Sugar Market Hard to Stomach
The world is experiencing a collective sugar crash.
Global raw sugar prices have been causing headaches for some time. Last week’s spot sugar fell to a six-year low of $0.1193 per pound. It then saw a nice rally at the end of the week, closing up 3.41% on Friday to $0.1274.
But this rally looks to be a dead-cat bounce.
Global sugar stocks are abundant, and continually weigh on prices. Plus, stocks haven’t responded to the jolt of low prices.
This creates a problem for sugar futures…
Global futures are trading at one-third of their 2011 prices, and could fall further still.
But, don’t go sugar free just yet! There’s a predictably sweet opportunity in this sluggish market.
Six Reasons for the Sugar Crash
Six strong headwinds in the near term and macro forces in the medium term are impacting the industry and putting downward pressure on the futures markets.
Reason 1: There’s too much supply. Supply projections from the U.S. Department of Agriculture (USDA) suggest that world production in 2014 to 2015 won’t change much from 2013 to 2014.
China is the world’s third-largest sugar producer behind Brazil and India. The country’s sugar output was 13.32 million tons in 2013 and 2014, up 1.9% from a year earlier, according to the Food and Agriculture Organization of the United Nations (FAO).
Reason 2: Sugar cane is a semi-perennial crop, meaning it takes time to switch from cane to other crops. (Cane provides 70% to 80% of the global sugar supply; the rest is derived from beets.) This makes farmers slow to react to low prices.
But, there’s no incentive to switch to other crops because the prices of many other agricultural commodities are also depressed.
Reason 3: The strong U.S. dollar has had a negative impact on the price of all global commodities, and sugar certainly isn’t immune.
Not only does a strong dollar pressure international sugar prices, but it sustains the value of world market sugar in local currency terms of key exporting countries, such as Brazil, thus encouraging more production.
Recently, the Brazilian real hit a 12-year low against the U.S. dollar. Yet the nation is continuing to produce record crops. Furthermore, Brazil, being one of the lowest-cost sugar producers, has considerable capacity to expand sugar cane farming areas on a large scale.
Reason 4: With global price declines in crude oil, there’s ongoing uncertainty over future biofuel demand, particularly in the United States and the European Union, meaning less demand for sugar-based ethanol.
Reason 5: While sugar consumption as a food product is increasing in emerging markets, demand is dropping in developed markets due to health concerns related to obesity and diabetes.
Reason 6: The widespread subsidization of growers, import restrictions, and trade blocs, such as American tariffs and European beet subsidies, have all been in place since the colonial days, and keep sugar prices low.
Yet, despite depressed prices, sugar futures and options are both liquid and volatile, making them a good market for commodity traders and hedge funds.
What’s compelling is that sugar tends to stick to a fairly consistent seasonal pattern, making price movements somewhat predicable.
Prices tend to bottom out around April and May, and enjoy nice rallies in June and July when peak harvest begins and demand rises.
The world sugar market is continuing to experience considerable price volatility. And the price for raw sugar witnessed a succession of peaks and downward corrections in 2010 before soaring to a 30-year high of $0.3608 per pound in February 2011.
The market fundamentals driving those volatile prices were large global sugar deficits in previous seasons and adverse weather in a number of countries, which reduced the size of the expected rebound in production.
A Spoonful of Advice
There are a few options available when it comes to futures exchanges. The New York Mercantile Exchange’s (NYMEX) No. 11 sugar futures contracts are quoted in U.S. dollars and cents per pound. Each contract represents 112,000 pounds.
Sugar No. 11 can also be traded on the Intercontinental Exchange (ICE) with the very same contracts offered on the NYMEX. The ICE also offers options and spreads on sugar.
Investors looking to go abroad can trade the Euronext Raw Sugar (No. 408), India’s Multi Commodity Exchange (MCX) (which is based in Mumbai), or the Tokyo Grain Exchange (TGE) Raw Sugar futures contract.
A simpler approach is to invest in an index.
There are three exchange-traded products specifically designed to invest in sugar futures. The iPath Dow Jones-UBS Sugar Subindex Total Return ETN (SGG) is the most popular option and offers exposure to front-month contracts.
The Teucrium Sugar Fund (CANE) is another option and seeks to avoid contango by investing in a basket of sugar contracts spread across multiple maturities. Then there’s the iPath Pure Beta Sugar ETN (SGAR), which employs a unique roll methodology designed to mitigate the impact of contango.
From a short-term technical standpoint, sugar is trading far below both the 20- and 100-day moving averages, indicating that the trend is to the downside. The market this week broke $0.12 per pound and looks to be heading to around $0.104.
But bear in mind that sugar’s seasonality is now in play, and that the pre-harvest rally will likely kick in over the summer.
From a fundamental standpoint, stocks should rebuild in the near term, according to the OECD-FAO Agricultural Outlook. But the stocks-to-use ratio is expected to average lower over the coming decade than in the previous 10 years, providing support for higher prices.
The next USDA Sugar and Sweeteners Outlook will be released on May 18 with global consumption and production estimates. The anticipation leading up to the report and its release tends to cause additional volatility.