Sugar Ready To Bounce?

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By Chris Shaw

Sugar prices have been in virtual free fall of late, declining by almost 40% in the last 30 trading sessions. Commonwealth Bank suggests the fall can be attributed to demand rationing and higher production as growers responded to what had been extremely high prices.

While this had been expected to push prices lower, the pace of the fall has been more than the bank had anticipated. CBA attributes this to demand drying up at prices above US25c per pound, while bearish sentiment has been compounded by buyers trying to renegotiate more favourable import agreement terms.

As well, futures markets were in steep backwardation and this has supported the deferring of purchases and so weakened price support. At the same time, Commonwealth Bank has identified some supply side issues that have been negative for prices, one being improving Indian production levels. Output of around 17 million tonnes is now expected in 2009/10, up from around 15 million tonnes previously.

An announcement by the EU it would export half a million tonnes of its sugar quota was also unexpected by the market, while Brazil has added to global supply by continuing to crush cane in the wet season. This is usually when mill maintenance is performed.

Around 40% of Brazilian mills are now expected to be operating by late March, which is a higher number than normal at this time in the season. This supports expectations of record production this year in the bank's view.

Even factoring in these supply side issues, CBA suggests it is difficult to justify the recent price falls, as weaker market sentiment has also played a role. As the bank points out, total open interest has fallen sharply as both hedgers and speculators have quit the market. One potential positive is open interest rose slightly last week, which CBA suggests may be a sign the market is calming down somewhat.

Given the scope of recent falls, the bank suggests the market is now susceptible to a sharp upward correction, primarily because the market will continue to have a huge structural supply deficit until well into the second half of this year.

International Sugar Organisation (ISO) figures support this, as a recent reduction in ISO's production estimate of more than 2.7 million tonnes implies a production deficit for 2009/10 of 9.4 million tonnes. This follows the 11.3 million tonne deficit recorded in 2008/09.

Supply may still come in below expectations as Thailand, the world's second largest exporter, recently cut its forecast for 2009/10 production by 250,000 tonnes. Production elsewhere may also be weak, CBA seeing China as a prime candidate given recent drought-like conditions.

This may also reduce Chinese strategic sugar reserves, as the bank notes there is some evidence stockpiles have been run down recently. With Chinese sugar consumption growing by more than 5% annually over the past 50 years, it appears likely the country will become more reliant on imports in coming years. This helps explain Chinese interest in the likes of the sugar assets of CSR ((CSR)).

Short-term, Commonwealth Bank expects a modest bounce in sugar prices, which should see the price move above US20c per pound and potentially to the mid-20c level. CBA expects market support to be restored by a re-entry of import buying in coming months, while it also suggests most known bearish news is already in the market.

As well, Brazil's centre-south harvest won't hit top gear for more than a month, so any delays due to bad weather would add support to prices in its view.

By June price pressures will again emerge as the Brazilian and Australian crushes get underway, while November should see another round of price pressures thanks to the Indian crush. From next year and into 2012 the bank expects pressure to be maintained on prices as global production continues to respond to recent record prices.

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