Flying through clear skies
The sugar futures contract for October/2021 closed out Friday at 19.67 cents per pound, almost two dollars per ton above last week’s closing. Curiously, the contracts with longer maturities appreciated more than those with shorter ones.
The two maturities that make up the remaining contracts for the Center South 2021/2022 crop (October and March next year) appreciated less than two dollars per ton; now, the months for the 2022/2023 crop appreciated seven dollars per ton on average and for the 2023/2024 crop appreciated twelve dollars per ton. We have said here that the prices for 2023/2024 had a potential for appreciation of 250/300 points. Our forecast is being confirmed little by little.
The average values in real per ton have increased significantly due to the aggressive market of the NDFs (Non-Deliverable Forward) that has been paying a coupon of 5.25% per year for 90-day maturities, 6.25% for 180-day maturities and 6.76% for 360-day maturities. That means more real per dollar over the curve, distorting the prices in cents per pound in the future. For the same total of real per ton that the mill is selling today on the spot market (NY quote times R$/US$ rate), the longer the maturity is, the smaller the value in cents per pound is, which balances out the equation. This is a key factor to explain part of the strong inversion of the curve.
The funds reduced the long position by 5,800 lots adding up to 250,800 lots on Tuesday, according to the COT (Commitment of Traders), the report of the principals.
We have expressed our opinion about the importance the companies of the sector should give to protection structures of the so-called tail risks many times. Imagine a distribution on a bell curve (Gauss normal curve equation), where the ends of this curve, called tail, represent events of low probability. When they occur, however, we look back and regret not having done anything to protect ourselves or participate in the movement.
A diligent reader of the weekly comment sent details on an operation he had made on December 10, 2020, that is, a little over 8 months ago. Convinced that what he heard on the market about the future possibility of reactions of the sugar price in NY and, a supporter of structures that get stronger when the fluctuations are violent, on that day he bought 50 calls at exercise price of 19.50 cents per pound maturing in March/2022, whose futures was trading at 13.73 cents per pound at that moment, 30% below the exercise price he had chosen. He paid 11 points for the options, spending a total of US$6,160. This week he took profit by selling it for 220 points, profiting a little more than US$117,000. Was that luck or discipline?
If a mill had made the same operation spending US$100,000, it would have profited about R$10 million. The issue that invariably comes up is convincing yourself or the company’s top management that buying a hedge at 19.50 cents per pound when the market is trading at 13.73 cents per pound can be a good strategy.
What we have to be aware of when embarking on a project like this is that it is about buying a hedge for an unlikely event and not for investing. Nobody walks out of the car insurance agency thinking they have made an investment after buying a policy. Nor do they do that, meaning to crash the car into the first lamp-post.
Choosing such structures is for those who are sure they will lose very little if no extraordinary event occurs, but if it happens, they will be at a privileged position compared to their peers. Flying through clear skies is all a pilot could wish for.
The elections next year and the effect anti-republican adventures led by the Presidential Palace tenant in Brasilia can cause pricing of commodities, in our case sugar and gas-ethanol, are a risk in the near future. What effect can a skyrocketing dollar have on your liabilities? It’s worth thinking through the problem to avoid trouble.
The fifth sugar pricing estimate for the exports of the mills related to the 2022/2023 crop shows a slowdown (movement started in the previous month) in the volume, reflecting concern over the size of the next sugarcane crop to be harvested in 2022. The mills are more cautious.
Our model has found that based on the data of the July 31, 2021 closing, 7,001 million tons of sugar are already fixed for the 2022/2023 crop, a volume representing 27.50%.
The average value of fixation for the 2022/2023 crop is 14.78 cents per pound, without polarization premium, equivalent to R$1,860 per FOB Santos ton, or R$0.81 per pound, both including polarization premium. This value corresponds to a hydrous at R$3.2400 tax-free per liter at the mill.
Enjoy your weekend!
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Mr. Arnaldo Luiz Correa is the Director at Archer Consulting. He is a Risk Manager with an experience of almost 30 years in the agriculture commodities market.
To get in touch with Mr. Arnaldo, write on arnaldo@archerconsulting.com.br
