Can It Get Any Worse?

NY closed the week at a high. July/2015, which expires next Tuesday, closed Friday’s session trading at 11.67 cents per pound, 12 dollars per ton over the previous week’s closing. All the other months closed positive, with 3-to-9-dollar fluctuations in the week. Rumors about Thailand having a Sugar surplus at around 1.5 million tons is like pouring cold water on those who thought the market could react.

A senior trader, who has always operated a good volume in the futures, believes that NY futures contract could reach 10 cents per pound due to the negative news that might come from Thailand. Should everything else stay unchanged, 10 cents per pound would represent R$716 per ton today. The last time this happened was in 2010. Non-indexed funds are short put by 100,000 lots (5 million tons of equivalent sugar!!). And with spreads this big, they (the funds) are alone. To reach R$716, however, NY times dollar would have to depreciate almost 15% off today’s value.

It is a fact that sugar keeps trying to bounce back from recent falls, but nothing happens to the fundamentals to justify any recovery. This week rumor had it that a big trading company is getting ready to receive a huge amount of sugar in October taking advantage of the abusive spread which has been traded. There is no telling whether there is an element of truth in this whole story. In addition, markets left on their own, such as the sugar market has been lately, ideas abound and strategic speculations proliferate. There is, however, something that supports this theory: mathematics. A spread that closed the week at 140 points but peaked at 160 points shows that even with a US$2 storage cost a month plus a US$5-6 financial cost per ton, there would still be 15 dollars net per ton left for those who received October in order to redeliver in March, for example.

The overall feeling is that the capitalized mills in the Center-South should postpone their sales until October fixing the contracts against March/2016, and that way pocketing the extra money the spread is showing. Meanwhile, they will supply the market with hydrous whose monthly sales volume is close to 1.5 billion liters. Over the April-June quarter, the total monthly hydrous sales is 18.67% higher than the volume over the same period last year. But, it is still far from the volume traded in 2009, which was 4.24 billion liters.

The daily average of closings in June (always taking the first month on the screen) has been 11.27 cents per pound up to now, the lowest since November 2008 when we were in the midst of an international crisis. Now the average in real, which is R$840.41 per ton FOB is the lowest since last September when it reached R$783.38.

I remember the crisis in May, 1999 when sugar hit 4.36 cents per pound. At a heated meeting, arguments which pointed to a recovery of price levels on the market ran out among the attendees. Any idea, no matter how minimally bullish it was, was immediately shot down by the great majority who already expected a market at 2 cents (believe me, this is serious). Trapped by the other participants, the only surviving bull present, not having anything else to say, came out with his final argument, “the market will have to go up. God will have to do something”, making everybody roar with laughter and clearing the air a bit. I don’t know if it was God, but the fact is that twelve months later, the market was trading at double the price.

Last week I commented here that companies which trade sugar on the domestic market using the ESALQ index as a fixation parameter run a huge basis risk. Heloisa Lee Burnquist, researcher and prestigious professor at ESALQ, having rendered a long list of services to the sugar-alcohol sector, gotten a PhD from the University of Cornell, one of the eight American Ivy League universities, and who flatters us by being one of our attentive readers, didn’t agree with my comment. She argues that the existence of a system to pay for sugarcane – Consecana – would be the most rational thing of this negotiation using the index. That’s true. What I meant, though I admit I didn’t make it clear enough, is that companies should avoid (because it increases the basis risk unnecessarily) having distinct pricing parameters at the two trading ends. If they buy sugar using ESALQ, they should sell it using ESALQ; if they buy it NY-based, they should sell it NY-based. They shouldn’t mix things up.
Basis risk can make a company go bankrupt, and that often does happen. Who doesn’t remember what happened to a company in the Center-South that made a long-term ethanol sales contract pricing the product against the RBOB (gas contract) a few years ago? I remember giving a conference at that time and arguing that the correlation between the two products (ethanol and gas) was 0.269 and that created an absolutely unnecessary risk. I heard that “highly scientific” old argument from some serious people who don’t accept to be contradicted, “Come on, Arnaldo, but everybody is doing that”. You already know the rest of the story.

The correlation between ESALQ and NY today (last 100 days) is 0.7614. It might not be that bad, but as we know, historic data don’t guarantee they will behave the same way in the future. I correct my comment on the last report which might have made the professor think I have something against ESALQ: the domestic market will have to evolve and learn how to use the same parameter (ESALQ or NY) at the two ends. These changes only occur through pains; never through love.