Soft commodities, which apart from coffee and sugar also include cocoa and cotton, been rallying strongly over past couple of months, as have grains.
While soybeans have led the grain gains after rallying by one-third, sugar has taken the lead among softs with its 29% jump.
The soft commodity sector has rallied by almost 17% year-to-date, primarily driven by strong gains in sugar. During the past few days coffee has joined in, hitting a 13-month high:
The reason behind the strong rally for both the sweetener and now Arabica coffee as well has been the emergence of unfriendly weather in Brazil. There is also, however, the renewed strength of the Brazilian real, which is up 20% against the dollar since January
Bothy factors have played their part in sending these two Brazilian output-dependent food commodities on a sharp upward surge.
Sugar has been advancing steadily since April when concerns about output from India and Thailand (due to drought) supported a move that recently gained yet more strength on the back of the wet, damp conditions in Brazil.
These developments helped slow the crushing process, leading to bottlenecks at Brazilian ports. The backup was due to ships lining up to take delivery of sugar at a time characterised by heavy shipments to overseas markets, not least China.
Hedge funds have jumped on the positive momentum wagon, accumulating a record long position of around 223,000 futures and options lots with a value close to $5 billion. While fundamentals such as the rising global sugar deficit remain supportive, such an extended long bet will be OK to hold but after seeing the price jump to the highest level since 2013 the market has increasingly been left vulnerable to a period of long-liquidation.
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Sugar for October delivery trades just below 20 cents/lb which is the highest level for a front-month contract since October 2013. The RSI has moved above 80 and last time this happened was back in March when it helped trigger a 16% correction and the reduction of a net-long position 60,000 lots smaller than the one currently witnessed.
Arabica coffee traders have been left frustrated by its inability to break out of the relative narrow range that has prevailed for the past 16 months. Several failed attempts in both directions have seen speculative bets build up only to be squashed by snap reversals.
During the past week, another attempt was seen to the upside and earlier today it reached $1.45/lb. The initial move was primarily driven by spillover buying related to the general pickup in demand for agriculture commodities during the past couple of months.
A strengthening Brazilian real also played its part.
The main spike this week, however, has been driven by forecasts for frost in Brazil – the worlds biggest grower of the Arabica bean – which could hit crops during the coming days. The market is therefore on weather watch to see whether this will be turn out to be another failed breakout attempt.
While fundamentals may emerge on the supporting side, hedge funds have also done their bit to support the latest surge. While bullish bets on sugar are at a record high, hedge funds just last week turned net-short after two weeks of heavy selling where longs were cut and shorts added. The covering of these shorts has played an important part in the latest surge.
If no damage to crops emerges over the coming weeks, coffee could revert lower as fast as it jumped with funds once again being caught out.
It also helps to explain the record long in sugar, as the rally seen since April has given funds no cause for concerns given how shallow corrections have been during this time.
Coffee traders now find themselves watching Brazilian weather forecasts
in order to track their investments. Photo: iStock
— Edited by Michael McKenna
Ole Hansen is head of commodity strategy at Saxo Bank