Sugar: A Sweet Trade On The Upside

Sugar prices reached new seven-month highs yesterday, driven by stronger equity prices and a weaker US dollar. Although India’s crop estimate was raised to 14.8 million tons from 14.5 million tons for this year, production is well off of last year’s pace of 26.5 million tons. Next year’s crop is expected to show a sizable increase over this year, yet India is expected to import Sugar once again next year. Traders may be skeptical of next year’s demand, given the fact that prices have risen due to finite supply and not demand. If Indian supplies had been anywhere remotely close to last year’s levels, we may be writing about prices being at 8.00-9.00 at this moment, given the low global demand. Brazil has been the beneficiary of India’s woes, becoming the chief exporter of the sweetener.

Brazilian output may rise to a record this year, as plantings increase by nearly 20 percent. The economy in Brazil has been battered by the global economic slowdown and resulting weakness in demand for commodities both at home and abroad. This has prompted farmers to step-up production to fill in the vacuum created by the small Indian crops and capitalize on the weaker Brazilian real by stepping up dollar-based exports of Sugar. If producers divert their capacity toward exports of the sweetener to take advantage of a weaker domestic currency, it would come at the expense of ethanol, possibly causing tight supplies of the cane-based fuel down the road, as domestic ethanol demand has remained stout. Even with the positive near-term fundamentals, downside risks remain.

Sugar has benefited from stronger equity prices, a rebound in the price of Crude Oil and a weaker Dollar. If these outside markets reverse course, it could put heavy downward pressure on the price of the sweetener. Because credit has remained tight, mills have been ramping-up production early in the crush season to generate cash, which could lead to a sharp increase in supplies in the very near-term and cause the mills to sell at less than ideal prices.

Trading Idea

Both the technical and fundamental outlooks for the Sugar market appear to be bullish, but with an air of caution. Some traders may choose to employ a relatively inexpensive trading strategy with a reward to risk ratio of at least 2:1. An example of one such trade would be a bull call spread, buying 1 July 15 call and selling 1 July 16 call for a debit of 0.30, or $336. The trader would risk the initial investment for a potential maximum profit of $784 if the July Sugar contract closes above 16.00 on the June 15th expiration date.

Technicals

Just as the July Sugar contract looked like it was in the midst of forming a triple top pattern on the daily chart, prices broke out above near-term highs last Friday. Now that prices have broken through resistance around 14.00, the next areas of resistance could come at the 14.73 highs from last May and September highs of 14.94. Despite the positive outlook on the daily chart, both momentum and RSI are beginning to diverge from prices, suggesting the market may face selling pressure in the near-term. At the very least, prices could come back to test newly established support at the 14.00 mark.

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