THE BOGEYMAN
This has been another week of record levels on the sugar futures market in NY, with all the side effects that stresses like this cause to the companies. The bogeyman is called margin call, and it has been scary; it has already come to US$3 billion. Imagine all this huge amount of money coming out of the companies’ cash flow.
As a senior trader from the commodities market once told me, “When the margin call bursts open the front door, the rationale throws itself out of the window”. And there’s no point in wanting to compromise; we all tend to turn bullish when the market goes up and bearish when it goes down. Let’s see if we can find some bear in the sugar week that starts next Monday here in New York.
May/2023, which expired this Friday, appreciated 216 points, or 48 dollars per ton over the week. The futures contract for July/2023, the next maturity, reflecting the weight of the Center-South crop, closed out the week at R$ 3,071 per ton. Over the last 23 years this value has been seen in just 1% of the times. This refers to all the NY quotations, converted in real per ton and adjusted by the inflation rate.
There are pretty clear signs that the high prices seen on the sugar market is made up of other components besides the changes in or worsening of the fundamental of the market itself.
One of the most evident signs that the fundamentals are supporting actors – and not leading actors – in this situation is when it comes to the volatility of the options. Some weeks ago, it was about at annualized 23% and this week it has hit 48%. And what has changed in the fundamentals that would account for this explosion? Very little has. The narrative was that of the end of the world, though – the crop of the Center-South would be smaller (how can we be so sure in April?), the lineup (the line of ships for loading) in Santos gets longer, India putting a halt to exports, Thailand with temperatures of 45ºC, among other events.
First of all, what makes volatility of the options double over a short period of time? When we say that the mills are fixed by 20-21 million tons of sugar for this crop, these fixations were made through the sale of futures contracts at the NY exchange, great part of this volume using the futures account of the trading companies, banks and other institutions that are providers of hedge structures.
With the increase in prices in NY caused by an explosive combination of funds purchasing aggressively, industrial consumers hedging themselves and mills without having too much more sugar to fix, those who are short with futures contracts at the exchange (trading companies) have to meet the daily margin calls, mechanism that the exchanges use to zero out daily profits and losses and decrease the market risk.
Based on the data survey of Archer Consulting, the average fixation price of the mills for the 2023/2024 crop is 17.75 cents per pound. The average of the closings of the corresponding months to the Center-South crop on Friday was 26.25 cents per pound – an average margin call of 187 dollars per ton. Now, multiply that – conservatively – by 16 million tons (assuming that several contracts have already had futures exchange via EFP and EFS). We are talking about a US$3 billion cutting. A margin call this large is painful.
Therefore, in order to mitigate the bleeding, most companies enter the futures market by buying calls aiming to decrease the margin call in case the market continues going up. The option premiums go up given the demand for this tool. The fact that the volatility has doubled shows that the market acted driven by uncontrollable panic.
The line-up of 1.6 million tons in Santos can be explained by the fact that the sugar buyers need to load the product they have bought from the mills as fast as possible to meet their final buyers’ demands, taking advantage of the inverted market and also the very high white premium, for those who will convert raw sugar into refined.
Now, what can justify a market that strongly believes in the shortage of sugar having a physical delivery of 940,000 tons like the one that happened now on May expiration? We have all learned that physically delivering a product against the expiration of a futures contract at the exchange is the last resource of the seller. He only delivers at the exchange when no one pays better than…the exchange.
There are other points that are worth paying attention to. Since this physical movement has a lot to do with the game of the spreads, that is, the ability of each trading company to operate the market taking advantage of opportunities in the difference between the prices of two traded months (the spreads) over time, the act of delivering or receiving sugar at the exchange can ultimately be just a part of a more comprehensive strategy. The difference of the demurrage (fee charged for failure to load or unload a vessel within the timeframe set out in its contract) and the most favorable conditions of delivery via the exchange (smaller daily loading) also helps with the physical delivery.
The market will need fresh news in order to be able to continue its upward trajectory. Let’s see how it will behave this week here in NY.
You all have an excellent weekend and those who are coming to NY, have an excellent trip.
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
