Sugar surged to 29-year highs in 2009. In January, the market capped off those gains with a spike over 30¢ per pound before pulling back in February. Is sugar in for another year of soaring prices or has the market flamed out? To find the answer, one must look no further than the market’s base fundamentals.
Unlike regional markets such as soybeans, orange juice or cocoa, sugar is a global market more along the lines of wheat. It is produced and used everywhere and thus, fundamental price projection becomes a bit more involved. For sugar analysis, it is global supply and consumption figures that matter.
One figure that encapsulates all of the fundamentals in this market is global stocks to usage. Stocks to usage measures the amount of supply left over at the end of the crop year compared to the expected demand for the upcoming crop year. If global sugar stocks to usage was 25% for the 2009/10 crop year, it means if no sugar was harvested in 2010, we have enough leftover supply to meet 25% of global demand for 2010. The correlation between stocks to usage and price movement is clear over time (see “Sweet correlation”). As stocks to usage declines, prices rally, reflecting scarcity.
Supplies remain tight, which is why sugar prices reached a new crescendo in January. Two consecutive years of near historic low stocks to usage figures in sugar have been the fundamental engine for the bull market. The 2009/10 global stocks to usage figure at 17%, if realized, will be the lowest in 26 years.
The reasons for the supply shortfalls are the same reasons that prices could eventually drift back to earth: production. India’s crop was decimated last year by dry weather through the monsoon season. Brazilian production suffered for the opposite reason — an overabundance of rain that carried over into the normally dry season. While sugar is globally produced and other factors contributed to the shortfall, crop problems in the commodity’s two largest producers can still pack a heavy enough punch to make a significant dent in world inventories.
However, these problems are old news. The market has spent the better part of 2009 and early 2010 pricing these expected shortfalls. It will soon be time to shift focus to the upcoming 2010/11 crop, which could spell trouble for the bull market. Sugar inventories could rebound over the next 12 months for varying reasons, including: Brazil, which begins harvesting in March, expects to yield 10% more sugar than last year’s disappointing harvest; India’s yields will likely return to more normal levels this year and the pendulum of ethanol vs. white sugar production will be shifting back towards white sugar in 2010 as lower petroleum prices are curbing demand for ethanol.
While it is too early to predict what 2010/11 global sugar ending stocks or stocks to usage will be, it seems fairly certain the world will produce more sugar for the 2010/11 crop year than it did for the 2009/10 crop year. Consequently, both ending stocks and global stocks to usage should rise.
This does not project a massive correction or a new bear market in sugar — it will take several years to rebuild stocks — however, it does suggest that the worst of the supply squeeze may be over and the majority of the move has already taken place.
Our projection for sugar is that it will put in a high in the first quarter of 2010, if that has not already occurred, and then level off and drift lower into the second half of 2010.
This may sound useless to a futures trader trying to decide where to buy or sell this week but to an option seller, it can be a set up for a profitable quarter, or even a profitable year.
The recent volatility in sugar has pushed option values to levels not seen in years. Sellers of 40¢ or 45¢ sugar calls have little care if prices topped out in January or push up to 31-32 or 33¢ through March. For option sellers, it’s the big picture that matters. And it seems unlikely that sugar prices will rise another 33-50% with fundamentals shifting into a less bullish posture.
Obviously, currency fluctuations will continue to play a role in sugar and all commodity prices in the coming months. However, the value of the dollar can only serve to enhance or hinder a fundamentally driven move. If sugar is going to rally by 50%, it will need a fundamental reason to do so.
That reason appears to have already come and gone.
James Cordier is head portfolio manager of Liberty Trading Group. Michael Gross is a market analyst with Liberty. Together they wrote “The Complete Guide to Option Selling” (McGraw-Hill 2005). They can be reached through their Web site, www.OptionSellers.com