Conclusion: We are long sugar because of its bullish three-factor setup via supply, demand and price.
Position: Long Sugar via the ETF SGG.
Whenever we add commodity exposure on the long or short to the Hedgeye Virtual Portfolio, it’s supported by a confluence of three factors: supply, demand and price. For much of the last few weeks, both supply and demand were supportive of getting long sugar. With yesterday’s (-10.2%) sell-off, we finally got our price.
From a supply perspective, the USDA recently released their forecasts for their 2010/11 marketing year, and estimates for global production, exports and ending stocks were all revised down from earlier forecasts, coming in at (-1.9M) metric tons, (-1.8M) metric tons and (-564k) metric tons, respectively.
In the report, we see that many of the world’s major producers and exporter’s production and export estimates were also revised down:
- Brazil, overwhelmingly the world’s largest producer at 23.7% of global production, saw its production estimate for 2010/11 revised down (-1.3M) metric tons to 39.4M due to dry weather;
- China, the world’s fourth-largest producer at 7.5% of global production, saw its production estimate revised down (-1.35M) metric tons to 12.67M due to dry weather that delayed planting earlier in the year;
- Thailand, the world’s sixth-largest producer and second-largest global supplier at 11.4% of world exports, saw both its 2010/11production and export estimates revised down due to delayed planting – most notably exports, which are now forecast at (-20%) YoY and will limit the availability of global supplies should any major importer experience an inventory shock.
We’d be remiss not to call out Australia, the world’s eighth-largest producer and third-largest supplier (6.9% of world exports), as it is currently experiencing severe flooding in Queensland – a region that is responsible for 95% of the nation’s sugar production. Premier Anna Bligh has gone on record saying that the current flooding is “unprecedented” and that damage control is likely to last until the end of next month.
One bearish data point on the supply side is India’s upwardly-revised production estimate of 25.7M metric tons – a difference of +1M metric tons from the May forecast on the strength of favorable weather (India is the world’s second-largest producer at 13.4% of global production). This is, however, offset by the fact that India will likely be reluctant to export, given that they are only months removed from a massive shortfall, whereby they became a net importer after years of surplus production (similar to what is happening in China regarding corn).
From a demand perspective, global consumption estimates for 2010/11 were revised upward +1.2M metric tons to 158.9M. From import perspective (price is set on the margin), we are seeing increased demand from countries like Russia, Pakistan and potentially Australia that have suffered from drought and/or flooding throughout the year as they try to rebuild depleted stockpiles.
Further, we are anticipating that both China and India (the world’s first and ninth-largest importers) to actually step up their purchases of sugar (and other agricultural commodities) in 2010/11 in an effort to build supplies in order to tame accelerating food inflation that is running in the double digits for both countries.
In fact, China’s imports for 2010/11 are forecast at a record 1.8M metric tons – a number we believe will be higher when it’s all said and done. Meanwhile, much to-do has been made about India reinstating its import duty tomorrow, and this expectation contributed to yesterday’s selloff. We caution, however, that a ~10% sell-off may be pricing in too much smooth sailing with regard to India’s sugar stockpile rebuilding. If domestic production falters in any way, expect India to act quickly and resume imports as a way of alleviating any potential scarcity within its domestic market.
While sugar is not a necessarily considered a necessity, the demand for sugar has been relatively constant throughout history, turning negative on a YoY basis only four times throughout the last 60 years, with the last occurrence in the 2005/06 marketing year. Given that, we are comfortable holding a bag of sugar here in spite of our forecast for slowing growth globally in 1H11.
From a price perspective, we were finally able to buy sugar on a pullback after admittedly selling it much too early on July 22nd (for a +6.7% gain, however). Interestingly, we did anticipate a near-term pullback given the lofty bullish sentiment of last week. This week, traders reduced their bullish expectations in the latest Bloomberg survey:
Lastly, from a quantitative perspective, sugar remains bullish from an intermediate-term TREND perspective with immediate-term TRADE resistance +13.8% higher at $103.11.