Commodity prices have taken a severe beating. A sputtering US recovery, a weak outlook for the Chinese economy, and fear of contagion resulting from the ongoing European debt crisis sparked a selloff in the stock market. The Dow Jones Industrial Average tumbled by 10% since it peaked in early May and – save for gold – the selling extended to virtually all other markets.
True, some markets that rely heavily on Chinese imports could see a direct impact from shrinking demand. However, amidst their zeal to liquidate increasingly painful long positions, in some cases, and to get on board with what seems to be the new downtrend in commodities, in others, funds and individual traders have perhaps ignored the fundamentals of some markets.
To illustrate, Chart 1 shows that open interest in sugar jumped to two-year highs over the past couple of months, while the sizeable net-long speculative position swung to a net-short position. We believe that the selling pressure in the sugar market overshot basically bullish fundamentals.
Thai production skyrocketed over the past few seasons. Normally a producer of 6 million to 7 million tonnes, output shot up to 9.5 million tonnes in 2010-11 and then to 10.5 million tonnes in 2011-12. Early estimates for 2012-13 are just shy of 11 million tonnes. Domestic consumption is about 2 million tonnes, and the rest of the crop is exported. Unless a weather problem pops up, the addition of 3 to 4 million tonnes to the pool of available sugar for world trade is a permanently bearish factor.
While India also helped “save” the market from sloppy Brazilian output (more on that later) by exporting close to 3 million tonnes in 2011-12, the situation is much different than in Thailand. Indian domestic consumption is the largest in the world. The 22-million to 23-million-tonne estimate that has been used in calculating Indian ending stocks is probably stagnant. In the May 2012 edition of its bi-annual survey Sugar: World Markets and Trade, the USDA lists Indian domestic consumption for 2011-12 at 25.5 million tonnes, up from 23.5 million tonnes in 2010-11. The forecast for the upcoming 2012-13 marketing year is 26.5 million tonnes.
As we’ve pointed out in the past, because of extremely high per capita consumption, the government has maintained policies intended to keep the domestic market comfortably supplied. Before the devastating drought years of 2008-09 and 2009-10, ending stock levels were typically over 50% of usage. Now, because of the liberal export policy, inventories hover around 25% of usage. We’re at the beginning of the key monsoon season – the key to Indian agriculture – and over the past week, the rains were 30% below the 50-year average. While it is still early, it underscores the fact that India leaves itself vulnerable by running its stocks too low. India cannot be considered a reliable exporter.
Recent developments in Brazil, however, have given the bullish case more immediacy. As recently as one month ago, 2012-13 Brazilian output was expected to recover from the current season’s drop in production – the first in a decade. Excessive El Niño related rains, however, have quashed any hope of an improved crop. Some recent estimates actually put production in the center-south output region, which accounts for 90% of Brazil’s crop, below last year’s levels.
Forecasts for output and exports vary wildly, but both have been dropping. Some estimates put export availability as low as 20 million tonnes, down from estimates for 2011-12 that according to some analysts were as high as 24 million tonnes.
The International Sugar Organization (ISO) forecasts that the 2012-13 global surplus will fall to 3 million tonnes from 6.5 million tonnes in 2011-12. Although the early-May ISO estimate anticipated deteriorating weather conditions in Brazil, it seems that conditions are even worse than expected. As a result, the global balance is probably closer to a balanced market.
We were stopped out of our long position in May sugar at 23¢ per pound. We recommend re-establishing long positions in October sugar, using a 19¢ per pound stop, close only.