Sugar’s Sweet Spot May Be Lower

07/15/2011 7:00 am EST

Focus: COMMODITIES

Andy Waldock

Founder, Commodity & Derivative Advisors

Dramatically increased sugar supply has the major market players believing that sugar’s rally is ready for a reversal.

We’ve spoken previously on MoneyShow.com about the value of food commodities throughout this year. However, the sugar market supply will most likely outpace demand this year.

The sugar market is quickly replenished with multiple harvests each year. The quick growth cycle combined with more normal weather patterns in the primary producing regions should see this year’s crop make up for the last two years of deficit production.

The sugar market was 2010’s most volatile market on a percentage basis. Using the stock market and gold as a comparison, gold would have had to reach $3,300 per ounce to match sugar’s rally for the year, and the Dow Jones Industrial Average would have had to fall to 4172 to match sugar’s decline.

Given this type of volatility, it’s easy to see why we look to the commercial traders’ actions to establish a sense of value in the markets. These are the traders who focus solely on their market and build their business plans around their ability produce sugar or turn it into a finished product.

Commercial traders have been exceptionally good at picking out the major turns in this market, and thanks to the Commitments of Traders (COT) reports, their actions are easy to trace.

Commercial traders were active buyers as the market traded down to 20 cents per pound in early May. Since then, the market has rallied more than 50% to over 30 cents per pound. Remember, we said sugar is a volatile market.

This move higher has been fueled by two factors. First of all, the refining margins on raw sugar have been exceptionally high. This brought in quite a bit of recent demand, but that will subside as the spread between raw and refined sugar narrows due to increased production. Secondly, there has been significant speculative money put to work on the long side of the market with investment coming from small traders, funds, and managed money.

The rally in sugar may be running its course as the spread between raw and refined sugar tightens and the commercial traders see this market as more and more overvalued. Through analysis of the weekly COT reports, we can see that ownership of long positions is shifting from commercial, value-based buying and into the hands of speculative buyers. Last week, commercial traders sold more than 14,000 contracts, which were almost directly bought by managed money and swap dealers.

The shift to a speculative stance in this market could leave it vulnerable to a selloff if the fundamentals hold steady. Production in Brazil, Thailand, Russia, France, and India all appear to be near all-time highs. Much of this is due to extra planting based on the high prices received last year. A rising tide may float all ships, but an overloaded one will still be the first to sink.

By Andy Waldock of Commodity & Derivative Advisors

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