Have you ever picked out a basket of high quality, low risk stocks and tried to buy them on a "dip?" And if they did dip, you weren't afraid to buy, because you knew you were buying a high quality company that would be around for a long time. Solid balance sheet, strong demand for it's products, etc., etc., made you comfortable that even if your timing was not perfect, the stock would likely not fall too far. You were willing to buy and hold and felt real good doing it. Right?
That's how you could feel about the sugar market at it's current price levels. For as we plod through the month of May 2012, sugar finds itself the benefactor of two high quality price predictors that equate to the gold standard of commodity analysis: A favorable "big picture" fundamental outlook and a cyclical catalyst to help encourage a price move sooner rather than later.
Supplies Hit Record Lows
By "big picture" fundamentals, we are typically referring to those 2 or 3 main figures that define a commodities supply/demand balance for the year. More often than not, these are Global Ending Stocks and even more specific, Global Stocks to Usage ratios. Ending stocks measure the amount of supply left over at the end of the crop year. Stocks to Usage ratio measures the Ending stocks as compared to the upcoming year's expected demand.
All of the news you may read if you do any sugar "research", such as Indian demand or Chinese production or supply/demand surpluses or deficits, they all get thrown into a big pot and reduced to these two figures.
Sugar's 2012 Global Stocks to Usage ratio will hit the lowest level on record- leaving little room for shortfalls in 2012 production.
In 2012, global sugar stocks to usage ratio will hit 17%, the lowest levels on record. This means that at the end of this crop year, leftover supplies will be able to meet 17% of next year's projected demand. While the reasons for this are complex, the short story is that emerging market demand from places like China, India, and even domestic demand from top producer Brazil are outpacing production as a longer term trend.
While this figure is not necessarily useful in determining the short term direction of sugar, it sets the stage and provides a backdrop for everything else that happens in the market. In short, prices might not always be moving higher. But the market's "color" emits a bullish hue.
This is extremely important to you as an Option Seller. Because you're not trying to guess market direction - only where prices are least likely to go.
Brazil, "Harvest Lows" and Higher Prices
The second ingredient to this trade is a seasonal catalyst. Big picture fundamentals are important. But knowing when potential causes of price moves will occur can be crucial in determining strike price and time selection of your options.
The chart below is a 15 year seasonal chart for sugar prices. Note that seasonal price chart reflect an average price pattern for 15 years. There is no guarantee prices will move like this in any given year. Past performance is not indicative of future results.
October Sugar Seasonal Chart: In the past, sugar prices have tended to establish lows in the heart of the Brazilian harvest, and then begin to strengthen into the second half of the year. (Past performance not indicative of future results)
What a seasonal chart does is reflect a certain set of fundamentals that tend to occur about the same time each year. In this case, the price pattern reflects the beginning of the Brazilian sugar cane harvest.
Brazil is certainly not the only sugar producer in the world. But it accounts for roughly 25% of global production and nearly 50% of global sugar exports. Therefore, harvest cycles in Brazilian sugar are a big deal for prices.
90% of this sugar is produced Brazil's center-south region. Harvest in this region begins in April and doesn't finish until November. However, May and June mark the meat of the harvest and the time when supplies are flowing most freely and rapidly to market. Thus, as is commodities rule #1, when supplies are highest, prices are often lowest. That is why sugar prices tend to establish lows in June.
After that period when the 2012 crop is effectively "priced" and harvest pace begins to slow, the market turns attention to the northern hemisphere beet crops. As the Brazilian supply train begins to fade and uncertainty over the northern beet crop builds, prices have often responded in the positive as is evidenced by the chart.
We have every reason to believe that this pattern will repeat in 2012. Given the low ending stocks projected this year, the market will be particularly sensitive to northern hemisphere crop anxiety.
Conclusion and Strategy
With Brazilian harvest in full swing, we feel sugar prices will be at or near a low over the next several weeks. Reporters will love to tout the slight sugar "surplus" the market could enjoy in 2012. What they won't tell you is that annual production surplus's or deficits are highly irrelevant in regard to overall prices. It's what's left in the barn at the end of the year that counts. Ending stocks to usage ratios will be at the lowest level in recorded history this year. That should mean limited downside in sugar over the second half of 2012.
OCTOBER 2012 SUGAR
The as the bulk of Brazilian harvest moves through the pipeline, the market will soon begin to turn it's attention the northern beet crop harvested in the fall. This could very well be a catalyst for higher prices.
As an option seller, you don't necessarily need higher prices to be successful. But the number of factors in sugars favor for Q3 and Q4 2012 should keep prices at least well supported.
As a put seller, that is your recipe for success.
Look to sell Sugar puts at strikes below the 20 cent level on any additional weakness this month. Margins are typically low on sugar options which can mean a higher ROI on successful trades.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.