Three Ways to "Sweeten" Your Portfolio
by Tony D'Altorio, Investment U Research
July 21, 2009
Money can often be made in investment backwaters where few others are fishing for profits. This is in stark contrast, for example, to the technology sector where everyone in the Wall Street community is fishing for the next Moby Dick stock such as Google or Apple Computer.
One quiet backwater of the investment marketplace is the world of soft commodities – coffee, cocoa, sugar, etc. Most investors don't give a thought to these commodities, except when they are drinking or eating them. One such overlooked soft commodity is sugar.
There has been a good bit of excitement this year in the sugar market as sugar has climbed to a multi-year high, at over 18 cents a pound. Sugar has some real solid fundamentals behind it and it looks set to push toward the highest level seen since 1981.
Here is why sugar is no longer a sleepy backwater of the investment world and ways investors can 'sweeten' their portfolio with an investment in sugar.
India Has a Sweet Tooth
When one discusses the fundamentals of the sugar market, the key player in the market is India. India is currently the world's largest consumer of sugar with domestic consumption pegged at 22.5 million tons.
Indian domestic sugar consumption is expected to increase even more in the years ahead due to the rising incomes of Indian consumers. According to sugar broker and researcher Kingsman, sugar consumption will continue to rise as these consumers buy more soft drinks and processed foods.
India also happens to be the world's second largest producer of sugar. A problem has arisen in the past year with Indian sugar output – production has fallen off a cliff. Indian sugar production is expected to fall by 45% to only 14.7 million tons this year.
This estimate on Indian sugar production was recently lowered again due to an expected poor monsoon season. Another key factor in the sharp decline in the Indian sugar crop is the trend of Indian farmers converting to more lucrative cash crops such as rice and wheat.
This decrease in Indian sugar production has led to a rapid drawdown in the country's sugar inventory. India's sugar stocks at the start of the new season on October 1 are estimated at 5 million tons, down sharply from the 10 million tons at the beginning of the current sugar year in October 2008.
This drawdown in India's sugar stocks has forced India to actually import sugar. India - the world's second largest producer and once a net exporter of sugar - is now a major importer of sugar. This is a key shift in the global sugar market!
A Sugar High in Brazil
India is being forced to import sugar at a time when supplies are tight globally: production of both cane sugar and beet sugar is expected to decline this year. The International Sugar Organization estimates that the sugar deficit for this year will be 7.8 million tons, up from a prior estimate of 4.3 million tons.
The world's largest producer and exporter of sugar is Brazil. Brazil's sugar output for export is expected to rise only 170,000 or about 5% during 2008-09 as local producers continue to favor ethanol production. This will keep the sugar market very tight.
The global financial crisis has had a marked impact on the global sugar industry. The crisis has had little effect on the demand side but has done great damage to the supply side. The Brazilian sugar industry has been hit particularly hard because of widespread use of cheap debt to leverage expansion.
Brazilian sugar mills no longer have easy access to credit to export their crop, hedge their crop, and expand their business. The sugar merchant, Czarnikow, said that funding issues for Brazil's sugar industry were “critical”. Funding issues are especially critical for Brazil's smaller sugar mills, which unlike Brazilian sugar giant Cosan (CZZ), have little access to the capital markets.
Sweet Investment Choices
For investors looking to take advantage of the supply/demand imbalance in the sugar market, here are three investment choices that give investors exposure to the sugar market:
iPath Dow Jones – UBS Sugar Subindex Total Return ETN (SGG) – This is an exchange-traded note whose return is based on sugar futures contracts.
Ipath Dow Jones – UBS Softs Subindex Total Return ETN (JJS) – This is an exchange-traded note whose return is based on futures in sugar, coffee, and cotton. The approximate weightings of the commodities are as follows: sugar – 44%, coffee (which has also done very well in 2009) – 31%, and cotton – 25%.
A reminder – ETNs are senior, unsubordinated, unsecured debt securities of the issuer, so there is some additional risk involved as compared to an exchange-traded fund (ETF), which actually holds securities.
Cosan (CZZ) – This Brazilian company has been growing rapidly through acquisitions, as it acquires smaller, struggling sugar producers. The company is now the 2nd largest ethanol producer globally and the largest exporter of ethanol in the world.
More importantly, Cosan is one of the world's largest producers of sugar cane and is the world's largest processor of sugar cane. The rising price for sugar globally is expected to help Cosan post a solid profit for 2010.
With the production of sugar expected to remain in decline for the foreseeable future and the demand for sugar being relatively resilient to an economic slowdown, an investment in sugar should sweeten up anyone's portfolio.