When Sugar Tastes Sour
Probably one of the best decisions I made last year was not the decision to
buy the ETFS Sugar Fund at $19.60 (SUGA.L) but to sell at $19.36. Yes I made
a slight loss but my reasoning was sound. The volatility was madness. One
day it could be up by 5%, the next down by 7%. It had no stability. What it
did have was a traditionally low volume market with stable pricing that had
been 'invaded' by hedge funds and ETF's.
At a seminar last year, I even asked Jim Rogers face to face, "How can
small, traditionally stable markets, protect themselves from bubbles created
by massive inflows of capital?" His answer was that there had always been
bubbles in commodity markets. My response to him was that previous bubbles
were usually created by internal market events, not by external actors who
had short term profit targets to hit. He ignored me and went on to the next
question.
Whilst I really believe in ETF's, I also realise their ability to distort a
market. ETF's (and hedge funds) can be disastrous for small illiquid indices
unused to hot money.
The problem is, is that the sugar price is down not because of hot money but
because of fundamentals. However, the hot money will eventually exacerbate
the situation by selling in a collapsing market.
White sugar prices have sunk 36.9 per cent since reaching a record $767 a
tonne in January. Raw sugar prices have also dropped nearly 50% per cent since
reaching a 29-year high of 30.40 cents a pound in February.
So what are these fundamentals? Brazilian yields are beating forecasts as a
waning El Nino brings dry weather, boosting prospects for a record harvest.
Mills began crushing cane early after two years of heavy rains pared output,
said Maurilio Biagi Filho, the world's second- largest grower.
"I had never seen a single mill operating in January before," Biagi said in
an interview with BusinessWeek on March 24. "This January, we had 90 of them
working at full capacity."
Conversely in India,in 2009, sugar soared partly because two straight years
of drought damaged the Indian crop. A weakening El Nino is a "positive sign"
for the monsoon, India's main source of irrigation, Ajit Tyagi, a director
general at the India Meteorological Department, said on March 18. "A repeat
of last year (drought) is positively not going to happen." In fact, it now
appears that last year, the Indian harvest was nowhere near as bad as first
thought.
The sharp decline in prices has encouraged some hedge funds to re-enter the
market with fresh long positions - bets on a recovery in prices - which were
more than double the increase in short positions, according to weekly data
from the Commodity Futures Trading Commission. But if production continues
to grow, demand will drop and the price will continue to fall. In fact,
considering the futures positions taken, I'd say that the price of sugar is
already inflated and sugar itself, overbought, despite the near 50% price
fall.
Sugar will find a bottom. There will be a time (whether in the short or long
term) when demand will outstrip supply. But it seems that with production capacity approaching
full tilt that that time is not now.
As I said, sometimes it can feel good to sell in order to preserve capital.
Have a profitable week.
Gareth
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