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Tuesday, July 27, 2021

Raw Sugar - Brent Crude Oil - Investment Insights

By Century Financial in 'Investment Insights'

Raw Sugar - Brent Crude Oil - Investment Insights
Raw Sugar – Brent Crude Oil

*Trading in financial markets carries risk and can result in loss of capital
*This performance is only observed with historical backtests and not traded by the company

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The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.

With Brent Crude oil prices increasing steeply for the past year, the ratio of Brent Crude oil and Raw Sugar is currently close to the low. As per the 5-year chart showcased below, the ratio is currently 0.2469, whereas the lowest ratio between the two commodities has been 0.1335.

The accelerating demand for ethanol will lead to lesser availability of sugar, creating a surge in the commodity price, whereas oil prices are on a tight rope as OPEC increases output levels. In addition, the shift to EV across economies is a slow poison for oil prices. Furthermore, India plans to push for a 20% ethanol blend to gasoline as soon as 2023, which may support sugar prices in the long run

US treasury 2-10 year spread US treasury 2-10 year spread

Ratio Between Raw Sugar & Brent Crude
Date: 23rd June 2021
Source: Bloomberg

Trade Rationale.

The strategy behind going long on Raw Sugar & going short on Brent Crude Oil trade is to take advantage of the fact that the ratio may increase. Clients can consider initiating the trade with longer dated futures, to avoid rollover costs.

Oil Prices on Trigger

The global markets have been significantly tight over the past few months with the consistent uptrend in oil prices. Amidst the dispute between KSA and UAE, the OPEC cartel has chosen to boost supply from August 2021 to rebalance the market’s demand and supply dynamics. Collectively, OPEC+ is expected to pump 2 million barrels per day from next month till year end. Altogether, the alliance expects production cuts getting phased out by September 2022.

Oil prices have been reacting negatively due to the increase in supply and the ongoing spread in new delta variant cases. Fears of plummeting demand is once again concerning investors. In news from China, oil imports have sunk to the lowest in two decades in 2021. The country has accounted for 44% of worldwide growth in oil imports since 2015. A reduction in import growth from China could further rupture crude prices.

A Sweet Rally

Investors might want to sweeten their portfolios with a touch of sugar this summer, as prices for the commodity look set to continue rallying. Last year, the 2020-21 season, Brazil exported 32 million metric tons of sugar, around half of global exports. For the current 2021-22 season, the USDA sees those exports dropping by approximately three million tons due to the frost that caused the worst drought in 91 years in the first half of 2021 that has damaged the sugarcane crop output.

In addition to demand for sugar, the demand for ethanol (a byproduct of sugar) also leads to a price rally for the sweet ingredient. Although ethanol demand is correlated with oil prices, as refineries blend ethanol in gasoline to save money when oil prices are elevated. However, the Indian government has initiated an ecofriendly plan to blend ethanol in gasoline to reduce air pollution. India plans to push for a 20% ethanol blend to gasoline as soon as 2023, compared to only around 5% currently. With consumption today at around 27 million metric tons and likely to grow in the future, India will no longer be a major surplus sugar producer and exporter by 2025.

Risks: If the ratio dips lower, the trade may result in a loss.

Disclaimer: It is important to note that Trading pairs is not a risk-free strategy. The jeopardy comes when prices of the two securities move contrary to the positions taken resulting in losses. Thus, it is important to adhere to strict risk management rules when dealing with such adverse situations.

Risks and Assumptions for Back-tested trading strategies
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The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
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The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
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Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
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Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
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The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
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Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
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Unforeseen events can lead to variation in performance from the tested trading strategy.
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The tested result has been computed with price feeds available from Bloomberg.
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The testing environment has not considered transaction or any other costs.
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Trading indicators used for the purpose of testing has been provided by Bloomberg.
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The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Date: 27/07/2021

Arun Leslie John
Chief Market Analyst

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