Commodity prices across the board have been sliding in unison. The degrees vary, but everything has been beaten up – energies, grains, precious and base metals, and softs. It may seem as though commodity-specific fundamentals have no relevance to falling prices, but that may not be the case.
Considering what the equity markets are telling us about the global economy, particularly the bleak outlook for the Eurozone, the demand side of the balance sheets may indeed have changed. Forecasts for consumption for many commodities were made under the assumption of slow but steady growth in both the developed and developing world. Now we’re talking recession and demand destruction.
The sugar market has been no exception, but it’s questionable how much a basic staple such as sugar would be affected by a recession – if there were one. Prices fell 5¢ per pound over the past few weeks and triggered our 26¢-per-pound sell stop. There have not been too many apparent developments on the fundamental side, but traders are factoring in the potential for a drop in usage estimates.
Estimates for 2011-12 Brazilian output, which have been slipping throughout the crushing season, have stabilized. Volatile weather reduced yields, leaving total production about 6% below last year’s output. Late in the crush season, the sugar-to-ethanol ratio favored sugar, but that provided only an insignificant uptick for total sugar output. Output of about 34.5 million tonnes is still a major disappointment when compared with early season estimates that reached as high as 40 million tonnes, which would have been a record.
Aside from Brazil, though, the other key producing/exporting countries have taken advantage of high prices.
Thailand will harvest another bumper cane crop. Until 2009-10, sugar output averaged about 7 million tonnes. In 2010-11, output jumped to 9.5 million tonnes and the forecast for 2011-12 calls for further gains to 10.2 million tonnes. Domestic consumption is about 2.5 million tonnes, which leaves the balance available for export. Foreign sales will therefore continue to be 3 to 4 million tonnes above historical norm.
India is in its second year of recovery after two consecutive years of weak monsoons which devastated cane crops. Output is expected to top last year’s 24.5 million tonnes, but there is no consensus on 2011-12. Estimates range from 24.5 million tonnes to over 26 million tonnes. The industry is pushing for 4 million tonnes of unrestricted export licenses.
Domestic consumption is very strong in India – traditionally accounting for almost the entire crop. Despite being the world’s second largest producer behind Brazil, India was absent from international sugar headlines until the 2008-09 season. It was self sufficient and did not participate in world trade, which allowed it to build inventories that were typically equal to roughly 50% of consumption. An Indian foray into the export market will leave its ending stocks at about 4 million tonnes, or about 20% of consumption.
We believe, however, that exports will could leave India vulnerable. Domestic demand is not very elastic. Current ending stocks estimates are based on static domestic consumption growth to between 22 million and 23 million tonnes. We’ve seen estimates that put consumption at considerably higher levels for 2011-12 which would mean that India would be left with insignificant inventories. The last time Indian stocks were that low the government had to intervene by restricting sugar purchases to food manufactures and engineering a decline in demand. Before India got a grip on the situation by slashing import tariffs as well, sugar prices had their first trip to the 30¢ per pound level.
With strong crops in Thailand and Australia, in addition to the unusual Indian contribution to the export market, the Asian import markets will be comfortable in 2011-12. Higher output in Asia, however, is compromised by the unexpected fall in Brazilian output. Sugar analysts are forecasting a global sugar surplus for 2011-12 of about 5 million tonnes, but they have all slashed their estimates by several million tonnes to account for the drop in Brazilian output. Nevertheless, with a surplus, the fundamentals are not bullish.
Our concern about India, while hardly frivolous, is certainly premature and would really only come into play if there was a weak monsoon next spring. Nonetheless, we list it amongst potentially bullish factors.
Industrial commodities may have further to fall, but sugar is different. Prices – particularly in Brazil – are perilously close to the cost of production which means the incentive to expand acreage yet again for 2012-13 will not be there.
By any technical measure the market has become oversold. Open interest has shed 140,000 contracts since the market peaked in mid-August. Open interest continued to drop even after prices began to consolidate two weeks ago. That’s a classic indication of effective commercial support. In fact, Commitment of Trader figures show that commercials have been strong buyers. We believe that there is an excellent, low-risk opportunity to probe the long side for a trade – not a marriage. Buy March sugar, risking 24¢ per pound, close only.
