Macquarie Agri-view Long liquidation adds downside risk, but also opportunities

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Macquarie Agri-view
Long liquidation adds downside risk,
but also opportunities
Feature article
 Funds are taking risk off the table. We look at which soft commodities have
suffered most from long liquidation in the current macro uncertainty and which
ones remain vulnerable to a further bout of selling. The liquidation to date is
still nothing compared with what we saw in 2008. While macro fears are
certainly spooking investors, at some point individual market fundamentals will
reassert themselves and some commodities will be seen as good value.
Latest market update
 Sugar: Carrying the burden of having a large non-commercial net length,
sugar futures are suffering from long liquidation. Following the October expiry,
the forward curve has flattened, with the May contract likely to reflect exports
from the bumper crops that will soon start getting harvested in India and
Thailand. Indian mills are lobbying the government to let them export up to
4mt in order to avoid domestic prices from collapsing due to the surplus;
however, crushing may be delayed due to cane price negotiations. Lower
prices should attract some Chinese buying, as they seek to rebuild depleted
inventories and control runaway cash prices. Also, as prices head toward the
low 20’s c/lb, questions will start emerging on whether Brazil will switch
toward ethanol production, which is still very tight in the domestic market.
 Coffee: NY Arabica suffered immensely from a stronger US dollar and risk
aversion. It has now completed a 50% retracement of this year’s 11-month
rally, which may lead to a technical bounce. With little origin selling and funds
net short again, it may spur a short covering rally. London Robusta was the
worst performing commodity within the Ag space, falling 22% in 3Q in
anticipation of a record Vietnamese crop due to be harvested from next
month. Rains finally arrived in Brazil, providing relief to the recent drought and
in time for flowering of the next bumper crop due mid-2012. Until then,
however, we still expect a physical shortage in arabica, with Brazil’s coffee
exports in September down 9.8% year-on-year and certified stocks down to
1.43m bags.
 Cotton: Having withstood the sharp sell-off that other commodities suffered,
cotton futures remain stable. Mill and commercial buying appears every time
prices dip below 98c/lb. In the next WASDE we expect US output to be
revised lower, although demand estimates will stay weak. The US harvest is
18% underway, with 80% of bolls now open (compared to 75% last year).
Less than 30% of the crop is considered good/excellent, compared with 59%
last year. Chinese cotton cloth output in the year-so-far is down 5.8% YoY.
 Cocoa: With large net short positions in both London and NY, funds are
clearly bearish this market. Departing from initial suggestions by pod counters
that the West African crops would be worse than last year, latest views point
to a crop setting that is similar to last year’s. Favourable weather, perhaps
due to La Niña, suggests that this could lead to a possible repeat of bumper
yields – and this is weighing on prices. The Ivory Coast has announced
reforms to the cocoa sector for 2012/13, involving fixed prices that will help
farmers re-invest in plantations in the coming years.