Grains Oilseeds

[Arctec]

SUGAR STRATEGIES

The "green" revolution toward the global use of more environment friendly fuels has opened new avenues of demand for corn and soybeans that were nonexistent just a few years ago, and this may develop into an even greater demand outlet for sugar. The use of sugar by the energy industry is becoming a major source of demand for that commodity, and it has the potential to grow substantially in coming years as more countries adopt clean fuel policies and take initiatives to lower their dependence on oil imports. Sugar based ethanol being one of the most cost efficient biofuels available certainly widens its appeal. Like corn and soybeans, the sugar market's transition from a "food" commodity to a "fuel" commodity has the potential to send prices sharply higher as the trade looks beyond record production estimates and begins to factor in the coming explosion in biofuel industry demand.



While Japan has lagged in the global transition to biofuels, it is a potentially huge market. As the world's second largest consumer of gasoline, they certainly have a motivation to reduce their oil dependency. Japan is the only Asian country with a UN carbon emissions cap, and Japan has agreed to cut its CO2 emissions by 6% under the Kyoto Protocol. This would mean that 500,000 kiloliters of gasoline consumption a year would have to be replaced by biofuels. If the US were to allow more duty-free imports from Brazil in an attempt to increase the percentage of biofuel usage for the short term, the current world production surplus of sugar could quickly dissipate. When considering the current supply outlook for sugar, it is understandable why prices have been under pressure, falling as they have from 18.54 cents per pound in April 2006 to a recent low at 9.99 cents in February 2007. The International Sugar Organization pegged world sugar consumption for the 2006/2007 season at 153 million tonnes, up 3 million from last year. The ISO anticipates a world production surplus of 7.2 million tonnes, and the USDA is projecting a world sugar surplus of 9.1 million. Weather in Brazil, politics in the energy sector and energy prices will have a significant impact on the balance sheets looking foreword.

The technical action in sugar last week indicated that a significant low may have been put in place. After a nine month bear trend, May sugar managed to gap above the key downtrend line from the July, December and early February highs. Since the October lows when May sugar first dipped under 11.00, open interest increased 295,291 contracts to a record high of 720,603 contracts. The move to an 11-session high on February 12th sparked a record volume of trade at 217,398 contracts, which seemed to be a key turning point for the market. On February 15th, the market gapped the downtrend line to a 27-session high. This has left fund traders in a weak position and the market vulnerable to significant short- covering ahead. Since the April 19, 2006 highs, the market has followed an 18- day cycle that managed to anticipate the July, August and October highs. The next cycle dates to watch for fall on February 28th and March 26th. Look for indications of lows, highs or an acceleration of the trend on these dates. Given the weak fundamentals, traders should first consider option plays which do not cost much to put on but may see a good return if the market were to see a major turn soon.

Suggested Trading Strategies: 1) Sell the October sugar 10.50 call near 78 and buy 3 of the October sugar 12.00 calls at 26 each. The spread will not hurt the trader if the trend remains down, but on a recovery bounce to 12.50, the 10.50 call should be near 211 (for a 133 point loss) and the 12.00 calls should be near 105 points (+79 gain each) for a gain of 104 points on the spread. 2) Sell the May sugar 10.00 call and buy the July sugar 10.00 call for a net premium paid of 10 points. If the timing is right, the investor may receive a cheap look at the upside once the May call expires on April 13th. (Future option values are based on pricing models and are not guaranteed.)