Sugar: A Sweet Deal For Investors

By John Devcic AAA

Some people estimate that man has been growing, cultivating and eating sugar since 6,000 B.C. Originally, men would chew raw sugarcane in order to taste the sweetness trapped inside. The Portuguese brought sugar to Brazil, and by 1540 Brazil had 2,000 sugar mills. During the 18th century, Europeans built sugar plantations on the Caribbean islands. Sugar grew tremendously and moved from being a sweet treat for the rich to a rich treat for everyone. Today, sugar is a traded commodity like all the other commodities in the futures market - however, the similarities between sugar and other commodities end there. In this article we'll take you through the sweet ins and outs of the sugar market.

SEE: Commodities: Sugar

Sugar Fundamentals
Sugar is grown from two main sources: sugarcane and sugar beet. Sugar beets are grown mainly in the United States and other non-tropical climates. Sugarcane grows mostly in tropical climates, such as Brazil. The majority of the world's supply of sugar is not traded on the open market and sugar is highly subsidized in its country of origin. This can make it nearly impossible to figure out the true supply and demand for sugar. All governments, to some extent, intervene with the production and growth of sugar in their country.

SEE: Your Subsidized Holiday Feast

Estimates from the American Sugar Alliance claim that only about 20% of the total supply of sugar will end up in what is called the "dump market," where huge government subsidies help producers sell their surplus sugar on the open market at nowhere near the cost of production. This dump market is essentially what accounts for the futures market in sugar. The dump market does not include the cost of refining, delivery, transportation or storage.

The exchange where sugar is traded is there to serve two purposes:

  • It is a buyer for every seller and a seller for every buyer.
  • It allows a place for the deliverable sugar to be standardized through futures contracts that can be traded on an open market.

SEE: Futures Fundamentals

Supply and Demand
The best way to start an in-depth look at the sugar market is to understand one of the basics of economics: supply and demand. Since sugar is a crop, there are factors which can hamper the supply of sugar during a particular growing season. Obviously the two biggest factors will be weather and disease. However cultivation, insects and soil quality are also factors that affect the growth of sugar. Just as it is difficult to properly track the supply and consumption of sugar around the world, it can be difficult for a trader or investor to accurately gauge the success of a particular growing season.

SEE: Economics Basics

The biggest demand for sugar is for use in food and food products, and will come from countries that import it to subsidize their needs. As of 2008, Russia, the U.S., the European Union, Japan and China are among the largest importers of sugar. Sugar imports are taken from the dump market. A growing trend is to use sugar to produce fuel in the form of ethanol. As of the early 21st century, Brazil is the world leader in utilizing sugarcane to create ethanol.

Sugar Policy
The U.S. sugar policy refers to the policy of the U.S. government that controls the flow and subsidizes the price of sugar that it purchases from the dump market. There are two major parts that make up U.S. sugar policy:

  • The tariff-rate quota (TRQ) - This ensures that there is sufficient sugar available to satisfy the needs of both producers and consumers alike at fair prices. The TRQ sets a quantity of imported sugar that may enter the country at a lower duty.
  • The price support loan program - Domestic production of sugar is supported by the USDA's Commodity Credit Corporation, which hands out non-recourse loans to sugar producers. Think of the loan program as a floor under market prices. Processors of sugar will receive a nine-month loan with sugar as the collateral. If the processors of sugar cannot sell the sugar at a price greater than the rate of the loan, they can turn over the unsold sugar to the government. This is called forfeiture.

Ways to Invest
Those interested in trading sugar have a few avenues to choose from. The first choice is through the purchase or sale of a sugar futures contract. All futures contracts are standardized, which allows both hedgers and traders to ease their minds about the quality and quantity of the underlying commodity. The need for this type of standardized contract becomes evident when you consider that nearly every country grows its own sugar.

The most common sugar contract is the Sugar #11. The contract months for Sugar #11 are March, May, July and October. Contract size for raw sugar is 112,000 pounds. The minimum price move is one-one hundredth of a cent per pound, or roughly $11.20 per contract. Futures contracts on sugar can be purchased by opening up a brokerage account with a broker that deals with futures.

You can also choose to buy an option on sugar futures. Like standard equity options, there are two benefits to buying these investments. The first is that you are limiting your loss, because you cannot lose more than what you paid for the option excluding brokerage costs. So, if you are wrong on the move of the price of sugar, your loss is only what you paid for the option. The second is that options are usually far less expensive than buying the futures contract outright. Futures can be a very risky proposition for novice or inexperienced futures traders, and options allow some level of protection.

The futures market is not the only way for a trader to profit from a move in sugar. You can also purchase stocks. When it comes to sugar, there are two names to keep in mind: Imperial Sugar Company and Alexander & Baldwin (NYSE:ALEX). Besides individual stocks and commodities, there are also exchange-traded funds (ETFs) and exchange-traded notes (ETNs) that will allow you to add sugar to your portfolio.

The first ETF that follows sugar is the ETFS Sugar ETF (SUGA), which is traded on the London Stock Exchange and is designed to track the DJ-AIG Sugar Sub-Index. When it comes to ETNs, the Dow Jones AIG Sugar Total Return Sub-Index ETN tracks the performance of the sugar futures contract held in the Dow Jones AIG Commodity Index Total Return. This ETN allows you to add exposure to sugar to your portfolio without having to purchase futures contracts yourself.

The Bottom Line
If you are interested in trading or investing in sugar you should do your homework. Understanding the ins and outs of this market can be tricky. With constant government intervention, which can cause wild swings in the price of Sugar #11 contracts, it's a good idea for new investors and traders to start with either stocks or with options on the futures contract.

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