After soaring to 36¢ per pound earlier this year, sugar prices experienced a wicked correction, falling by 40%, to just shy of 20¢ per pound (Chart 1). Expectations for a bumper Brazilian crop, a surprise surge in Thai output, and a broad correction in commodities were the catalysts for the selloff. At the time it seemed that it was lights out for the bull. A rather spectacular rally in June and July took prices right back to 31¢ per pound, dispelling any notion that the bull market had ended.
While prices were falling so were Brazilian output estimates. Once the harvest began in April it became clear that inclement weather would reduce yields to lower-than-expected levels. The market was complacent with early forecasts for yet another record crop in Brazil, which at one point was estimated to reach close to 40 million tonnes. Extrapolating from estimates for the Center South region (Chart 2), which produces about 90% of Brazilian sugar and which analysts focus on, 2011-12 output will be just over 37 million tonnes. Some analysts are predicting even lower output. The unexpected 2-milliontonne-plus jump in Thai output should have compensated to some degree, but demand from Russia, Indonesia, China and the Middle East has been very strong.
Near-term global tightness resulted from the chronic backlog at Brazilian ports that plagues sugar and other export commodities. That has cleared up now. The problem with sugar supply in Brazil, however, runs deeper than overburdened ports and a poor crop.
Early forecasts for a global surplus of 10 millions tonnes were premature and probably steered the ethanol/sugar production ratio to higher levels than would comfortably accommodate the country’s sugar export commitments.
To little avail, though. Ethanol supplies have become tight as well. Brazil will import about 650 million liters of ethanol from the US this season. That’s only about 2.5% of total usage, but highlights the inability of the industry to keep up with demand. It is estimated that automobile sales in the rapidly growing economy is growing by 20% per annum.
The government was toying with reducing the mandated minimum 25% ethanol blend in car fuel to ease the pressure on tight supplies, but has recently abandoned the idea.
Looking ahead, there is little chance that sugar production will capture any significant increase in its share of the cane crop.
Production costs for sugar have risen over the years, another reason that we’d be hard pressed to see a meaningful drop in the ethanol/sugar output ratio going forward. Over the past several years, costs have increased from the low teens to over 20¢ per pound. That’s a powerful bullish case for further price gains that would allow prices to rise enough to provide incentive for higher sugar output.
The leap in Thai production has been well known for many months and has obviously not played much of a role in alleviating pressure on the market from the smaller-than anticipated Brazilian output. For that matter, we believe, that with estimates still ticking down, the market has not yet fully absorbed the potential fallout.
The early forecasts for a 2011-12 global sugar surplus in the neighborhood of 10 million tonnes have shriveled dramatically. Estimates are all over the place, but a recent estimate by a statistician at F.O. Licht put the global surplus at a scant 800,000 tonnes.
Our May 18 recommendation, with sugar hovering near the lows of the correction, at about 21¢ per pound was: "Current price levels present an excellent low-risk opportunity to enter the long side. Buy October sugar at the market. Place initial sell stops at 20.50¢ per pound, close only."
So far so good. Raise stops to 26¢ per pound, basis October, close only.