Sugar bears only think they have the upper hand

By Sholom Sanik

After teasing bulls with a spike to 20¢ per pound, sugar prices (NYBOT:SBH14) have eroded all the way back to their July lows.

The Oct. 18 fire at the Santos Port terminal in Brazil turned out to be a one-day event. Total monthly sugar shipments for Brazil have been down by more than 10% as a result of the damage to the facility, but the market was never very worried about the world supply situation. Some sugar shipments from the damaged warehouses will restart in January. More capacity will be restored by May. A combination of other ports picking up some of the slack and a well-supplied world market has allowed sugar prices to fall back to the lows.

Atypical dryness for this time of year is a mixed blessing for the Brazilian cane industry. On the one hand, it allows mills to continue crushing the current crop, but on the other it deprives the developing new crop of much-needed moisture. In any case, despite the harvest of a 10%-larger cane crop, estimates for sugar output for the center south region – where 90% of Brazilian cane is grown – have not changed much from the 34.5-million-tonne estimates we’ve seen over the past few months.

In mid-October, a large percentage of sugar mills in India balked at the government-controlled minimum price that they must pay to farmers for cane, claiming that it is too high and that they cannot turn a profit while world sugar prices are so low. Crushing normally begins in early November, but the millers refused to start the crushing season. The protest lasted for a few weeks, but eventually the millers caved in, and the crushing season got under way.

There was talk that the delay would of tighten world supplies, but again – like the Brazilian port situation – even before the dispute was settled, nobody seemed to be very concerned. The director general of the Indian Sugar Mills Association assured the market that despite the delays, Indian mills are still in perfect shape to meet export forecasts of between 3 and 4 million tonnes for the 2013-14 marketing year. Bears did not even blink as world prices continued to slide.

The standoff between the Indian millers and the government, while resolved without incident, underscores what we’ve been talking about – ad nauseam – over the past year. Production costs in the major sugar-producing nations, such as India and Brazil, have increased dramatically over the past few years, but prices have been falling. Ultimately, we will see mill closings, as we have in Brazil and the near miss in India. The market did not react – true. But how long can it last?

Production costs are unlikely to drop. Energy prices teetered a bit recently, but remain near historic highs. Labor costs in developing nations are rising. If world sugar prices do not stabilize and then rise, falling production and the inevitable deficits that are sure to follow will replace the burdensome surpluses we have at the present.

It will be a slow grinding process, but we believe it has begun. The International Sugar Organization (ISO) estimates that global sugar production fell 1.2% in the 2013-14 crop year, while consumption rose by 2.2%. There was still a production/consumption surplus of 4.7 million tonnes, but it will fade. The ISO forecasts that the trend of lower output and increased consumption will continue in 2014-15, with production falling by about 1.5% and demand increasing by 2.2%, which would result in a deficit of about 1.5 million tonnes.

We maintain our recommendation to hold positions in long-term sugar calls. At about 55 tics, October 2014 18¢ calls are a steal. Load up.

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