on September 30) increasing the pressure on the spreads. July, for example, is trading with a discount of 11.8% p.a. against October which, in turn, is trading with an 18% p.a. discount against March/2021.
Some analysts believe that the impact of the coronavirus can decrease the world sugar consumption between 5 and 13 million tons. Right when we will have to produce more sugar because the energy market will also go through some unprecedented demand downsizing. It’s mandatory that the federal government implement ethanol inventory financing fast and efficiently.
Soybean price in Brazil continues breaking new records. The bag of soybean has come to R$105 at some ports. I wonder when we will lose the sugarcane planted area to soybean which pays a lot more. Sugarcane is too costly with the cutting, carry and transport in comparison to soybean, for example.
Dear readers, do you remember when you learned at school that the price on any asset cannot be lower than zero? And that the price of any product could drop more than 100%? Well, forget what you learned, because 2020 has come to break paradigms. And we haven’t even gone through one-third of the year yet.
I’ll explain – the futures contract for WTI oil maturing in May on its last day of trading was traded at incredibly negative 40 dollars per barrel. This is an unprecedented and very rare situation called long squeeze.
Less common than the short squeeze, movement of a rally on a commodity price caused by a hasty coverage by those who are short, probably responding to some fundamental event which caused it, in the rare event of a long squeeze, those who hold the product, on the verge of receiving it and not being able to store it, be it due to lack of available capacity, be it due to the high cost to do it, get rid of the goods selling them at any price, even paying someone to keep them.
The newness of this bizarre situation has gotten so that the traders have started to worry about how to correctly price the value of an option under a scenario of such huge uncertainties and disturbances like this one. Just to make it clear, the fair price of an option is calculated by the Black & Scholes formula, created in 1973 and one of the most used tools on the financial market. It so happens that every deduction from the formula – and we will save you from the technicalities – assumes the market prices follow a log-normal distribution, which being as simplistic as possible, means that the formula assumes traded values on the positive note. It (the formula) doesn’t work for values smaller than zero – what now?
To address this unusual circumstance, the Exchange has informed all interested parties that starting now and until further notice it will use Bachelier option pricing and evaluation model, from 1900, to be able to accommodate negative values and allow option listing with negative exercise price for a number of assets (RBOB gas, WTI, and Brent oil). In short, of course, the puts will be worth much more than they were in the previous model. Bachelier was a French mathematician, born in 1870, and who influenced Fischer Black and Myron Scholes, 1997 Nobel Prize winners for the formula they created. Bachelier was thought to be the pioneer of the modern probability theory and the founder of financial mathematics. We exchanged from 1973 to 1900.
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Justice Minister Sergio Moro’s resignation for not agreeing with our President’s meddling with the commanding office of the Federal Police is the beginning of the end of Bolsonaro’s government. With Moro’s resignation, Brazil loses and the corrupt politicians win because the change in leadership of the Federal Police should slacken the fight against corruption. For decades Brazil has sadly seen the highest office of the Republic be held by the most disqualified people who use the country to their own advantage instead of serving it. Not even PT (Workers’ Party) with all its evils managed to meddle with the Federal Police. If proved, Bolsonaro’s crime is serious. And we haven’t gone through one-third of the year yet.
A pretty appropriate Bertrand Russel’s statement about these dark times is, “One of the painful things about our time is that those who feel certainty are stupid, and those with any imagination and understanding are filled with doubt and indecision.”
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Lydia Pimental, Agrifatto’s CEO, has launched the book “Administre o risco de preços pecuários: um guia prático para o hedge de sucesso” (Managing the risk of livestock prices: a practical guide for successful hedging), which I had the chance to read before its release. The book talks about the tools for managing the risk of livestock prices and hedging. It’s always auspicious to see the interest of companies in risk management grow. You can learn more about the book on www.agrifatto.com.br/loja
Have a nice weekend.
Arnaldo Luiz Corrêa
