by Agrimoney.com
Hedge funds could face hefty losses on coffee and sugar bets if frost in Brazil turns out more severe than expected - although some brokers said it is more likely that producer selling will spare speculators a drubbing.
Managed money, a proxy for speculators, raised its net short position in New York-traded raw sugar futures and options by 18,500 contracts to more than 77,000 lots as of last Tuesday, according to data from the Commodity Futures Trading Commission, the US regulator.
That was not far from the record net short – the extent to which short bets, which profit when prices fall outnumber long positions, which benefit when values rise – of 88,140 lots for sugar set last month.
And, indeed, the gross short position, of 234,499 lots, was less than 100 from the record high, a reflection of the extent to which hedge funds saw prospects of a large world production surplus depressing values.
'Frost remains a concern'
For New York arabica coffee futures and options, while hedge funds covered some of their short positions over the week, the net short, at 21,460 lots, remained historically high.
However, hedge funds have been left at risk of being wrong-footed on their bearish bets by forecasts for frost and rain in parts of Brazil, threatening coffee and cane harvests, and potentially causing some crop damage too.
"Frost remains a concern" for Tuesday and Wednesday in areas including Parana, a coffee producing state, and parts of Sao Paulo, a major grower of cane too, weather service MDA said.
Luke Mathews at Commonwealth Bank of Australia said: "Up to 5 inches of rain is slated this week, and temperatures may drop below freezing according to some forecasters."
Macquarie said: "The last time Brazil's coffee regions faced frosts were in 2011, when we saw a sharp rally," with frosts further back causing price spikes too.
It was a frost which drove New York arabica coffee futures to their record high of 337.5 cents a pound in 1977.
Cane downgrades ahead?
On the sugar markets, Nick Penney, senior trader at Sucden Financial, said that "reports of rain and frost over the cane areas of Centre South Brazil have spurred speculators into covering some shorts".
Chart levels as high as 16.74 cents a pound, up 2% from Monday's levels, looked immediately attainable if "weather forecasts continue to show expectations of rain and cold weather which will further reduce potential output and put in doubt original estimates for the crop year", he said.
Already there is talk that Unica, the Brazilian cane industry group, is mulling cuts to its estimates for the cane crop in the Centre South, responsible for some 90% of the country's output, and for the proportion of cane turned into sugar, rather than ethanol.
Macquarie said that its own estimate of a 590m-tonne Centre South cane crop looked "optimistic" given the potential for rain delays to harvest.
CBA's Mr Mathews said that "the undesirable weather could result in further downgrades to Brazilian sugarcane production prospects".
'Selling opportunities'
However, Macquarie said that coffee and sugar price rises faced limits to their progress from the extent of selling by producers they were likely to encourage.
"The risk here is that producers will view these as selling opportunities, in an otherwise bearish market," Macquarie analyst Kona Haque said.
"This will serve to cap both the extent of the rally as well as the duration of it."
In coffee, some 9% of Brazil's arabica coffee crop from last year remains to be sold, with only 13% of 2013 output hedged so far.
"We think that Brazilian growers will take advantage of any ensuing rally by selling some of their new crop," Ms Haque said.
'Step up hedging'
In sugar, Mr Penney said that "we have seen a marked increase in hedging activity whenever a speculative rally takes place.
"With the continued weakness of the real, we feel producers in Brazil will step up hedging towards the 17 cents-a-pound level."
Raw sugar for October closed up 0.7% at 16.40 cents a pound in New York on Monday.
Arabica coffee for September was 1.9% higher at 125.5 cents a pound in late deals.
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