Time to short sugar, coffee and soybeans

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

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-todate, sugar, coffee and soybeans have returned 35%, 19% and 25% respectively.

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 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.

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).

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.

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 longterm 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%.

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 pricenegative.

Nitesh Shah – Commodity Strategist – ETF Securities