Sugar: Epicure's Paradox

The N.Y. sugar market reached its lowest level since Jul.10, trading this week at 17.47 cents per pound. May.13 closed Friday quoted at 17.65 cents per pound. The remaining months closed with moderate losses between three and 19 points, or $0.67 to $4 per ton.

In the last 12 months the market has been going downhill. We went from the high of 24.58 cents per pound to the low mentioned above. The average closing of the last 12 months is 20.01 cents per pound. The funds are over 100.000 lots naked short. The vulnerability of a position of this magnitude is equal to sitting on a box of explosives and lighting up a cigarette.

The sugar in N.Y. continues to trade far away from the parity with ethanol. Both anhydrous and hydrated trade today in the internal market at an equivalent of 19.67 and 20.77 cents per pound comparatively to sugar. For exports, the levels indicated by the market of 625 and 675 dollars per cubic meter FOB Santos, are equivalent to sugar at 17.73 and 18.28 cents per pound. The ethanol traded at the CBOT is equivalent to NY at 19.18 cents per pound. To sum up, the sugar for exports is the worst liquidation today for the mills. This makes a greater disposition for ethanol in this beginning of harvest at the Center-South.

Weather Report
If the rains arrive in the month of April (which seems to be the case) and delay the beginning of the harvest for some mills, it may be that the delivery in May, whose expiration will be in 17 sessions, will suffer some pressure on the spreads, firming in this way the May expiration in relation to the following month, July. For the moment, only conjectures.

An assiduous reader of this commentary sent us a graph of N.Y. of the last six years, and interestingly in the last five years the market reverted a bear trend that would always occur in the window April/May/June, after the May expiration, climbing strongly after that.

In 2008, N.Y. reached the unbelievable print of 9.44 cents per pound at the beginning of June and reached the high of 14.69 three months later, an increase of 56%. In the following year, at the beginning of April, the market sank to 12.13 cents exploding to 18.01 cents three months later, a 48% increase.

Somber Past
In 2010, during the Sugar Dinner in N.Y., the mood was somber when then the market dipped to 13 cents per pound only to come back to life like a phoenix within the same three months, to strong 19.88 cents per pound, an increase of 53%. In 2011, déjà-vu. Again during the Sugar Dinner, we saw the lowest trading point at 20.40 cents. And what happened three months later? We had 31.68 cents per pound, or a 55% increase. Last year, the lowest value in the window April/May/June was 20.90 cents recovering only 15% in the same three months to get to 24 cents per pound. Will this trend repeat this year?

If it gets liquidity for an NDF (a non-deliverable forward contract for sugar fixation in reals per bag using N.Y. and the exchange rate) with a May/14 expiration, for example, or in other words for the beginning of the 2014/15 harvest, a mill will be able to hedge its sugar at R$800 per ton, ex-mill. Although this gives a return over production costs to first tier mills, we have seen this figure above R$1,050 this year. Things have changed.

Selling options these days is almost a sacrilege. The volatility melted to levels so low that inhibits any speculative strategy for selling. The best thing to do is to buy options, maybe even financing them with the selling of another, leaving the exposition neutral to an eventual recovery of volatility that would affect premiums immediately. For the sugar consumption industries, the selling of a put combined with the buying of a call (buying option), both out of the money, along the curve of the expiration months for this harvest, sounds really interesting.

Epicure's Take
I am going to borrow from Epicure’s paradox. He was a Greek philosopher who lived 340 years before Christ and influenced many philosophers of our time. I will try to adapt it to the relations of the federal government with the sugar and ethanol sector. If we think the government knows it all, it is capable to do it all and works in a manner that is just and perfect for the economy, then why is that that it cannot solve the problems of the sector? For the government and its current recklessness towards the sector to coexist, it is necessary that the government does not have at least one of the three characteristics. In other words, it either does not know it all, is not able to do it all or it does not work in favor of the economy.

If they know it all and can do it all, then they have the knowledge of the problems of the sector and the power to end them. If still they do not resolve them, it is because it does not work in favor of the sector. If the government can do it all and wants the better for the sector, then they have the power to do away with the problems. If still they do not solve them, it is because they do not know it all. If the government knows it all, works in favor of the sector then it knows the problems that exist and wants to resolve them. If it does not do it, it is because then it cannot do it all. Therefore, if the problems cannot be eradicated, why call it government? Epicure may roll in his tomb, but I thought the paradox was appropriate.

The historical volatility of the market in the last 50 days dropped to 20.54% (it was 20.71% six weeks ago). The 100 day volatility dropped to 21.45% (it was 24.69%) and the 200 day fell to 25.45% (it was 26.41%).

Make note on your agenda: The XX Intensive Course of Futures, Options and Derivatives – Agricultural Commodities – by Archer Consulting (in Portuguese only), will take place on the 24, 25 and 26 of September 2013, in Sao Paulo. Please access our site for more information (www.archerconsulting.com.br).

Have a good week everyone.