SWEET REVENGE
This week, the sugar futures market in New York continued the drop started on Friday the previous week making prices return to the lowest point of 22.80 cents per pound traded in early July. At Friday’s closing, the contract for March/2024 closed out at 23.40 cents per pound, with an accumulated drop in the week of 169 points, a little more than 37 dollars per ton. The following trading contracts showed equally expressive drops of 176 points (39 dollars per ton) for May/2024, October/2024 and March/2025. The 2025/2026 crop shrank 140 points on average (a little more than 31 dollars per ton). The fundamentals took a “sweet” revenge on the funds.
And speaking of the funds, according to the CFTC on the COT released Friday based on Tuesday’s position, the funds liquidated 63,400 lots, but should still be long by 80,000 lots this Friday. Just for the record, the accumulated drop of 281 points (about 62 dollars per ton) on December 5 and 6 has been the fifth largest since 2000. Now, the 196-point drop on a single day (43 dollars per ton) has been the tenth largest over the same period.
Prices in real per ton suffered a serious setback. The average prices fell 167 real per ton for the 2024/2025 crop and 129 real per ton for the 2025/2026 crop. Risk management is a very serious subject.
The market wants to blame the sharp price fall on the recent decision of the Indian government to limit sugarcane ethanol production. This measure shows a potential increase in sugar production in India due to the smaller amount of sugarcane for ethanol production and suggests a reduction in the need for sugar import by the country, contradicting previous forecasts. However, the damage seems to be disproportional. It’s the fundamentals that have overlapped the narratives. Of course, with the global oil price fall, it becomes economically more feasible for India to prioritize sugar production instead of ethanol production, reflecting a pragmatic assessment of the current situation of the market. But causing this avalanche is going too far.
Could this change in policy open up the possibility for the country to resume its sugar export activities in the 2024/2025 crop? The previous concerns over the shortage of supply and global deficit seem to have dissipated, almost like a sandcastle crumbling under the pressure of new information. Now there are questions about the reality of a tight and scarce market. So, we cannot rule out the potential for new price drops, once the expectation for a more supplied market is taking root. The situation demands a careful reassessment of the projections and strategies on the part of the market players, taking into account this new context where India can emerge in the sugar export scenario as a leading actor again.
The market fall has been expected for a long time (at least by us). We saw the correction of a market that was going up with the help of the hedge funds based on old news about the bullish fundamentals of the market. But an important element was responsible for the speed-up of the fall in New York. There were more than 115,000 lots of puts sold on the March/2024 between exercise prices of 20 and 27 cents per pound.
As the market was falling, the delta (probability of exercise) of the puts was growing and increasing the risk for those who had short position in order to capture premium, believing that the market would never reach those levels. When that happens, the seller of uncovered puts has two alternatives: he either sells futures so that this sale halts the loss of the puts or he rebuys the options.
Going over the data published by the ICE, we see that the number of short options increased over the period where the sugar market had a significant fall of 200 points. That means that the strategy used to protect from losses (known as “delta hedging”) was carried out mostly through the sale of futures contracts, which intensified the price fall due to the despair of those who were short at that position.
Another important element for the sharp fall of the sugar market in New York is the behavior of the trading companies. These companies, believing in their own optimistic forecasts about the market, probably had a long position on the sugar futures markets and on the calls as well. When the prices started falling fast, these companies were forced to liquidate their sugar futures contracts as well as the long calls to limit their losses, a procedure known as “stop sales”.
These stop sales are like an emergency mechanism that automatically triggers itself to sell an asset when its price falls to a certain level, helping to avoid greater losses. In this case, these additional sales contributed even more to the sugar price fall, resulting in a pretty negative situation for the market.
It’s important to mention the devastating impact of the operation with accumulators and options with barriers that were strongly affected by the sharp fall. Mills had their hedge strategies totally destroyed by these risky, and in many cases, damaging financial structures. Although we had over and over again warned about the dangers of these approaches, it seems like many companies insisted on ignoring these risks. This stubbornness to adopt risky financial tactics continues to result in serious consequences, as we saw with the sharp devaluation of the hedges of several mills, highlighting a lack of learning of and adaptation to market realities.
The search for a small improvement on pricing – a handful of points – leads several companies to venture into illusory and dangerous financial strategies, such as the accumulators. On the financial market, these tools are ironically dubbed as “I kill you later”, a pun on the word “accumulator” due to the hidden risks they represent. It’s vital to understand that there are no gains without risks: there is no “free lunch” on the financial market.
The idea that “one plus one can only be more than two if one minus one is less than zero” is a financial metaphor. It means that in order to have a significant edge (a gain above the expected), it is necessary to accept a proportional disadvantage (a risk for a greater loss). Many times, this reality is ignored, but the companies have to understand that the apparent advantages of certain strategies carry equally great risks with them, which can result in devastating losses.
Over the 20 years Archer Consulting has been providing agribusiness companies with consulting, I have constantly pointed out the importance of a risk or strong and sensible hedge policy. This policy must ban, or at least strongly limit, the use of risky financial structures such as accumulators or options with barriers, especially when the goal is to hedge against market risks. Such strategies can be effective on low-volatility markets, but they are extremely dangerous on markets with great price fluctuations.
It’s essential that risk managers understand this reality and quit believing in miracle solutions. The inconvenient truth is that many tend to forget this lesson until a new crisis comes along. It’s a learning and forgetfulness cycle that needs to be broken to assure a more effective and responsible risk management in the sugar-alcohol sector.
To read the previous episodes of World Sugar Market – Weekly Comment, click here
To get in touch with Mr. Arnaldo, write on arnaldo@archerconsulting.com.br
