Black Friday in commodities too
A new and more contagious Covid-19 variant identified in South Africa shook the world market this Friday, in a week made shorter by the Thanksgiving holiday in the USA, causing panic among the investors and the resulting speedy flight of risk assets.
Brent oil started trading at 72 dollars per barrel, a drop higher than 11%. Along with it, other commodities, such as WTI oil, RBOB gas, diesel, suffered sharp losses, all of which above 10%. Grains and soft commodities dropped 2% and 4%, respectively, on average. Nobody can complain about not taking advantage of the offers during the Black Friday week.
The sugar futures market in NY couldn’t come away unscathed from such damaged macroeconomic environment and closed out Friday, at the post-holiday session, at 19.40 cents per pound (after having hit the 19.15 low) for March/2022, accumulating a loss of 77 points against the previous week, equivalent to 17 dollars per ton. The average loss from May/2022 to March/2023 was 69 points, about 15 dollars per ton. For 2023/2024, it was only 26 points, or 5.50 dollars per ton.
The equivalent values of the closings of the futures contracts of NY that cover the 2022/2023 and 2023/2024 crops of the Center-South, shrank R$58 and R$42 per ton against the previous week. March/2022 melted more than R$100 per ton in the week, strengthening our thesis that not pricing in real per ton (together with the purchase of an out-of-the-money call option with strike price 200-250 points above the market) is an unnecessary risk with tragic consequences for the P and L.
In our comment last week, we said that “the fear was to watch the market fall into emptiness due to the events we cannot see and if they happen, we have a sense of urgency that many times makes us change tires on a moving car”. Having no talent for being a fortune teller, I always mean to bring my improbable readers the concept that risk management cannot be treated with omission, but with absolute priority. What good is it to have effective gains in agriculture and industry if when it’s time for hedging disaster strikes?
It seems doubtful that the combination of weak real and strong sugar will go on for very long. The recent values in real per ton compared to the last 5 and 10 years, adjusted by the IPCA, have only been exceeded by 5% and 2.5% of the times over the analyzed period. The chance your hedge will work out is 40:1, or in the worst-case scenario, 20:1.
Those who have been on the commodities market for a long time know about its cyclicality. Low prices for a long period of time inhibit production, cause ruptures and change in cultures (from one product to a more profitable one) until there is a shortage with the rise in price on the part of consumers eager to have the product. Shortage causes high prices that encourage the increase in production in the following crops, with stock building up and even newcomers producing in order to be able to participate in profitable prices the market offers. This has been working since the beginning of time.
So, commodities seldom carry such appealing margins for a long period of time, except for those lapses of production deficit, frost, drought and other factors that don’t seem to be the stars right now. Even with the strong increase of about 40% in the production costs of sugar in the Center-South and assuming a margin on the cash flow cost of about 25%, this would come to R$2,000 per FOB ton equivalent to NY at about 15.50 cents per pound. This is the type of caution the mills should keep in mind.
The industrial consumers of sugar can sell ITM puts and pocket the premium decreasing the cost of acquisition of raw material if they are exercised. A put at the strike price of 19.50 cents per pound traded at 0.92 cents; if the consumer is exercised, he will have bought sugar at 18.58 cents per pound. If not – because the market expired above the strike price – he at least pocketed the premium.
The House of Representatives passed a Provisional Measure that allows the direct sale of ethanol from the producer or the importer to the gas stations. What does this mean to the market? It means nothing, absolutely nothing. The vanguard of delay that has taken root in Brasilia will capitalize on that, spreading the word that the measure will make the fuel price at the pump cheaper. With the oil price drop and the slightly stronger real against the dollar, what will happen soon is a Petrobras price reduction at the refinery, which can already be at least R$0.25 per liter. Those out of the loop will believe that the government “has been working towards that”. A total B.S.
Brazilian sugar exports have reached 28.4 million tons in the accumulated of twelve months ranging from November/2020 to October/2021. This volume is just 0.7% above that of the same period last year. Over the seven months of the 2021/2022 crop (from April to November), the volume reaches 16.9 million tons of sugar, a reduction of 28% against that over the same period of the last crop which hit 23.5 million tons. Based on the pace of the exports this year, we believe Brazil will export 24 million tons at the most.
You all have a good weekend.
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