Late last month, I closed a huge long Sugar position I was carrying in my portfolio (Article: Portfolio Update: Profit Taking On Sugar). The prices were only couple of percent away from the 52 week highs, conditions were favourable as Sugar market was in a demand / supply deficit and the news was very fundamentally good. So why did I do it? At the end of August I closed at 30 cents and stated my reasoning as follows:
It was Marc Faber who first taught me that when a price of an asset fails to make a new low on unfavourable news, it could be starting to price in more favourable conditions. The same is true for an asset that fails to make a new high under very favourable conditions. I think the bulls have completely priced in recent supply shortages out of Brazil and we could experience quite a large correction.
Fast forward almost a month and it seems that Sugar is now changing its medium term trend from bullish to bearish and the correction I saw, is now upon us. The news last night was as follows:
A triple whammy of weak Chinese auction prices, a rare upgrade to Brazilian production hopes and an retightening in Europe's import policy gave sugar futures their worst losses in six months. The revision ended a long run of downgrades which have been a big factor in driving sugar futures up by more than one-third in the last four months.Furthermore the source said that results from the latest Chinese auction of 200,000 tonnes of sugar from state reserves, while not yet published, showed prices, which have topped 8,000 remninbi a tonne previously, falling in some areas below 6,000 remninbi per tonne. The EU is expecting a significantly better beet harvest this year, with early yields in France, the region's top producer, coming in 24% higher than in 2010.
Here is the updated chart which was previously posted in late August in the portfolio update (Article:Portfolio Update: Profit Taking On Sugar):
As we can see the trend is now showing signs of a reversal in the short to medium term. I was contemplating shorting Sugar yesterday, however, I have recently opened up a decent amount of traders in the portfolio and I prefer not to over trade or over expose myself to risk. Bears will point to a technical formation where the Sugar price in the recent rally failed to make a new high when compared to the February 2011 peak of 34 cents. My reply to these these bears is not to worry so much about the short to medium term technicals, but study Sugar's conditions. So lets get into it...
Global Sugar demand is expected to soar up to 50% by 2030, with huge under-investment on the supply side, since The Global Financial Crisis of 2008, leading to deficits and shortages. As the price of Crude Oil and other energy commodities rise, this puts even more pressure on Sugar (or Corn), which is also used for ethanol purposes. Therefore, the 50% increase in demand might be just the starting point as Oil/Gasoline go higher in the coming years.
The global market is expecting Brazil to deliver the supply for half of that 50% increase demand, however the largest producer of the Sugar in the world is starting to show signs of supply side crisis. Brazil's Sugar industry is in a very poor state as we saw with its 2011-12 production setting its first decline in Sugar cane output in at least a decade. Furthermore, the number of new Sugar mill openings is expected to drop to only five... from a huge 30 three couple of seasons ago.
What we have on our hands in under-development, under-investment and very low historical prices when adjusted for inflation - chart above. A perfect recipe for a huge bull market in Sugar for years to come. The truth of the matter is, it is not just Sugar, the whole Agriculture is completely depressed. It has been the worst industry for over two decades.
Lower prices and very bad margins are the reason we have under-investment in the first place. No sane entrepreneur will ever invest into an industry where he will lose money. Of course, the cure for lower prices, is low prices... which have for 10 years now, creating very very low incentives to build up supplies. This, obviously, leads to huge shortages. At the same time technological break throughs have discovered many new uses for Sugar, while the rise of Asia has increased demand by millions and millions of tones per year creating deficits in recent times.
When a global crisis happens, no business can get funding, let alone a Soybeans planter, Cotton farmer or a Sugar cane grower. What most super bears, who point to deflation and total collapse of all prices, do not understand is that even if demand in commodities falls, supply can fall even more, and therefore we have shortages on our hands creating a bull market. We haven't increased the global arable land since the last commodity bull market in 1970s. The population and its wage growth has increase enormously. Where is the extra Sugar going to come from?
In 1930s Agriculture we had a collapse in demand and yet under-investment in the supply side let to an even bigger collapse, therefore creating shortages. We experienced a huge bull market and one of the best industries while the whole world was in depression. In 1970s Agriculture was one of the best industries while the whole world was in stagflation, and the demand side totally collapsed with high interest rates and high inflation creating constant recessions. However, once again supply side investment collapsed faster, and shortages built up. Sugar rallied from 2 cents to 66 cents - a real bull market!
And the same will now happen in 2010s, while the whole world is in defaults and bankruptcies. Even if demand falls dramatically, supply side is totally depressed and soon we will have no Sugar at any price. Average age of farmers around the world is between 55 to 65 and in same countries much much older. Young people are not studying agriculture or willing to be farmers. Instead they all want to own they our hedge funds and be the next George Soros. Young people are not helping build supplies of any Agricultural product to divert the up and coming price spike crisis... they are actually helping to create it by studying law, accounting, business or trying to be famous on TV (American Idol or whatever else is "cool" right now)!
You see, it doesn't matter if Greece defaults, the world will still use Sugar or Cotton or Wheat or Corn. It doesn't matter if Chinese property bubble pops, the Chinese will still consumer Sugar at a faster rate than before. Unlike the US housing bubble, most Chinese do not have a bank account, credit card or a home loan. They will not be affected by the crash. But they will keep consuming Sugar, just like today! It doesn't matter if we have deflation in housing all around the world or deflation in debt around the whole Western World. What does matter is that every crisis sets lower and lower amount of investment into these industries and totally depresses supplies. We are now setting ourselves up for a repeat of the famous food crisis of 1974 and any further credit problems in Europe or US will be the final nail in the coffin for supply side investment!
I am very bullish on commodities, especially agriculture, so it pays to be trading with the long term trend and not against it. I will be following the Sugar market, its conditions of demand / supply, investor sentiment, speculator positioning, technicals and media news very closely in the future for those who are also interested in investing somewhere else other than stocks and bonds.