Short Covering Rally Arrives for Sugar as Funds Take Profit

June 1, 2018 7:38AM CDT

This week’s comment finds July sugar futures in the throes of a significant short covering rally. Open interest has declined more than 60k contracts while July sugar has rallied about 120 points since 5/16.  In this small amount of time the July contract has managed to take out previous resistance, 11.89, and rise above the 50-day moving average, 12.01 on it way to it’s current price level, 12.79, a place sugar hasn’t been in since late March.  This has moved July sugar squarely into technically overbought territory.  What’s more, it is likely that this rally is not supported by fundamentals. 

The jawboning of energy markets by the tag team of Saudi Arabia and Russia has been little noticed by the sugar market.  Crude and gasoline markets have been brought low by the implication OPEC will increase supply after their agreement to reduce production expires in 2018. Even with this outside market pressure sugar has continued to rally. Brazilian cane processors have been favoring ethanol over sugar due to higher margins brought about by higher crude prices which in turn reduces the supply of available sugar.  A convenient truth that fits perfectly onto this current rally.  And, it will be more than interesting to see if this fact alone is enough to sustain this rally. 

12.87 represents a line in the sand where trend followers well be forced to be buyers.  That means funds who held near record short positions two weeks ago have been moved out of a large part of that short position and will now be forced off the sidelines and into long positions. Typically, being astute technical market participants, we believe that the chart will anticipate changes in the fundamental picture. If the sugar market is breaking out to the upside, even though we know fundamentally that the supply part of the equation is overwhelmingly bearish, we should respect the price action and the ability of the ‘technicals’ to portend a change in trend. This is often true. Is that the case here and now? Sugar can remain overbought technically.  Price action is very bullish and forcing the hand of the funds. Funds have more short positions to cover and new long positions to enter. How much higher can it go? It is hard to see sugar trading over 14.00 for very long.  Still, entirely possible.  If you already have calls in place take some profit and let some ride. If this market has legs, and is heading over 14.00, calls bought even now could work out well for those with the risk tolerance. Ultimately, I believe that sugar is coming back down. A quick look at the chart below shows that after it rallies it can fall apart just as fast if not faster.  To that end I am suggesting traders look at put spreads that will benefit should sugar begin to make its way back down to 11.00. It does not appear that sugar production has declined for some producers it has even increased.

Sugar Jul '18 Daily Chart

Sugar Jul '18 Daily Chart

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