Looming Sugar Shortage Launches Sugar ETFs

On Friday, concerns over future supplies of sugar pushed prices up to their highest levels since November 10th as inclement weather in the US and declining output in Brazil pave the path to projected shortages on the supply side of the commodity. 

Mother Nature is delivering one of the coldest weathers in the past decade throughout parts of the United States causing freezing temperatures in Florida to severely damage sugarcane crops and limit future production of sugar. 

Further supply concerns have been fueled by recent data coming out of Brazil, the largest per capita sugar producing nation in the world.  According to Unica, a sugar industry group, sugar output in Brazil’s largest producing region declined by 18 percent in the second half of November from a year earlier and production is expected to continue to decline in the coming months. 

Thirdly, a supply shock has started to form due to a judicial ruling which threw out the United States Department of Agriculture’s approval to use genetically modified seeds to produce sugar-beet.  According to the USDA, this could potentially hinder U.S. sugar production by nearly 20 percent as that genetically modified beets have come to account for 95 percent of the U.S. sugar-beet crop in the past five years and the abstinence of these seeds will force the use of traditional sugar-beet seeds, which make current surpluses of sugar-beet seeds highly susceptible to depletion.  In fact, the USDA anticipates that a shortage of traditional seeds is likely to cut 1.6 million tons from next year’s sugar-beet crop.   

In a nutshell, global demand for sugar continues to rise as production faces headwinds pushing prices of the sweet, edible crystalline carbohydrate higher and is likely to keep prices elevated in the near term. 

One way to play sugar is through the iPath DJ-UBS Sugar TR Sub-Idx ETN (SGG) which tracks an index that intends to reflect the returns that are potentially available through an unleveraged investment in the futures contracts of sugar as well as the rate of interest that could be earned on cash collateral invested in specified Treasury Bills.

A second play on sugar is through the PowerShares DB Agriculture Fund (DBA), which is a more diversified commodity play than SGG and gives exposure to a broad base of soft commodities.  DBA tracks an index which is a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodities.  Furthermore, DBA allocates 12.5% of its assets to sugar futures contracts.

A third play on sugar could be the UBS E-TRACS CMCI Agriculture TR ETN (UAG), which seeks to replicate the performance of an index which measures the collateralized returns from a basket of 10 futures contracts representing the agricultural sector. Furthermore, the commodity futures contracts that are held are diversified across three constant maturities from three months up to one year.  In regards to weightings, UAG allocates 20.86% of its assets to sugar futures contracts.

When looking at trends, SGG has been in a clear cut uptrend since the lows in May and it appears that it is about to take out its November highs. DBA shows a very similar pattern as it rallies from its lows in June. UAG also displays a similar pattern although the lack of volume creates dots and gaps on the chart so we would be more comfortable using the more actively traded SGG or DBA as our sugar trading vehicles.

From a risk perspective, the aforementioned ETFs and ETNs carry the inherent risks and volatility that can be found in almost all commodity driven securities.  Of the risks involved, one of the most important to be mindful of is contango.  This phenomenon prevails when the futures contract’s prices are being traded at a premium to the spot price and decline over time.   Lastly, when dealing with SGG and UAG, it is important to keep in mind that these are debt structures and carry an additional credit risk that the issuer behind the ETNs could default.  To help protect against these risk it is important to utilize a strategy which helps identify when an upward trend could come to an end.  A quick check at shows potential problems in store if SGG breaks below $84.77 or if DBA breaks below $29.75.

Disclosure: No positions

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