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Trading Sugar and Other Soft Commodities

Commodities like sugar, soybean and wheat are an asset class that you may have thought out of your reach but given spread betting there might never have been a better time to start trading commodities. In these volatile times you can use spread betting, futures, options and CFDs to access commodities trading and make money out of trading them in much the same way that you do spread betting on gold or crude oil.

Trading any market puts you up against a variety of players, including buy and hold investors, day traders, institutions and major share funds. Stepping into the commodities arena will introduce extra factors, because commodities like cotton or coffee, which are used by end producers who need to hedge their outcomes, drive many of the world’s commodities markets. This answers a question commonly asked by new traders: ‘Why would someone want to sell if the prices are going higher’? It can be as simple as the fact that they are a producer or user of the commodity and they are looking to lock in a future price, that is, to ‘hedge’ their exposure to price movement. There will always be participants buying and selling, for a variety of reasons.

 

Over the past year, soft commodities like wheat, corn, soybeans, soybean oil, sugar, cotton and coffee have been rising. So you might ask what is driving this seemingly sudden food crunch?

Simply put, the world population is increasing - currently standing at 6.7 billion and that’s a lot of zeros - 6,700,000,000 and this is expected to reach 9 billion by the year 2050) - which means that every year the population is increasing by some 50 million! There is also an ever increasing demand from China and other developing countries for a greater variety of food stuffs [no, Chinese don’t content themselves with just rice these days ;)], as they can increasingly afford cereals and red meat. The average Chinese consumer ate 20 kg of meat a year in 1985 and now eats 50kg. It is also interesting to note that 70 per cent of all grains are already used for animal foodstuffs - and that it takes two to three kilos of grain are needed to produce one kilo of chicken, while six to eight kilos are needed for one kilo of beef!

Biofuels are also contributing to the rise - governments in the US and UK have pledged to give more importance to fuels derived from crops to reduce the dependence on foreign oil and reduce carbon emissions. George. W. Bush has stated that the USA is addicted to oil and should replace 75% of imported oil by 2025 by alternative sources of energy including biofuels. The EU and UK want 5% of petrol and diesel to be made from biofuels by 2010 and maybe 10% by 2015. Last year biofuels took about one third of America’s record maize harvest even though fuel production from crops is often inefficient. Ethanol fuel which is used widely in Brazil and increasingly in the US can be made from sugar, corn, palm oil or rapeseed. In Brazil, however ethanol is mostly made from sugar cane crop and all Brazilian cars are now equipped to use ethanol as their sole fuel source.

Climate change is also causing droughts and flash floods that are diminishing crop yields. Add to that increased awareness about the environment and supermarkets replacing plastic bags with maize, sugarcane or starch packaging and there are good arguments that the price/demand for our sweet friend is likely to remain strong.

Trading Commodities via Spread Betting

  1. Spread betting offers a very easy way of trading commodities - the contracts are very much similar to futures but the stakes are smaller (although the spreads are often bigger).
  2. Most spread betting providers will allow you to take positions in relation to soft commodity price movements foodstuffs such as cocoa, sugar, wheat, corn, soybeans, soybean oil, cotton and coffee.
  3. Commodities trading is still mainly US-based but spread betting offers a way to speculate on commodity prices. Capital Spreads, for instance quotes soya beans, corn, and sugar from the Chicago Board of Trade pit, as this is where the prices are made.
  4. Commodities are uncorrelated with equities but related to demographics, change in diet and particularly with the weather (droughts, hurricanes, floods, climate change…etc). Climate change is making water more expensive which will in turn push the price of grains up. Sugar is also increasingly being used to produce ethanol which means that the fate of oil will also be linked to sugar pricing as higher oil prices will serve to drive alternative solutions. With Brazil, the world’s largest sugar exporter and ethanol producer, diverting more of its supplies to ethanol production, we may continue to see the bull in the sugar market. On the other hand a glut of sugar due to too many suppliers, the weather or a change in consumer taste is likely to push prices down.
  5. Remember also that trends can be very persistent - prices have a tendency to rise (or fall) much further and for much longer than anyone predicts so don't give too much importance to short-term reversals.

Spreadbetting Sugar, Soybean, and other Grains


Good to Know:

  1. Do look at seasonal factors because they dictate when products like wheat, corn or soybeans can be planted and harvested, and when they can be delivered to the physical market.
  2. Such crops are also affected by uncontrollable variables like weather, droughts, freezes, quality of harvest…etc. These non-quantifiable variables have a considerable effect on commodity prices but it is not possible to quantify droughts and correlate them to Soybean or Corn prices for instance. In such cases the fundamental law of supply and demand controls these outcomes. This also makes it harder to trade a system…
  3. Most commodities are very extended in price and hard to make accurate cycle forecasts because even if you are one or two days 'off the swing in one's account its very sizeable, and volatility is supreme! Increasing your position size after a string of losses in commodities is not recommended. Perhaps soybeans had four losers in a row and you decided to double your position size on the fifth trade. After all the market has to give a winning signal now, right? Wrong. Each trade you take at double position size shortens the life of your trading career! And remember there is no better feeling than taking out your initial capital and playing with profits only.
  4. Some exchanges also set daily trade price limits and you can find yourself trapped in a losing position with no immediate way of closing out. This means that its vital to set stakes at a sensible level and make use of stops (in such cases guaranteed stops are even better!).
  5. Trading in commodities can lead to bountiful profits as well as cruel losses, so ensure you do some research and make sure the plan you are using involves strict risk management guidelines.
  6. Trading on equities connected to the commodity industry is also possible as these will directly or indirectly benefit from any increase in demand. Possible candidates include:
  7. On the other hand if you envisage the commodity prices to continue rising you should steer away from the highly competitive world of food manufacturing, with companies like Cadbury Schweppes (CBRR), Real Good Food (RGD), Northern Foods (NFDS), Associated British Foods (ABF) and Nestlé (NESN.VX) likely to be squeezed further as the raw materials keep spiraling.

Sugar trading for some sweet profits...

  1. About 60% of the world’s Ethanol production comes from sugar.
  2. As I stated above most commodities behave according to the fundamental law of supply and demand. In agricultural production supply cannot be turned on or off like a tap - in the case of sugar, for instance, a few years ago (in late 2005/early 2006) the prices soared which in turn encouraged farmers to dedicate more farmland for the production of sugar at the expense of other commodities, notably soybeans. This, in turn led to a vast oversupply following record harvests and has negatively affected the price of sugar today.
  3. Any future rally of sugar will be likely connected to demand for fuel - as crude oil prices rise, Ethanol becomes an economically viable substitute. As demand for Ethanol soars, so will the demand of its principal ingredient, sugar. This leaves food manufacturing companies, the traditional buyers of sugar to bid against energy refineries for raw material. There is also increasing demand from emergent economies such as China and India which leaves sugar a demand led market.
  4. Ethanol can be produced from sugar cane and although this produces a lower mileage generally than gasoline it is still a valid fuel substitute to oil. It burns cleaner with less nitrous oxides and other hydrocarbons and you’ve seen how alcohol burns with a clean blue flame. In Brazil, for instance Ethanol has been in use since more than a decade, as it’s much cheaper there to make it out of sugar cane, than refine oil to make gasoline.
  5. Note the major producers and consumers so that you can keep an eye on the fundamental factors, such as weather, that affects sugar supply and demand.
  6. A lot of the sugar produced in a country is consumed locally and only a quarter of the remaining global production is open for sugar trading. This means that shortages or gluts in one of these countries can lead to a large change in the supply in the sugar trading market.
  7. I like to compare crude oil with sugar - the price of crude oil was low for several years, and then once the price had a larger than normal price surge people realized the supply was tight. We have the same situation with World Sugar. One of the major problems is the accuracy of the reports given. They have never been correct and probably never will (most of the sugar reported in storage is simply not there). Note that these comments are intended for education purposes only - what I have said above is not a recommendation to pile up on sugar or any other commoditiy for that matter!
Sugar Chart