Sugar Contemplates Another Leg Higher

| About: iPath Dow (SGG)

Summary

Sugar has fallen 18.5% over the past year.

However, since a mid-August bottom, sugar has rallied over 28.3%.

In May, global consumption exceeded global production, closing a narrowing gap that began over three years ago.

Then, in November, consumption, while remaining greater than production, decreased in tandem with production, leading to a -6.2% move to the downside and price consolidation.

The focus remains on whether or not consumption will continue to exceed production heading into the next Sugar: World Markets & Trade circular in May.

Technicals

The global benchmark for sugar is the Sugar No. 11 contract, which trades on the ICE. Sugar No. 11 concerns the global, raw sugar trade, derived from sugarcane. As such, Sugar No. 11 does not consist of refined sugar ("white sugar"). Also, Sugar No. 11 is not to be confused with Sugar No. 16, which also trades on the ICE, that represents sugar delivery to five select ports for refinement in the U.S. Exposure to Sugar No. 11 can be achieved through the iPath Dow Jones-UBS Sugar Total Return Sub-Index ETN (NYSEARCA:SGG). The ETN holds the front month futures contract for Sugar No. 11.

Click to enlarge

As seen in the above chart for SGG, sugar has traced an inverse head and shoulders pattern over the past year with a head at $25 and a neckline at $35. Sugar's technicals are largely inconclusive at the moment. Starting from the top, the RSI indicates sugar is neither overbought nor oversold at 46.47. On the same note, the MACD (bottom of chart) remains neutral. However, printing below the price, the Parabolic SAR is bullish, with support from the 100 day SMA. If the 50 day SMA realigns itself below the price, the technicals will definitely tip in the favor of the bulls.

Click to enlarge

With CFTC data, I created a chart that shows the net short positions of futures contracts traded for the Sugar No. 11 contract over the past year. As depicted above, traders have increased their net short positions greatly since September, although their collective bearishness has begun to fade over the past month. Other factors constant, CoT data goes both ways. The bearish case is that traders are on the right side of the trade and further consolidation should be expected for sugar. The bullish case is that traders have made the wrong call, and will now need to cover their shorts, placing upward pressure on the price of sugar.

Fundamentals

See the below charts that show global sugar production compared to consumption and global ending stocks, respectively. Please note that all of the following data comes from FAS consumption and production reports, as well as FAS ending stocks reports. Also, volume is expressed in units of thousands of metric tons (K MT). Click to enlargeEndingStocks.png

The above fundamental data is very positive for sugar. For one, consumption continues to exceed production. However, what truly confirms the bullish thesis is the fact that ending stocks continue their decline. Ending stocks represent the amount of commodity available for re-export after a single harvest. As such, the amount of ending stocks is equivalent to the amount of commodity that world producers carry into the next export period. Therefore, high ending stocks indicate producers will be able to mitigate the impact of a supply crunch or demand spike. Alternatively, low ending stocks leave producers with minimal "insurance" against a shortage. In the case of sugar today, where global consumption exceeds global production, ending stocks will continue to be pushed lower and lower, in turn placing upward pressure on the price. Currently, ending stocks for the year trailing November 2015/16 are 39,598 K MT, or 23% of the same time period's production total of 172,146 K MT. While not overtly worrisome for the bears, 23% protection is not exactly positive. The below chart shows the decrease in global net production from the previous year compared to the decrease in global ending stocks from the previous year, starting with the 2014/15 year when the first YOY decrease in ending stocks was registered. The chart that follows it takes it a step further and shows the amount of K MT sugar in net production decrease needed to create 1 K MT of decrease in ending stocks.

Click to enlarge

Click to enlarge

While the first chart showing the two data sets is not particularly conclusive, the second explains what is really going on in sugar, which is the increasing depletion of sugar supplies. Since 2014/15, the amount of net production decrease needed to register a 1 K MT fall in global ending stocks has decreased rapidly, indicating a quickly depleting sugar supply. In fact, in the year trailing November 2015/16, less that 1 K MT of net production decrease was needed to decrease ending stocks by 1 K MT.

Conclusion

Provided net global production continues to be negative, even more pressure will be put on ending stocks and the fall in supply will push sugar prices higher from the fundamental side of the equation. In addition, if shorts continue to cover their positions and technicals return to bullish territory, sugar will trend higher. However, a return to positive net global production and short selling will further the current price consolidation in sugar.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.