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 “Markets can remain irrational longer than you or I can remain solvent


The famous quote by the British economist John Maynard Keynes was remembered by a market executive this week. It mirrors the situation the mills are in having waited – unsuccessfully – for better prices in order to fix their sugar. There is a limit between condescending waiting and the moment to throw in the towel in despair. This threshold was crossed in the week that just ended. Even though the market looks irrational, the length of this period can still be longer than the capability the mills have to withstand the cash flow shortfall waiting for better days. And the funds that are short by 170 thousand lots at the average price of 13.50 cents per pound estimated by us are profiting almost four hundred million dollars.

The futures sugar market in NY closed Friday with July/2018 at 11.63 cents per pound, representing a 24-point fall in the week or 5.29 dollars per ton. All the other months closed at a low that ranged from two to six dollars per ton. The October 2018/March 2019 spread closed at 111 points embedding an annualized discount of 24%.

Some things have been missed by the thorough analysis made by the great mass of managers involved in the sugar-alcohol market. One of them is the fact that we have seen the prices of hydrous ethanol plummet by R$500 per cubic meter in just 4 weeks under the off-season scenario and the ethanol consumption growth. Who would have thought? It strengthens the thesis that panic spoke louder and pushed the mills to close anhydrous contracts with the distributors with much more generous discounts than what we saw in the past. It is too bad, but this destruction of the market is a fact.

As an experienced analyst has said, “what we see is the spring being pressured”. If when hydrous left the mill at R$2.3000 and got to the pump at R$2.8900 per liter the consumption got to be almost 1.4 billion liters in March, what will happen to the consumption with a reduction of R$0.50 per hydrous liter, compared to gas still without price reduction and with the perspective of a high within the world scenario?

In the 2015/2016 season, we saw the hydrous consumption in the first semester (April to September) come to 9.3 billion liters in a fleet of flex vehicles of 24.6 million units. With an estimated fleet of 27.7 million units today, this consumption would jump to 10.5 billion liters. Looking at the yearly consumption history based on the period of April to September, in theory, we would have the potential to consume 20.5 billion liters. We don’t even have to go into the argument to see that there wouldn’t be hydrous to meet this potential demand. That is, the price will balance out and the arbitrage with sugar will continue to make the mills produce as much ethanol as possible.

Will the sugar market drop any further? Over the last ten years, only 2.33% of the times did the market remain below 11 cents per pound and when it did, the longest period was 24 alternate days. Likewise, over the same period, only 2.33% of the times did the market remain above 30.77 cents per pound and when it did, the longest period was 48 alternate days.

Real has shown stress signs due to the political instability in Brazil (the greatest one goes by the name of Federal Supreme Court) along with the increasing possibility of the FED (Federal Reserve) promoting changes in the American interest rate along the current year and the effect this can bring onto the price of commodities. If the real devaluation (say R$3.6000) comes with the price maintenance of oil abroad (say Brent at 72 dollars per barrel), over the short term (6 months) the hydrous ethanol curve assuming that the price at the pump will be 60% of the price of gas, the value of the hydrous will get to 13.20 cents sugar equivalent per pound.

Although the surplus has grown, the Center-South continues producing the same amount of ATR as nine harvests ago. This is worrying, mainly because this year, with low sugar prices on the foreign market, there is a tendency for few cultural treaties in the sugarcane fields in addition to the aging of the sugarcane. Though the current scenario inspires care because the position of the funds is comfortable and we can still be far from the lows, the world will not be able to do without Brazilian sugar for two straight harvests.

On the domestic market in Brazil, sales are slow and prices continue to drop; we don’t know how bad the real can get against the dollar since the political and foreign scenarios don’t help. On the other hand, the most efficient mills in Brazil cannot produce sugar at the current price level. As panic has set in, it is possible for it to drop even further. However, without making any correction of values based on the inflation, that is, observing only the daily closing of NY over the last ten years, those who sell now have a 98.1% chance of making a bad deal.

This won’t be a year to pay off debts. Up until the end of March/2018, Archer Consulting’s survey shows that the debt of the mills reached R$88.98 billion, a 3.89% increase against the same period last year.

Registrations for the 30th Intensive Course on Futures, Options, and Derivatives – Agricultural Commodities are open. The course will be held on August 7, 8 and 9 in São Paulo-SP at the Hotel Wall Street on Rua Itapeva. If you plan on taking it, remember that spots are limited and in the last events they ran out 40 days before the course started.

The book “Derivativos Agrícolas”, written by me and journalist Carlos Raices, is already available on Amazon Books, iTunes, Google Play, Kobo and Livraria Cultura.

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Have a nice weekend.

Arnaldo Luiz Corrêa

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