by Jason Pearce
Sugar has been in a bear market for so long that it only seems to move in two directions: down and down some more! However, no trend lasts forever. This certainly does not mean that we should forget the words of Keynes who said, “The market can remain irrational longer than you can remain solvent”. But the fact of the matter is that changes in supply and demand will cause a trend to eventually reach its conclusion over time. Since markets have a habit of overshooting their equilibrium price, the end of one trend is often followed by a new trend in the opposite direction. If nothing else, a sharp retracement should occur as trend followers unwind their positions when the ride is over.
Looking at a combination of market fundamentals, price action (the ‘technicals’), and seasonal patterns, it is quite possible that the recent two-month increase in sugar prices is more than just another bear market rally. This could potentially be the start of a new bull market. Based on the history of this commodity, it may have a lot further to run. If so, traders had better pay attention.
The Global Glut
After peaking at a thirty-year high on Groundhog’s Day of 2011, the bull market saw its shadow and retreated. As it turns out, this was the start of what would turn into a multi-year bear market.
Fundamentally, the bear market was driven by a global supply glut that hammered sugar prices as supplies exceeded demand for five years straight. This was due to a combination of big crops coming out of Brazil (the world’s largest sugar exporter) and slowing demand in China (the world’s largest sugar importer).
Furthermore, the Brazilian real has been in a multi-year bear market as it shed nearly two-thirds of its value from the 2011 peak to last month’s record low. This kept their sugar exports streaming along as it negated any incentive for Brazil to hold anything back from the marketplace.
It looks as though there may finally be light at the end of this bearish tunnel, though. Excess rains hampered the Brazilian harvest and now dry weather is posing a risk to the next Brazilian crop. For the new season that starts this month, the International Sugar Organization is forecasting that demand will finally exceed production for the first time in years. This trend is expected to continue with the size of the gap between supply and demand more than doubling the following year.
As a further threat to supply, El Nino has returned and it is projected to be one of the strongest since record keeping began in 1950. This weather pattern has the potential to wreak havoc on crops all around the globe, including sugar. If you’ve ever seen or traded a weather market in commodities (think drought in the grain and livestock markets or freezes in the coffee and orange juice markets) then you know that the sky is the limit for how high the prices can go.
Bear Market Duration
This bear market has been a doozy. It is one for the record books. Although markets can and sometimes do break records, commodities are statistically mean-reverting. In other words, the trend will eventually end and the market will give back the lion’s share of its move. It’s similar to a pendulum. The more extreme the market moves in one direction (in price or time), the more likely it is to reverse and swing significantly in the opposite direction.
The nearest-futures sugar closed at a price of 14.52 in 2014 and posted an annual loss of nearly –12%. This follows a –27% annual loss in 2011, a –16% annual loss in 2012, and another –16% annual loss in 2013. This four-year duration of consecutive losses marks the longest string of annual losers that sugar has experienced in the last half century.
From high to low, this bear market in sugar lasted a duration of 4 years, 6 months, and 22 days. This is the second-longest bear market in sugar since 1969 and it falls less than a month shy of matching the record 4-year, 7-month, and 15-day decline from the 1974 record high to the 1978 low. The $64,000 question now is whether or not the “sugar bears” will be like the Chicago Bears this year and match their longest losing streak in franchise history!
In addition to the duration of this bear market, the size of the decline is also significant. Basis the nearest-futures, sugar declined a whopping -72% from the 2011 bull market peak to the seven-year low that was posted in August. This is the largest sugar bear market in sixteen years. This size of the decline was just one percentage point shy of matching the -73% bear market decline into the 1999 low, which ranks as the third-largest bear market in nearly half a century.
In the interest of full disclosure, the top two bear markets were downright cataclysmic. Sugar suffered a -91% meltdown during the 1974-1978 bear market and it endured a record -94% decline during the 1980-1985 bear market. This does not negate the severity of the recent bear market, but it does show that Keynes remarks apply to commodities as well.
Given the historic extremes in terms of both the duration and the size of the recent bear market in sugar, it only makes sense that we should expect the pendulum to eventually swing hard in the other direction. It is possible that the swing has now started.
The Upside Potential
Let’s say that the multi-year bear market reached its conclusion in August. Furthermore, we’ll also assume that sugar has started a new bull market. If so, what sort of expectations should we have for future prices?
While we don’t know what the future holds, we can go back to the past and see how the market behaved before. By examining prior bull markets that followed bear markets, perhaps we can get a feel for the upside potential in sugar.
Trading this market is not for the faint of heart. Sugar tends to make sizable moves. This is a good thing! You can’t make big money in a market that doesn’t move much.
Following the last four bear markets in sugar, the new bull markets experienced gains of +166%, +304%, +263%, and +177% from the final lows. Just matching the minimum +166% gain from the current low would put sugar at 27 cents. That’s nearly double the current price. If you knew in advance that a commodity market was set to potentially double from current levels, wouldn’t you try to capitalize on it?
In the event that sugar matches the median-size bull market gain of +220% or an average bull market gain of +228% (based on the last four bull markets), it would be on a trajectory toward either side of the 2011 multi-decade high near 36 cents. If the pendulum analogy holds sway, the new bull market could go even further than that.
I will emphasize, however, that sugar is not morally obligated or legally bound to repeat its past behavior. It could do something totally different this time. Analyzing the past simply allows us to determine the probabilities. There are not certainties in the business of speculation. But knowing the probabilities is quite valuable. In the land of the blind, the man with one eye is king.
Sweet Seasonal Patterns
When you look at the last four decades of sugar prices, a seasonal pattern emerges. From a macro view, it appears that sugar tends to hit bottom towards the end of September. It then has an overall bullish trajectory until late January. If so, we are currently only one-quarter of the way through this bullish timeframe. Buying dips over the next couple of months could be the trading strategy to use.
Dialing it in a little closer, it appears that sugar has a seasonal tendency to make a pullback into mid-November and another dip in mid-December. If so, traders should be watching for this pattern to materialize over the coming weeks. It could offer a great setup to either establish a long position or add on to one.
The Technical Outlook for Sugar
Recent price action may confirm the suspected trend change. In the interest of keeping things simple, let’s take a look at just one sugar chart. After all, Occam’s razor theorizes that the simplest answer is usually the most accurate one. He probably would have been a great trading system developer.
Looking at the sugar ETF (symbol:SGG), we see that September ended with the first end of week close above the weekly 20-bar Moving Average since June of 2014. This triggered a bullish trend change.
In itself, there is nothing inherently magical about the weekly 20-bar MA. It is merely a reference point. The reason that we reference it, however, it because of what happened the last three times that SGG bounced into the declining weekly 20-bar MA. In January, May, and July this sugar ETF rallied up to a multi-week high and traded either side of the declining weekly 20-bar MA. By the end of the week, SGG had backed off and closed the week out with a loss. New multi-year lows were seen shortly thereafter.
This time around, SGG traded within striking distance of the weekly 20-bar MA in mid-September, backed off for a week and a half, and then blasted its way to new multi-week highs at the end of the month. For good measure, the ETF continued its “sugar spike” into this month. This changed the bearish pattern of bouncing and then rolling over at the weekly 20-bar MA.
Now that this technical resistance barrier has been broken, it becomes a support level. At this point, a pullback to the weekly 20-bar MA might offer a low risk entry point on the long side of SGG. It may be even more lucrative if were to occur in mid-November when a temporary seasonal pullback is due.
Another simple observation is that the price structure itself turned bullish. SGG pulled back to a higher low in mid-September and then rallied to a higher high in late September. By definition, a higher low and a higher high indicates that sugar is currently in an uptrend. Until this pattern changes, you want to be on the long side of this market.
The case for a new bull market in sugar has been presented. The synergy of historic extremes reached in a mean-reverting commodity, followed by rapidly changing fundamentals in a bullish seasonal time window, and recent price action signaling a trend change are quite compelling. Now that you have been enlightened, you still have to know what to do with this knowledge.
There’s an old saying that “the Devil is in the details”. There’s an even older saying that “God is in the details”. Perhaps the difference between the two is the outcome. Making a forecast for the sugar market is one thing, but trading it is another matter. To trade successfully, you must have a detailed plan of where to get in, how much to buy, where to add to positions, and where to get out.
There are several ways to skin this trading cat. There is no absolute right or wrong answer, although there are some widely-accepted principles (trade with the trend, let the profits run, cut losses short, don’t add to losing positions, etc.) that serve as guidelines. Every trading must find the methodology that best suits their personality and temperament. You must roll up your sleeves and do the hard work. Figure out how your trading methodologies and systems will apply to the current opportunity in sugar. If you don’t currently have a detailed trading plan, find a mentor who can help you create one. It’s going to take plenty of effort on your part, but the rewards are well worth it. Good luck in the Sugar Bull!
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