Sugar Squeeze

| About: iPath Dow (SGG)
With the current slew of bearishly construed economic data, one would assume that a call selling approach may be the best strategy for many commodities markets. But as we know, these markets can often march to the beat of their own drummers. And the bull story in sugar is one that needs telling.
Sugar prices had an impressive breakout in late August, the latest in a steady push higher since seasonal lows in May.
Disappointing global production in 2008 and 2009 created a supply/demand deficit for sugar, which took prices to 30 year highs earlier this year. Prices then weakened into May as expectations for a recovery in global production scared off the bulls. Since that time, bullish enthusiasm has returned to the sugar market as players came to realize that 2010 is unlikely to produce a surplus of sugar. Granted, global production of sugar is expected to bounce back to to about 164 million metric tons in 2010. But global demand has spiked and is also expected to come in near 164 million tons – an all time record.
Much of this new demand is coming from developing nations such as China. Increased incomes for citizens of these countries means more disposable income available for “luxuries.” And as we are finding, the first luxuries on the list tend to come in the diet – especially sweets.

China has led the way in the global demand for more sugar
Chinese sugar demand has increased nearly 33% in just the last 5 years – vaulting it into the third largest consumer of sugar in the world. Other developing nations reflect similar increases. Demand surges such as this leave little room for crop shortfalls.
Recent strength has come from slower cane crushings in Indonesia and concerns over lower beet yields in Europe and Russia. However, our sources in Brazil (which accounts for nearly 25% of all global sugar production, report that crushings are down substantially due to an abnormally dry season. This is an issue that has not yet been widely reported in the press and one reason why prices have seen a recent surge. Not only could this affect this year’s crop but it could also put next year’s development in question.
The specter of questionable production against a backdrop of surging demand gives fundamental support to sugar’s technical breakout in August. It also presents a market that could hold up well even if US and European economies slow in the second half of 2010.

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As production costs of sugar now run about 15 cents per pound in Brazil, we doubt prices could fall much below that level in 2010, and puts sold at or below that level would appear to be excellent sources of income for option selling investors.
We do advise waiting for pullbacks to get the best premiums as the sugar market is “spec heavy” right now and vulnerable to quick technical corrections. Look at these as put selling opportunities.

Disclosure: No stock positions