Sweet Profits in Sugar?

August, the eighth month of the year, is the last month before the traditional harvest time in the Northern Hemisphere. Thus, the old saying was “If the 24th of August be fair and clear, then hope for a prosperous Autumn that year.”

So far, the month of August has been very fair and clear for the stock market…and for the commodities markets. These buoyant trading days of early August continue last month’s bullish action in both the stock and commodities markets.

But as we approach the harvest season, my thoughts turn first to the rumblings in the grain pits. Agricultural commodities have been rallying strongly for several weeks. All the farm goodies enjoyed a nice jump after falling fairly sharply during the early part of this year.

These strong agricultural prices have been helpful for most of the “ag-focused” stocks I have recommended to the subscribers of Mayer’s Special Situations. The ag plays I favor focus primarily on fertilizers or irrigation equipment.

Sugar, is another agricultural product worth paying attention to. I think we’re in good position for another big sugar rally. I’ve been doing a lot of work on Brazil lately, in preparation for my upcoming trip there. And while I knew Brazilian infrastructure was poor, my research really hammers home to me just how bad it is. What does this have to do with the price of sugar?

Well, Brazil is a big sugar producer. Apparently, there are 122 ships sitting around in Brazilian ports waiting to load sugar for export. Some trucks are waiting as long as 40 hours to unload their cargo on these ships. What a mess! It makes me think of what Peter Fleming wrote in Brazilian Adventure, “A man in a hurry will be miserable in Brazil.” You need a lot of patience to operate in this market.

Heavy rains have something to do with it. Ports have stopped loading, to try to minimize water damage. In any case, the sugar coming out of Brazil may be less than normal. I listened in to comments by Cosan’s CEO (Cosan is a big Brazilian sugar refinery) and he thought there would be less sugar produced this year than the year before.

Another factor to add into this: India’s monsoon season had about 16% less rain than normal for June. India is a big producer and consumer of sugar. This is not a good sign for the sugar crop there.

Inventories of sugar are already pretty low. F.O. Licht, a firm with a 130-year history in commodities, reported that the Philippines, India, Pakistan and Indonesia are “virtually out” of sugar reserves.

No surprise, then, that speculators are loading up on sugar again.

A recovery in sugar prices would likely aid stocks like Imperial Sugar (NASDAQ:IPSU), which took a beating in its last quarterly report as sugar took a big dip. In coming quarters, this may well reverse.

By the way, the performance of coal is worth noting. We’ve talked about China’s voracious appetite for coal, in particular the metallurgical coal, used in making steel. It can’t make enough to satisfy its own demand.

This next chart makes that really clear:

China Coal Balance

China has a yawning gap in met coal, and those blue bars on the chart show you how much it’s had to import. This is likely a long-term and permanent gap. So I expect there will be good opportunities in supplying China with met coal in the years ahead.

One other interesting note in this admittedly brief and haphazard commodity survey: Palladium may be giving off a clue. Over the weekend, I read an interesting letter by John Clemmow at UBS, who put forward a novel idea about the relationship between palladium and gold.

Palladium is an important industrial metal. Lately, it’s become more exciting, because it is the key metal used in diesel engines. These engines are selling strong because of demand from emerging markets – a trend expected to continue for years. Along with this, Russia is, apparently, close to exhausting its stockpiles of the metal. But no one knows for sure, as such stockpiles are state secrets.

In any case, palladium is a market that appears to be in surplus. This is a trend that doesn’t seem likely to end anytime real soon. Mine supply is not likely to decline. If anything, it will rise. Plus, there is a lot of palladium in stock.

Yet palladium rose recently to $488 per ounce, the highest price since June 23. This is in sharp contrast to the gold price, which is down. Clemmow notes, “Gold…can be many things, but as I’ve pointed out before, [it] only massively outperforms in a climate of fear. Palladium is – to me – the ultimate risk on metal trade. If it is going up, then so should the price of other risk assets.”

Clemmow finds that a palladium-gold ratio tracks the stock market closely. “The news that palladium is rising while gold is falling is just another signal that risk is coming back to the market.” Here is his chart:

Palladium vs. Gold

As I say, it’s a rather novel indicator, another measure of fear or lack thereof. Right now, it shows fear receding and risk assets rising. Clemmow’s indicator says stocks are headed higher. We’ll see.

In the meantime, there are many curious wrinkles in the commodity markets these days and lots of opportunity. It’s a great unfolding drama with never-ending twists and turns. Forced to hazard a guess today, I’d bet August is very sweet for sugar and that agricultural commodities in general continue to lead the pack.

Chris Mayer
for The Daily Reckoning

The Daily Reckoning