Sweet Volatility In Sugar

Sugar experienced a protracted period of bear market price action. In February 2011, the price of the sweet commodity peaked at 36.08. Since then the price dissolved falling to lows of 10.13 cents per pound in August 2015. Since those lows, we have seen a rebound in the price of sugar. It rallied to 15.85 cents by December 2015. The rally from the lows took sugar over 56% higher in a four month period.

Sugar was one of the few commodities that posted highs in an overall bear market for the asset class in 2015. Sugar moved 4.96% higher in 2015 with all of the gains coming in the fourth quarter of the year when it appreciated by 18.32% on a quarter-to-quarter basis.

This year, sugar saw a return to bearish price action. The price fell from the December highs to 12.45 cents per pound on the active month ICE futures contract on February 19. Since the sugar market had become accustomed to lower lows and lower highs for more than four years, many market participants assumed that the move to almost 16 cents was nothing more than a bear market recovery and that prices would head lower.

Speculators Return

During the recovery rally in late 2015, open interest exploded higher. Open interest is the total number of open long and short positions on ICE sugar futures contracts. Open interest moved from lows of under 740,000 contracts in mid-October 2015 to highs of just under 900,000 in January.

The increase in open interest reflected trend-following long positions and others who bought sugar futures as it rallied. When the rally in sugar failed, open interest fell back to below 750,000 contracts.  Those speculators who bought sugar futures closed their positions.

February 19 was a turning point for sugar.

The soft commodity exploded higher to 13.92 on February 23. By March 23 the price had rallied to 16.75 per pound. Sugar appreciated by 34.5% in just over one month. At the same time, open interest increased 12% over the period. Rising price accompanied by increasing open interest generally provides technical validation for a move in a futures price. Sugar closed the first quarter of 2016 at 15.35 cents per pound adding to 2015 gains and posting a 0.72% increase for the first three months of the year.

Longer term charts point to technical resistance at around the 18 and then the 20 cent levels. However, in the early days of April selling returned to the sugar market and the price dropped to lows of 14.23 cents on April 8 but buying returned to the market and it settled at 14.69 cents on the session.

Many technicians look at the 50% retracement level of a long-term move as a magnet that prices tend to gravitate to over time. The 2011 highs of 36.08 and 2015 lows of 10.13 per pound would imply a move to just over 23 cents if the market is to recoup 50% of the losses since 2011. All commodities have their own idiosyncratic characteristics and sugar is no exception. While the technical state of a market is a key factor in the path of prices, fundamental supply and demand are also important.

Currency Moves the Market

The current state of the sugar market is improving from a supply and demand perspective. This is the result of two key factors, events associated with the world’s largest producer and exporter and production output from other nations around the globe.

Brazil is the world’s leading producer and exporter of sugar cane. The Brazilian real, the currency of the nation, plunged between June 2014 and January 2016. Brazil is a major producer of commodities, the bear market in raw material prices caused the value of the real to drop. Additionally, a number of political and economic scandals in the country decreased faith in the government and when it comes to fiat currencies, particularly in emerging markets, currency values are a function of faith and credit of a nation. Scandal and lower commodity revenues caused the real to plummet.

The dollar rallied around 27% over this period on the dollar index, which is an index of major currency values against the U.S. currency. During the same period, the real declined by around 47%. The dollar is the pricing mechanism for most raw material or commodity prices around the world. That is because the dollar is the reserve currency of the world and the U.S. has traditionally been the largest and most stable economy.

There is an inverse historical relationship between the dollar and commodity prices. When the dollar rallies, the prices of commodities tend to decline. That is because commodity prices in other currencies move higher when the dollar strengthens encouraging selling from producing nations around the world that are not dollar based. In the case of the Brazilian real, the weaker real had two dramatic effects on the sugar market. First, even though the price of the sweet commodity was falling in dollars, it was rising in real terms. Second, the production cost of sugar dropped as the local costs for labor fell as they are based on the Brazilian currency. This meant that the world’s largest producer and exporter could continue to sell sugar into the market at economic levels.

Moreover, the fall in the price of crude oil meant that demand for sugar-based ethanol in Brazil declined. In the nation, sugar is an important ingredient in the production of ethanol because of Brazil’s status as the major world producer. In the U.S., the biofuel is produced from corn as the U.S. is the world’s largest producer of the grain. Falling demand for sugar-based ethanol in Brazil freed up more sugar for export, which caused an increase in selling in the international market for sugar. This is likely what sent the sugar price to its low in dollar terms of just over 10 cents per pound in August 2015.

As you can see, the move in the Brazilian currency helped cause the lows in sugar. In late 2015 and early 2016, the real has recovered. Beginning in February 2016, the oil price recovered. These have been important factors in the recovery for the price of sugar.

Fundamentals Turn Sweet

The second reason for strength in sugar has been production output in Asia. The strongest El Nino in years affected weather patterns in Asia over recent months leading to problems for certain agricultural crop production. Green Pool Commodity Specialists, a Brisbane, Australia-based researcher in a March 2016 report said that a global sugar shortage has developed and it will exceed expectations next season because of El Nino-induced droughts. Those droughts have damaged crops in major Asian producing nations. India, Thailand and China will all see reduced levels of sugar output resulting in an imbalance in the sugar market. According to the report, world consumption is likely to exceed production by 4.95 million tons in the 2016/2017 season – an increase of 19% from Green Pool’s January forecast. After five straight years of surplus conditions, sugar is now heading towards its second straight season of a deficit. Demand now exceeds supply. Green Pool also increased its estimates for the 2015-16 shortage of the sweet commodity. It expects a deficit of 6.65 million tons up from 4.14 million in an earlier forecast. They blame El Nino for the deficit as it has “reduced planting, reduced plant health and reduced plant care” in sugar growing regions of Asia. In a sign of the tightness developing in the sugar market, the May-July ICE sugar futures spread moved from a contango mid-February 2016 to a backwardation for a brief period. The backwardation is a clue that fears are mounting about supply shortages in the commodity. Backwardation is a condition whereby nearby futures prices are higher than deferred futures prices. Backwardation is often a sign of supply concerns in a market that is in a fundamental deficit where demand exceeds supply. The nearby sugar futures contracts have been moving back and forth between contango and backwardation over recent months.

In March 2015, Rabobank increased its forecast for this season’s sugar deficit – according to the bank; demand is now greater than supplies by 6.8 million tons, an increase of 2.1 million tons. “As a result of the projected deficit, by the end of 2015-16, the global stock-to-consumption ratio is expected to dip very slightly below its ten-year average level, suggesting a return to a more balanced supply/demand position”, according to Rabobank. One of the possible factors that could shift Brazilian sugar production lower is diverting more of the cane crop to ethanol production or adverse weather slowing cane production Rabobank said in their report.

When technical and fundamental factors line up in a market, it generally yields a powerful signal for the price. Beginning in February 2016, the path of least resistance for the price of sugar shifted higher. Both technical and fundamental supply and demand factors are positive for the sweet commodity. Sugar is historically one of the most volatile commodities on futures markets. It is likely that we will see a pickup in activity and an increase in price ranges in sugar in the weeks and months ahead.