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Oct. 21, 2005

Sell/Short Sugar
As energy prices have surged during the last few years, the idea of a gigantic bull market in Sugar has been promoted by a number of commodity analysts. Sugar, no longer just a sweetener, is more and more being converted into ethanol for use in internal combustion engines, and consequently the basic supply-demand equation for this commodity is said to have changed....Most lately, there is a lot of talk about Brazil (the world's largest producer & exporter) diverting more and more of its crop to biofuel for use within its own borders, thus serving to drive world prices higher....While this may be true, I believe this market is a big candidate for a major sell-off. My reasons, in this case, are essentially technical and the best way to explain them is to show you (which I'm sure will put many of you to sleep).
As I recently pointed out in the Gold market, Open Interest is the total number of longs (buyers) and shorts (sellers) in any futures market. Like the markets, a chart of Open Interest never moves in a straight line, but instead rises and falls as traders enter and exit the markets over whatever period of time you want to examine....What stands out on the first chart below is how the number of players in Sugar has exploded over the past few years, notably most sharply so during the last six months. This recent surge in Open Interest had pretty much come on the coattails of the energy markets as traders jumped on the Oil-is-going-up-forever bandwagon, surmising that Sugar should be going along as well....
Per Commitments of Traders as of 10/18/05, there are now 268,176 speculative longs in Sugar as opposed to just 56,952 speculative shorts, which is something of an "overload". While this does not mean Sugar has to go down, when taken together with tendency of Open Interest to rise and fall in any futures market, it certainly suggests the strong possibility of some sort of long liquidation induced sell-off similar to what I think is beginning to take place in the Gold market....
Take a look at what I'm talking about....And remember, the bulk of this buildup is due to speculative longs...
This next chart views Open Interest on a daily basis going back to March of this year. This may get a little too technical for some of you but what I am noting here is the recent move from 10 to 11 cents and the fact that Open Interest was actually declining as this move was taking place. This is important in that when you have an upward price move, it is obviously due to buying pushing that market higher...However, if Open Interest is falling during that price rise (as is the case here) it can usually be attributed to Shorts giving up and getting out, as buyers, not NEW buying coming in...Where anything can happen in the futures markets, this sort of thing is what does occur at the end of many bull markets, i.e, the shorts finally give up and then the market turns south....The next thing you see is buying coming in again (open interest rising) but the market doesn't really go anywhere, which is what you can observe as the market now sits here in the 11.50 to 11.75 area.
Next....Volume....In a classic bull move, as prices rise, volume (total contracts traded) should be doing the same. What stands out very clearly on the next chart is how prices have recently accelerated but volume is sliding at the same time. In a nutshell, this also suggests the market is running out of steam, that all that is maybe holding this market up now is "the story", NOT strong demand.
It goes without saying there are no absolutes in futures trading and that everything I have cited here may see the market go higher anyway. In fact, if I am wrong, I believe I will be VERY wrong, in which case this is great set up for the "2 & 1 thing". To me, Sugar is either about to really bust out and suddenly be at 13 1/2 or 14 cents, OR, it's going to fall out of bed....With the tremendous buildup in Open Interest, the last thing I'd now expect is sideways, or a creep along in one direction or the other....I have to say the same reason I generally stay away from this market is the same reason (among these other) I am now interested in it: Sugar is usually quite erratic....It can be moving along smoothly, looking quite "orderly" in what it is doing, then, "Boom", it suddenly reverses in the opposite direction, in a BIG way....Which is what I am expecting now....I look for a minimum of 2 1/2 to 3 cents on the downside, taking the March contract shown below to 8 1/2 to 9 cent area.
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Bill Rhyne
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