Author: Michael Ferrari, PhD
VP, Applied Technology & Research

 

‘Parasitic Trading’ being blamed

(photo from the FT)

 

In a letter to the InterContinental Exchange (ICE), the sharp rise in raw sugar prices to 30 year highs and related volatility is being blamed on ‘parasitic’ algo traders, according to the World Sugar Committee.  The chart below (from ino.com) shows the progression of the March2011 contract, which has nearly doubled in six months.  This reaction (usually coming from those affected by higher rawmat prices) is nothing new.  Whenever there is a significant spike in a liquid market, it follows that the algo card will appear.  It has yet to be proven whether the methods associated with high frequency trading (HFT) actually contributes to higher prices, or just increases the volatility of the underlying contract.  In either case, this will be an agenda item for the G-20.

Regardless of the extent that HFT might be moving the current sugar market, fundamentals are at the epicenter.  Food inflation is grabbing the headlines across the board, with everything from corn to coffee experiencing supply side issues in the face of strong demand.  We have discussed the overall price increases in many previous posts, several of which have highlighted the relative contribution of adverse weather across many of the primary agricultural growing origins. 

Taking a look at sugar, cane production at the top three producing countries (Brazil, India, China) is healthy y/y, but in all three regions, output estimates are now lower than they were 3-4 months ago.  Expectations for the 2011/12 (Oct/Sep) crop will be important, as the world market is waiting for a shift to net surplus status.  The global balance has been in deficit for > 2 years, and potential tightness is keeping prices in the range that we are currently experiencing.  In addition to the tightness in physical supply and +/- developments regarding crop progress, we are monitoring two other drivers as indicators on directional movement.  The first is the relative strength of the USD vs. the major benchmark currencies, and the second is oil.  While every analyst is focusing on USD as a barometer for commodity moves, sugar is particularly sensitive to this factor right now, and much has to do with activity in Brazil.  High oil prices increase the premium that Brazilian producers can realize through the sale of cane ethanol.  In addition, when the economics are in the favor of the Brazilian Real coupled with stronger demand from the ethanol sector, it is advantageous for Brazilian producers to sell physicals domestically in the short term, and then when the USD strengthens, put the excess supply back on the world market.  As the notion of a slower shift to excess global supply is verifying, we look at Brazil being in the driver seat for the coming months.