In commodities, conceptually, the spread is the price difference between two futures contracts with different maturities. We can say that the spread is the expectation the physical market participants show about that commodity reflected on the futures market. Spreads often account for a great percentage related to the number of contracts traded in the day. In sugar, spreads account for at least 50% of the daily volume on average.
When the physical market starts realizing there might be a shortage of the product, a delay in the start of the crop or any hindrance that curbs the availability of that commodity, the spreads appreciate, that is, the contracts with shorter maturities go up more than the contracts with longer maturities because the main players start deploying their trading books and bring the maximum volume its portfolio allows to the shorter maturities. And they do so by buying the various pairs of available spreads (May/July, July/October, October/March, and so on) until their position reflects the planned strategy to take advantage of the situation that the physical market projects.
Therefore, the origin of the inverted market is exactly at this point. The concern over the eventual shortage of the product raises the price curve on the shorter maturity. The non-index funds also prefer to stand on the buying side when this opportunity comes along. The curve inclination can be steeper if the futures expectation is for a greater crop and/or the local currency curve against the dollar is also descending. Does that sound familiar?
The best books on commodities assert that it doesn’t matter how irrational a market can trade at, be it due to excessive speculation or due to operations guided by robots, algorithms, artificial intelligence, mathematical models or tea leaf readings, the important thing is that when the fundamentals walk in the door, those who are in the opposite position throw themselves out the window.
However, the sugar fundamentals have taken a back seat for a long time already. The pandemic has lit the yellow light casting doubts on the consumption behavior and the expectation for the global economy recovery. Luckily many mills took advantage of the market dynamics and fixed their sugar in real per ton. But what about the spreads – where are they in all this?
In this shorter week due to Friday’s holiday, the sugar contract for May/2021 in NY closed out Thursday at 14.71 cents per pound, an almost 11-dollar-per-ton fall in the week that, together with the real appreciation against the dollar, represented a loss of about 60 real per ton equivalent compared to the previous Friday.
The price curve of the 2021/2022 crop (for mills in the Center-South) has flattened. The spreads have collapsed: May/July went from 50 early March to 0; July/October shrank from 22 to 2 over the same period. This is the startling and unequivocal reflection that the market understands there is enough sugar in the pipe line and that the demand is weak, both validated by the delay in nominating the vessel that, on a market that was still inverted a short while back, should be a buyer’s priority, right?
The market now runs the risk of suffering overwhelming pressure with the possible outflow of the non-indexed funds, which will have to sell the purchased lots, at a time when there seems to be no buyer on the market. It can get worse if there are fixations from other origins that didn’t take advantage of the good prices in cents per pound.
The hedge funds reduced their exposures in the soft commodities. Sugar suffered a 9% fall in March, cocoa melted 9.5%, coffee plummeted 10.3% and cotton shrank 15%. You remember when we said here that this new commodities cycle little story didn’t add up, especially because when the so-called commodities cycle really occurred in the first decade of this century, with the Asian economies going full blast, the soft commodities weren’t included.
The daily average of the sugar closings in NY in March converted by the exchange rate supplied by the Central Bank of Brazil was 2,046 real per ton, about 60 real per ton below the average of February. Now the average of the closing of the first NY contract in March was 15.80 cents per pound, 117 points below the average seen in February. Over the last 20 years, in 80% of the cases the average of March has been lower than that of February.
For April, the track record changes a little: in 75% of the times the average price seen this month that is starting has been lower than that of the previous month. The correlation between the two months, on a 20-year curve, is 98%. April’s average price, in general, is 7% lower than March’s price. The model shows 15.07 cents per pound – that remains to be seen over the next weeks.
—
The clueless dweller of the Palácio do Planalto shot himself in the foot believing he could convert the Armed Forces – a State institution – into Fort Apache little soldiers who, along with him, would irrefutably embark on his scams for a coup. I think, however, that the meaningful fading of his popularity, along with a cognitive barrier worthy of a behavioral psychology study, will make him mess up big time, especially when he sees the chances for reelection dwindle. Let’s see. Foreign exchange hedge highly recommended!!
Those who have the opportunity to read “How Democracies Die” by Steven Levitsky and Daniel Ziblatt – two renowned Political Science professors at the University of Harvard – will come across similarities between the erratic presidential behavior and the political figures such as Hitler, Mussolini, Vargas, Chávez, Putin, Marcos, Trump, among other lower rated ones. They are key players who take advantage of moments of inattention to checks and balances of the democratic societies and present themselves as homeland saviors, usually pointing out an enemy – real or imaginary – who needs to be harshly fought against or fatally wounded. On taking office, they took off the mask and showed their true colors.
You all have a HAPPY EASTER.
Arnaldo Luiz Corrêa
