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Bitter Pill: Is Sugar Industry headed for a Down cycle?

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Just as the world was witnessing a gradual recovery, over the last year, from the worst crises after the Great Depression, the asset class which clearly stood out and could be easily termed as a star performer for the FY 2009-10 is Sugar as a commodity.

Sugar – As the best performer? Na…A jackpot by no means for its Consumers but for its investors in this commodity-class or probably even stocks of companies involved in manufacturing of the white sugar. The price of sugar has moved up – from Rs.20 per kg a couple of years back to Rs. 50 per kg just two weeks back – on the back of demand supply mismatch in this commodity over last year.

The Bitter Tale of Sweet Sugar

However, after witnessing a huge upsurge, the sugar prices have turned bitter for a major part of last couple of weeks on the back of sharp downswing in the international prices. The sugar prices in the international markets had witnessed a peak of $740 per tonne this year.

Over the past week, the sugar prices have seen a correction of about $30. While the over-all slump from the peak price-point stands at around sharp 20% off from its peaks at sub-$550 per tonne, triggering a panic amongst traders and speculators holding long positions in the commodity or sugar stocks.

Has the Down Cycle Begun?

India remains the world’s largest consumer of the sugar and hence largely affected by the fluctuating tales of this white sweetener. At the same time, India’s policy initiatives and consumption pattern of the sugar also has a volatile bearing on the international prices of sugar as a commodity.

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Charts Courtesy: Business Standard

As per an article in the Economic Times,
“Local sugar supply estimates for 2010-11 surged to an estimated 26 mt —two million tonne higher than the annual domestic consumption, indicating that India’s import dependency in the coming year would be virtually nil.”

This indicates a scenario of marginal supply-side surplus over the domestic demand scenario for the up coming year. In other words, it could be a pointer towards self-sufficiency in demand-supply equation for the world’s largest sugar consuming nation.

Thus, improving demand-supply equation in the domestic sugar market, which would result into lower dependency on imports, is one of the prime reasons for softening of the international prices of the sugar as a commodity.

As in any asset class which allows build-up of speculation, the volatility usually lasts for a longer period and occasionally even over-stretched in reply to relative fundamental shift in the asset class. Thus, even speculators have played their own role to play in dragging down the commodity prices sharply due to initial fears of a possible negative turnaround in the prospects for the sector going forward.

India is the biggest producer of sugar behind Brazil. Additionally, India is also the biggest consumer of sugar in the world. This could internally lead to local realignment of sugar production based on the consumption pattern of the domestic economy.

In a way, this directly affects the production output of sugar from India which forms a substantial chunk of global output as well. In fact, the woes for sugar prices is further fuelled by expectations of better crop output from the world’s leading producer Brazil.

Policy Initiatives for Sugar Industry

Until now the government had extended the duty free regime on the import of raw sugar up to March 2010 in order to combat the rising prices of sugar domestically. The government had given permission to private traders to import refined sugar at zero-duty with quantitative restrictions. This measure was initiated in order to augment domestic supply of sugar and consequently keep sugar prices under the check.

As per the official of Indian Sugar Mills Association (ISMA) as quoted by Economic Times,
“We have urged the government to re-impose import duty on white sugar at the earliest as our survival is at stake. Sugar is being offered at the Kandla port at Rs.30, 000 per tonne and there are no takers. World prices are also nose-diving, signaling the end of a profitable cycle.”

By above, the ISMA provides to convey the government that with sudden fall in prices of international sugar prices and the prevalence of zero-duty structure, the domestic sugar prices needs to be shielded by the sharp fluctuation in global sugar prices by way of import duty on sugar thus ensuring that domestic output remains competitively priced against cheaper imports.

Domestic production price for sugar are slated to be around little over Rs.35 per kg leaving little margin of profit for home producers on their refined products. Currently, the domestic prices are prevailing around Rs. 42-44 after sharp price correction witnessed in last couple of weeks.

To sum it up, the prospects of softening consumption demand and improving production estimates from India, better production estimates from leading producer Brazil and softening of international prices globally has led the analysts to debate in open as to whether the down cycle has actually begun in the global sugar industry.

The stock price of leading Sugar companies like Bajaj Hindustan & Shree Renuka Sugars have slumped to over 35% from their peak prices on the back of speculative built-up in these counters fuelled by higher commodity prices over the past year.

My Views on Sugar Industry

The Sugar industry may not be actually headed for yet another down cycle so soon. The industry has just come out of the slow down since last couple of years and may not settle for yet another down cycle so soon. The consumption has increased over a period of time and with increased prices even the production has received quite some fillip on the back of smarter prospects of returns on the farmer’s produce of cane over last two years.

However, the over-heated prices of sugar may seek some sort of consolidation and small sharp corrections as we rightly witnessed more recently. In fact, the correction seems healthy in nature for both consumers and producers as it seeks to check the over built-up of speculative positions in the prices of sugar.

My view is that the sugar industry may be headed for a down turn at a later date, but not now. Roughly, over a span of next 1-2 years, once the prices of sugar stabilizes at higher levels and the producers get handsome remuneration and enough encouragement to further augment the production of sugar, the softening of prices may be the call of the business cycle next up.

A bitter pill in form of softened sugar prices is better bet at least for a while? What say?

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