The sugar futures in NY went further down this week, trading at below 11 cents per pound. The non-index funds broke another record and now are short by almost 190,000 contracts, total nonsense given the sugar fundamentals and, under normal conditions – as a market analyst from the Big Apple put it – would be a bullish sign, but that’s not how it works.
Trading volume at the exchange has been extraordinary, but the largest share of this volume is related to spreads. On the physical sugar market, especially in the Center-South, the volume of washouts that have occurred is amazing. As you know, it’s an operation agreed upon between parties – mill and trading company – where the former agrees to pay a pecuniary penalty whose value is smaller than that it will get for redeploying its sugarcane to ethanol production.
Another market analyst has also spoken out during the week, “F…the fundamentals. We are in the middle of a great operation where the algorithms and robots are what counts; they understand zilch about sugar or fundamentals.” You can cry all you want. Remember that recently algorithms and robots have also led sugar to price levels which went beyond more than 180% of the production cost and of course nobody cursed them then.
Sugar prices in NY, whose October/2019 maturity closed at 11.01 cents per pound in the week, don’t pay ¾ of the Brazilian mills, whose FOB Santos production cost is at least 100 points above that value. It makes no sense to continue producing sugar at these levels. The bubble (the huge short position of the funds) will burst – the question is when and how intense that will be.
Less sugar hedge will be demanded against the next expiration in March due to the volume of wash-outs, less sugar will be produced and, therefore, fewer futures sales will be necessary as well. For the funds, which are long in energy and short in softs, the week was great because the spread between both of them was on average above 5%. What will be their reaction be if something in the scenario changes?
Are the funds in a hurry to get out of the huge short position in sugar? Absolutely not – the long-short position they have is very beneficial to them (in the yearly accumulated, more than 33%, that is, sugar they are short at has dropped by 9% and oil, which they are long at, has gone up by 25%).
The more sugar shows signs of weakness, the more they sell it. The algorithms and their robots can’t tell a sugarcane tree from a penguin, and they don’t have to. At the other end of the trading, there is a trader, a risk manager, a CEO who tears his hair out to understand what is going on and has to explain himself to the Board; it is an unfair and inglorious battle.
This will change. The fundamentals always stand out, but we might die before this happens. On the bright side, there is a substantial reduction in the sugar supply on the part of Brazil, the lowest availability of Brazilian sugar for the world market probably in a decade. We also have a vigorous increase in ethanol consumption which keeps remunerative prices for the production mills. In our opinion, the funds have a worrying and vulnerable short position, but they don’t care. The prospects for production and income for the next harvest – though it’s still too early – are not encouraging at all. The volatilities are low, putting at risk those who are short calls.
On the downside, there are the same old questions: India with a good production prospect for the next harvest, excess sugar around the world, an open position in October/2019 which can signal yet another huge delivery on the expiration date of the contract, deteriorating the gloomy perception on the physical market even further.
Which side will win this arm-wrestling match?
Make a note on your calendar – the XXXIII Intensive Course on Futures, Options and Derivatives should occur in March/2020, on March 24, 25 and 26 at Hotel Wall Street on Rua Itapeva in São Paulo. Wait for confirmation.
Have a nice weekend.
Arnaldo Luiz Corrêa
