Time to short sugar, coffee and soybeans

ETF Securities Commodity Research – Time to short sugar, coffee and soybeans

Summery

• Sugar, coffee and soybeans have made spectacular returns this year, but much of their gains have been driven by currency movements, particularly the Brazilian Real.
• With record production of Arabica coffee and soybeans expected in 2016/17 and a narrowing deficit in sugar, the rally is likely to come under pressure.
• If the Brazilian Real remains stable, we expect fundamentals to prevail and the price of these sugar, coffee and soybeans to decline.

Brazilian Real drives rally

The El Niño weather pattern led to a failed monsoon in India and unseasonably wet weather in South America in 2015/16. However at the time of onset of the adverse weather, the price of sugar, coffee and soy made only muted moves. The sharp depreciation of the Brazilian Real weighed on their performance as stocks of these commodities could be sold in US Dollars, providing millers and farmers with improved margins. When the Brazilian Real started to appreciate we saw the price of the commodities make substantial returns. Year-to-date, sugar, coffee and soybeans have returned 35%, 19% and 25% respectively. (Click to enlarge)

Weather patterns changing

The El Niño of 2015 was one of the most extreme on record by some measures, but the impacts of the weather phenomenon should be largely behind us now. The National Oceanic and Atmospheric Administration forecasts that the opposite weather phenomenon, La Niña, will emerge by the Northern Hemisphere autumn with a probability of 75%. La Niña involves a cooling of the Pacific Ocean (in a similar manner to El Niño warming the ocean), which changes trade winds and weather patterns from what is considered to be normal. Broadly speaking, areas that were excessively warm and dry in El Niño are likely to turn cool and wet in a La Niña. We assessed the likely impacts of La Niña emerging in autumn/winter (see Opportunity to short agriculture with La Niña) which highlights that the weather phenomenon is likely to be price negative for many crops with the exception of sugar. Cooler Southern Hemisphere temperatures are likely to reduce the heat damage that we have seen in the past crop. Sugar maybe an exception as cooler, wetter weather could reduce the sucrose content of cane in Brazil. (Click to enlarge)

Record coffee production

After two consecutive years of production decline, coffee output is expected to rebound to an all-time high. Brazil, which produces approximately 45% of global Arabica supplies has seen favourable rain during the flowering of its coffee bushes, setting the scene for a healthy crop. Although the beginning of the harvest has been slowed by rain, current dry and warm weather should allow for field work to catch up. Brazilian output is expected to rise by close to 20% in the current 2016/17 crop. Elsewhere, production in Honduras (7% of global production) is expected to make a recovery after the planting of ‘rust- resistant’ trees several years ago, which is helping to improve yields. The country has engaged in a renovation programme to protect its coffee from the rust-leaf fungus which has reduced production from Central America and Mexico for the past four years. Honduran production is likely to hit an all-time high of 6.1 mn bags (a 7% gain). (Click to enlarge)

Narrowing sugar deficit

After 5 consecutive years of sugar surplus, 2015/16 was the first year of a deficit. The failed monsoon in India and Thailand has seen production in these two countries decline the most (the combined output of both countries is about 25% of global production). Production in Brazil (20% of global production) also declined, not because of a decline in cane growth, but because more cane was used for ethanol production. The 2016/17 cane harvest in Brazil, which is about a quarter complete, is progressing 15% faster than last year’s harvest. With relatively low gasoline prices we don’t expect a large diversion to ethanol this year. Sugar production in Brazil is running 25% ahead of where it was last year and we expect a 7% increase in Brazilian sugar output in 2016/17. (click to enlarge) The Indian monsoon is currently approaching its northern limits and rainfall has been at the long-term average. In contrast to last year, resevoirs will likely be amply replenished. Indian sugar output is likely to rise as a result of more favourable conditions for its cane crop. Sugar consumption is expected to rise by 1% globally, leaving the market in a production deficit despite the increase in supply. However, that supply deficit will narrow. While sugar stocks will continue to decline, they will remain above the long-term average of 31 million tonnes.

Soybeans head for record production

The Argentine soybean harvest in 2015/16, which is virtually complete, is expected to produce 8% less soybeans that the previous year as flooding in April and May spoiled the crop. Argentina provides approximately 20% of global production. Brazil (30% of global production) has seen its harvest remain close to the previous year’s levels. The 2016/17 year crop for Argentina and Brazil has not yet been planted. The US 2015/16 crop was a record high. Although USDA projects a decline for 2016/17, we believe that their forecast remains overly conservative. By July 3rd 2016, 22% of the crop was blooming (8% ahead of last year) and 72% of crop was in good or excellent condition (10% better of last year). Moreover, planted acreage of soybean in the US has increased by 1%. (click to enlarge) Speculative positioning in soybean futures stand more than 1.5 standard deviations above the 5-year average, highlighting that investor optimism remains elevated. We believe that the investor optimism is a response to the disappointing Argentine crop of 2015/16. While the 2016/17 Southern Hemisphere crop is not yet in the ground, our analysis of La Niñas indicate that weather conditions could be quite favourable for the crop this year.

Downside risk to Real

While difficult to predict the path of a currency that has been so volatile in the past few years, we believe that the good news about relative political stability (after the impeachment of the President Dilma Rousseff) has been largely priced in. Economic conditions remain challenging for the country and therefore limit significant further appreciation. We believe that currency appreciation will no longer be a meaningful catalyst for price increases in sugar, soybean and coffee for the remainder of this year and the crops will trade on their own fundamentals. Rising production should therefore be price-negative.

Important Information

General

This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”). The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value. This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States. This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents. ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.