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Although it didn’t catch anyone by surprise, the current short position of the non-index funds of 134,000 lots released this Friday looks very vulnerable to me. What is clear is that the average sale price of the funds since the short position started to be built has allowed its managers to add more volume onto the current levels, which ends up pressuring the futures market, causing panic for those who were expecting better days to fix the physical sugar, and, of course, showing a great mark-to-market performance late last month.

When I talk about the vulnerability of this huge short position it is because I see that all bearish news found in the world sugar universe today is duly inserted in the prices, reflected on all its extension and even, as it almost always happens, moving the price curve too far from the production cost. Well, who cares about production cost, right? Well, there is nobody, nobody in the world today who can produce sugar with a profit margin, paying for financial costs, if we take as a basis the closing price of the futures contract in NY for October/2018, which this Friday closed at 10.85 cents per pound.

The worrying issue to me, if I were sitting in the chair of a manager to a speculative non-index fund, is whether the profit potential of this gigantic short position substantially compensates for the inherent risk it has if we have a climate problem, for example. We saw during the week that the temperatures are very high in this European summer and that the drought can hurt the European sugar beet harvest. The same goes for the Center-South of Brazil. This week we saw several trade houses and respected consultants reducing their crushing estimates. A year ago we bet on 585 million tons of sugarcane for this current harvest; today 550 is a number everybody seems to agree upon. And even so, the market does not fight back.

Even the rocks know that the futures sugar market has had great difficulty recovering prices for an obvious reason: there are more people wanting to sell futures than wanting to buy them. Well, in this case, why would the funds need to rush into covering their short position if there are more people (the mills) needing to sell. At these times, the real flesh and blood manager – yes, because we take it for granted that the decisions are made by bipeds and not by robots fed by complicated algorithms that couldn’t care less about rational and innocuous discussions that we humans make – bets on the panic and lowers the stop levels on the market. That is why the price spikes we have seen in such a short period of time are not rare.

Another point that deserves a thorough analysis is that in July the total volume of futures traded in NY was just 1,726,000 contracts, almost 2 million contracts less than in June and the open position over the period increased by 74,000 lots and the market fell 9%. In June, 3,720,000 contracts were traded, the open position fell 72,000 lots and the market fell another 8%. In June, there was a probably greater fixation of price by the mills (fall in the open position), but in July, with a lot less volume, the funds were able to move the market to lower levels, adding new shorts (increase in the open position). With a lot less volume, they were able to overthrow the market even further. The real flesh and blood manager doesn’t need to rush.

Well, this week the funds covered part of their short (after Tuesday), but the market absorbed the covering because of the price fixations by the mills, which everybody knows, are late. Let’s imagine that the total volume laid down by the mills up until the end of July (Archer Consulting number should be released to the clients next week) is 75%. Usually, the total volume of fixations against May-July-October adds up to 79%, coming to 21% against March. Let’s assume that 30% of the March position is already fixed, so there is still 70% missing. If March, as we said, represents 21%, there is 14.7% missing. In short, if the mills still have to fix 25% of the harvest and if out of this percentage, 14.7% is that of March, so there is still 10.3% missing to be fixed against October. October represents about 39% of the harvest. If there is still 10.3% missing, it can be concluded that the mills still have a little over 25% of the October volume to be fixed. This should come to about 66,000 lots.

I do believe this number is smaller because it does not take into account the rollover that a lot of mills did shifting the month of fixation from October/2018 to March/2019 in order to gain more time to get better prices. If our reading is correct, and if this number is really smaller and if we throw the ingredients coming from possible climate problems on top of it all, be it in Europe or even in the Center-South, the funds might not see the mills supplying them with liquidity in an eventual short-covering anymore and there might be some maximization in the NY response.

In short, let’s keep a close look on the movement of the spread Oct/Mar. The managers might have a grenade in the hand. If the pin is pulled out, that is, smaller-than-expected fixation by the mills, it can go off in their own hands.

There are only two spots left for the 30th Intensive Course on Futures, Options and Derivatives – Agricultural Commodities which will be held this week, on August 7th (Tuesday), August 8th (Wednesday) and August 9th (Thursday) in São Paulo-SP at the Hotel Wall Street on Rua Itapeva. The next one will take place only in March/2019.

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Have a nice weekend.

Arnaldo Luiz Corrêa

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