Sugar: Sailing in Murky Waters

The sugar futures market in NY closed Friday in negative territory compared to last week. March/2020 closed at 12.32 cents per pound, a weekly fall of just 9 points, or about two dollars per ton. The other trading months closed at lows between 10-12 points.

The non-index funds added on new sales over the week and came close to the short position record: 176,500 contracts. Just for the record, coffee and sugar have accumulated losses of 5% and 3%, respectively, in October. These are two commodities in which the funds are doing as they please.

Early this week, the Canaplan event headed by the former president of ABAG, Luiz Carlos CorrêaCarvalho (Caio) and held in the city of Ribeir?oPreto once again stood out as one of the best in the sector because of the pragmatic way it laid out and discussed the various aspects which the sugar-alcohol market is worried about. The great lecture by Martin Todd, from LMC, focused on the difficulties the sugar market has in order to be able to break the 14-cent-per-pound barrier. With 25 million tons of sugar in stock divided between two countries – India and China – the Managing Director believes overcoming such price barrier is a complex task. However, he agrees that the worst in terms of price has already been seen.

There is a consensus that the Center-South will not experience expansion in the planted area in the next years. The expected GDP growth for 2020 will speed up fuel consumption and Brazil’s sugar availability will be even more undermined. Should this happen, Brazil will be helping to dry up the large world stocks. The fundamentals, as we have always said here, are pretty constructive. We just have to make a deal with the market.

Two weeks ago, the prestigious English newspaper The Economist cover story pointed out how the stock market (read Wall Street) has been taken over by computers, algorithms and mathematical models. “Investing fifty years ago”, says the magazine in its October 5th issue “was clearly a human issue. Reading the Wall Street Journal on the way to work, a TV set turned on the trading floor and the ability to be able to read those yellow strips which were spat out of the telex and news machines offered a meaningful comparative advantage of information.

The subject addressed by the publication is exciting and raises questions about the true role of the markets. And, of course, here I will look after number one: the commodities market. And how much can this change be affecting it too?

It’s reasonable to admit that some markets can be held hostage to algorithms and their effects on the price trajectory, making the old and careful method of analyzing the fundamentals as obsolete as the slide rules or Gordon Gekko’s red braces

Wanting to know in advance how the market will behave has always been a constant market operators’ search – a true philosopher’s stone because predicting the direction and volatility of the prices correctly is absolute certainty of profit.

Commodity companies have always invested in research focusing on production analysis, consumption, stocks, aspiring to predict periods of abundance and shortage of a certain commodity and position themselves on futures markets, spreads, arbitrage, basis and volatility before their competitors do. Today, this specialized technical staff who works collecting and analyzing this information – which is raw material for the executives’ decision-making – go by the impressive name of market intelligence.

My professional training (Cargill in the 1980’s) has made me be a fundamentalist. Though the commodities market usually blow the fluctuations out of proportion because of the range of elements that make up commodities pricing and because they are extremely sensitive to sudden changes in the product availability, I have learned over more than 40 years on the market that the fundamentals end up prevailing – at least that’s how it used to be.

We can see distortions on the futures markets when we compare the price traded on exchange with the physical market of that product, or asimilar product, or even with a product which is made out of the same raw material. So, for example, there must be a close relationship between the prices traded on futures markets of soybeans, soy meal and soy oil, since these last two result from the crushing of the first. If prices don’t keep this correlation, arbitrage is made, selling what is overvalued and buying what is undervalued until the relationship is equal again. It’s as simple as that.

We could find distortions on the sugar market when we saw, for example, 3 years ago, hydrous ethanol being traded with an 800-point discount equivalent to the sugar price in NY. The distortion showed that NY was artificially inflated by the funds, probably driven by the same algorithms and mathematical models we reject.

Just as the algorithms act today on the stock markets, challenging innovation limits, creating artificial intelligence and learning algorithms (Machine Learning), looking to select what stocks to buy and sell, migration of this approach to the commodities market obviously happened at the drop of a hat. Not coincidentally, the funds have systematically bought energy at the expense of selling softs short.

The executive/trader/buyer of inputs who decides when it is time to fix prices at the exchange drawing on the competent analyses of their market intelligence staff, needs to be aware that on the other side of the counter there might be an artificial intelligence that is just trying to buy or sell at the lowest risk, and it doesn’t matter whether it has rained or not in the sugarcane field, if real is valued or not, if the carry over of ethanol will be reduced.

The decision-making process which used to be based on the fundamentals now have more elements to be looked at, making the decision-making process even harder and the risk management a tool that needs ongoing updating and creativity so that it can navigate in such murky waters.

The XXXIII Intensive Course on Futures, Options and Derivatives is set to be held in March/2020 - on March 24, 25 and 26 at the Hotel Wall Street on Rua Itapeva in S?o Paulo, SP. Don't miss it.

Have a nice week.