Will Sugar Funds Hold Up?

The futures sugar market in NY closed the week at 16.80 cents per pound for May/2014 – a 55-point drop or about 12 dollars per ton. Up until March/2016, the other months closed at lows between 5 and 33 points, 1.10 and 7.28 dollars per ton, respectively.

The May/July spread weakening goes to show that the export sugar market is totally lethargic and that nobody on the international market wants sugar on short-term delivery. Already predicting a possible delivery in May, holders of long position maturing May resell and roll it over until the next maturity date, putting the spread under pressure. A 64-point difference between maturity dates with a 60-day long interval for a market which trades at 16.80 cents per pound translates into carrying a position about 25% a year in dollars. What is that?

Why would a refinery or an industrial consumer, for example, pay a 25% equivalent a year more for sugar against July compared to May? One might argue that there is a lack of demand on the end consumer markets (less consumption of beverage, etc), impossibility of stocking raw material (preventing from any buying in advance to take advantage of the spread), perception of a weakening economy (and that is why the market is totally abandoned). The thing is such an open spread makes for a big sugar receiver in May, betting things will get better for the commodity premium on the international market over the regulatory 75 days the NY contract gives the buyer to present the ship to load the sugar. In a worst case scenario, the possible receiver would redeliver the sugar in July pocketing the financial gain. Zero cost option waiting on El Nino, the rains in July, below-average milling, etc. There is only one company that can do that. Raise your hand if you know what company it is.

But the weakening of the spread also scares the funds which continue to be bought at 100,000 contracts and see May (where they are mostly placed) be pressured due to the lack of demand. That is, in the short run the market can go for 16.67 in May, when an opportunity for those who want to protect from a possible rise in prices in the second semester because of the weather opens up.

The sugarcane harvest number for 2014/2015 released by CONAB is the greatest among all the analysts, traders and producers on the sugar market: 613 million tons. The market did not pay much attention to it. The lowest number is at 570. That is, there are 43 million tons hanging over our heads.

The government has been signaling with the increase of the anhydrous blend in gas from the current 25% to 27.5%. According to the Archer Consulting model, this would increase the anhydrous demand by approximately 1.1 billion liters for the 2014/2015 harvest, assuming this change goes into effect as of May 1st. With that, about 15 million tons of sugarcane will be pulled out of the sugar production to meet the additional demand.

A federal government official gave an interesting, to say the least, assessment at an interview to the news agencies. Showing the same peculiar wisdom which abounds in the Lula/Dilma’s Workers’ Party (PT) government, he said this measure (possible increase in blend to 27.5%) should make sugar mill owners invest in production again. Another being from outer space whose galaxy I have never heard of.

Meanwhile, over 400 employees have been laid off this week by a large company in the sector. This is just the tip of the iceberg as to what happens to a segment which sees its product being hit by a federal government blind policy, subsidizing gas. Sad!

The straddle (combination of options which consists of selling a call and a put of the same exercise price) of 19 cents per pound for March 2015 is trading at 287 points. This means if a trader sells this straddle and the market expires by mid-February below 19 cents per pound, it is bought at a minimum price of 16.13 cents per pound; on the other hand, if the market expires above 19 cents per pound, the trader will have sold it at a maximum price of 21.87 cents per pound. The risk lies in if the market stays below 16.13 cents or above 21.87 cents per pound.