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Bulls Are Buzzing Over the Sweet Sugar Rally!

Fundamentals

Sugar futures continue their relentless surge higher, reaching highs not seen in 28 years, as the seasonal monsoon rains in India have been disappointing. This lack of moisture is causing some forecasters to lower the estimates for Indian Sugar production to as low as 15 million metric tons, down from earlier estimates of nearly 20 million metric tons. The potential production shortfall is causing analysts to raise India's potential Sugar imports closer to 7 million tons, up between 2 and 3 million metric tons from earlier estimates. This looks to be the second consecutive season in which Sugar output has failed to keep up with demand and higher prices are needed to help ration demand. There has been little commercial selling of Sugar lately, despite multi-decade high prices, as tightened credit conditions have kept some producers from initiating selling hedges. This has eliminated a natural seller from the market that would have normally emerged during the current rally. Commercial buyers who need to purchase Sugar have to pay higher cash market prices for immediate needs while they await supplies from Brazil in the coming weeks. Speculative traders, especially commodity funds using trend-following systems, have been adding to their long Sugar positions as prices rise. The Commitment of Traders report shows large non-commercial traders added an additional 16,982 net-long contracts, which raised their total to a whopping 205,857 net-long contracts as of 7/28/09. Despite these seemingly bullish fundamentals, traders should be wary of potentially violent price corrections, especially as the market begins to move parabolic. This is especially true should the rains return to the cane growing regions of India and those who are long Sugar begin to look for the exits.

Trading Ideas

Given the sharp rise in volatility that has occurred during the past several sessions, Sugar options have become more expensive. Anyone that may be considering trading Sugar may possibly wish to investigate either bull call spreads, if they believe the market will move higher -- or bear put spreads, if they are expecting a price correction. One of the advantages of these debit spreads is that the strike price sold can help to offset the price of the options purchased. The downside is that the maximum profit is capped by the strike price of the short option. An example of a bull call spread would be buying an October Sugar 21 call and selling an October 25 call. An example of a bearish put spread would be buying the October Sugar 20 put and selling an October Sugar 17 put. The premium paid is the maximum potential loss on the trade, while the maximum profit is the difference between the long and short strike prices, minus the premium paid for the spread.

Technicals

Looking at the daily chart for October Sugar, we notice that the upward move in prices accelerated sharply this week. This up-move comes after two prolonged consolidation periods which served to shake-out weak longs. However, this may also mean that the rally is getting a bit overdone, especially with the 14-day RSI reading a very overbought 83.92. A correction back to the 18.00 to 19.00 area would not be out of the question nor negate the bullish technical trend. 21.00 is the next resistance point for October Sugar, with the 20-day moving average currently near 18.45 acting as support.

Mike Zarembski, Senior Commodity Analyst