The futures sugar market in NY plummeted this week, closing Friday at 10.20 cents per pound for the contract maturing in October/2018 after having traded the low at a 10.11 cents per pound. This is the lowest level in the last 10 years (it broke the 9.84 cents per pound of June/2008).
The values in real per ton, however, are far from the lows. This very year the NY price converted into real per ton by the exchange rate provided by the Central Bank broke the R$870-per-ton low of April 25. Friday’s closing, despite contemplating a 7.50-dollar-per-ton drop in the week, represented R$920 per ton.
Although the price didn’t reach the low, the fact is that, as a trader, who for obvious reason chooses not to reveal his real name, put it, “A lot of mills hold off on pricing, and if the Indian government keeps creating more problems than finding solutions, next year what we are more likely to see is zombie mills”.
A market analyst, outraged by India, points out that that country has a floor price (always above the production cost) which gets the mills into trouble; then they have loans for the millers so they can buy the high priced sugar. Then they have buffer stocks programs, paid for by the taxpayer. Then they have export programs: giving free transportation to the ports for the millers, direct export subsidies. Then when the international price is low, they have import tariffs. Then they buy up huge amounts of sugar for giving away to the poor. Market signals rarely make it through to this whole system, which leads to massive overproduction; no one could sum it up better.
The vulnerability of the mills is the main ingredient of this bloodbath we are watching. A lot of fixation and rolling still to be done (including Thailand), troubled macro scenario because of Turkey, which creates instability on the emerging markets, maximizes the pressure on the soft commodities (coffee, sugar, and cotton) via devaluation of the currencies of the producers and spread panic worldwide. The cotton market (Turkey is one of the main buyers of the United States) has already dropped 9% this month. Sugar has dropped 6% and coffee has dropped 5%. Life is hard for those who work in softs (excuse me the pun).
And as it always happens in market situations close to panic, there arise prophets of the apocalypse. The gem of the week could be attributed to one of them who said that at the current market level in NY, the mills are still making money off of sugar. Even the most efficient mills of the Center-South can hardly have a production cost below R$42 per bag, ex-mill, cash cost only. Today this would come to about 100 points above NY. Taking into consideration that some businesses were done at a 35 discount this week, the break-even point is 145 points away.
The heavy dark clouds hovering over the sugar market will have great difficulty clearing away. They have gathered with others and are turning into a perfect storm. Funds accumulating 150,000 short contracts, macro scenario hitting the softs, the real depreciating, elections in Brazil, pricing delay make the market recovery difficult. The environment of the soft commodities will take a toll. Can the market break the 10 cents per pound? It can, because markets exaggerate. A few things are out of place, though.
The spreads traded at the exchange show a curve with extremely distorted carry. Of course, this conceptually occurs when there is the perception that there won’t be a shortage of the product and that the buyers put off their purchases as long as they can, making the sellers (who have the goods) pressure the price curve, especially those with shorter maturity. From March/2019 to March/2020 the curve is showing a carry of about 13%. That’s too high.
The fair value of the H9, using the carry criterion of 6% bringing it from H0, is 75 points off. The spot, that is, October, is off by 120 points. When we used this criterion in the crazy high in the last quarter of 2016, we noticed that the sugar market in NY was extremely distorted. And now?
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Have a nice weekend.
Arnaldo Luiz Corrêa
