Many commodity prices have somewhat rebounded in 2016 following a general decline in prices since 2013. While many investors have focused on crude oil as well as the shiny yellow metal gold, a commodity that may have been overlooked by the community is sugar.
After a slow and gradual decline prices, sugar has bottomed in late-2015, and prices have rebounded strongly this year, as shown in the chart below.
The general consensus is a supply side factor that’s driving prices up. Where there was once too much supply in the global sugar market (2012-2014), all that excess have been soaked up recently, and alongside higher expected global demand and a change among weather patterns affecting output in major producers/exporters causing further concerns that supply is lagging demand.
One area to look out for is the European beetroot market as beetroot is a complement to sugar cane in Europe (for various institutional, cultural and economic factors).
Another driver for sugar prices is the crude oil market as well. Due to the use of biofuels (ethanol) processed from sugar, the sweet commodity has a correlation to the prices of black gold. If crude oil prices rise, there could be more demand as well for biofuels, which increases demand for sugar crop.
If looking at supply and demand dynamics in order to figure out where prices may head to is tough, another way to size up the situation is to see how the market is positioned. A look at futures contracts and open interest data reported by the CFTC (in their COT report) will give us a better idea on what the market is thinking about this.
Generally, there are 2 major parties that utilise the futures market, producers/sellers and speculators. Producers are companies that typically use futures contracts to hedge their positions. For example, a corn farmer normally knows when he is harvesting his crop and selling it, so in order to prevent the risk of prices in the future declining and hence lowering his potential profits, he approaches the futures market and sells at current prices for a future contract, effectively hedging his physical exposure. On the other hand, speculators are traders or investors who are utilising futures as a way to make money from price movements.
Because these 2 major parties approach the futures market for different reasons, their collective behaviours tend to diverge. The producers/hedgers tend to buy when they think prices are heading downwards because they need to hedge against future risk, whereas the speculators tend to follow the direction of prices, decreasing their buying or going net short when prices are declining. Conversely, the producers/hedgers tend to decrease their hedging (buying less) when they think prices will head up.
Latest available data as of last week shows us the divergence between the hedgers (the commercials) and the speculators (the non-commercials) is at the greatest in more than 4 years, coinciding with the rise in prices year-to-date. Note the decline in the amount of open interest among the commercials (white line), this usually suggests that the hedgers know prices will continue to head up in the near-future.
A look at the price charts of sugar prices showed that prices have already risen by 47.9% year-to-date (in USD terms as of 26 September 2016), and the trend suggests a bull-market like momentum ongoing. From the perspective of higher time frames (weekly and monthly price data), we could either be in a middle of a bull market in the sweet commodity, or seeing an extended rally that could exhaust soon.
Current reward/risk may not look particularly favourable. If one is bullish, waiting for a retracement in prices to better position an entry into the commodity would be a great way to gain exposure and to ride the current uptrend. Look out for changes and variables that could influence near-term supply and demand of the crop in the mean time. If weather conditions in the major exporting nations improve and output comes in better-than-expected, the rally may exhaust out. If that happens, be ready to play a reversal and a downtrend. This trade could have the potential to make multiples of your capital invested if managed properly…