A Trade as Sweet as Ethanol
The Brazilian Mills Have Voted
Another week, another stalemate between the rock and the hard place that is Hormuz. In spite of what looked like some slight movement over the weekend by the Iranians towards a negotiated settlement, the gap between the two parties remains. Iran now appears willing to trade control over Hormuz for peace and a lifting of sanctions. They made overtures towards reducing their nuclear ambitions, but appear to want to lock in the ceasefire before negotiating for the full removal of their stockpile and the exact timing and level of enrichment. Trump, seemingly emboldened by the Rimland strategy of blockade and interdiction, appears resolute that it must be a package deal and that no quarter will be given on the two key questions we laid out last time: freedom of navigation and a non-nuclear Iran. By keeping a lid on energy prices while the stock market rips, he has earned himself trade space to push for a resolution closer to his stated goals.
What we might call in trading a position that is “positive carry, positive convexity,” meaning one where the status quo works for him, while exposing him to asymmetric gains. Particularly after having used the ceasefire as justification for not triggering the 60-day war powers review that would tangle his plans in congressional meddling.
Whether or not this status quo holds is anyone’s guess. To us it appears equally likely at this point that we will see some sort of escalation as movement towards a sustainable peace. Meanwhile, every day the strait is closed, global energy and food markets get tighter and tighter. Every day fertilizer remains dear is a day that less of it goes onto crops, which in turn reduces yield further, which in turn raises medium-term expectations for prices.
Next time, we’ll likely go deeper on the inflationary pressure we see coming on the horizon, pressure which led us to sell a bit of longer-term duration towards the end of last week (a position we may add to if bonds rally this week). We’ll also start looking at the impacts on emerging market debt and currencies we see particularly exposed to this witches’ brew of acceleration and inflation (we’re looking at you, India).
Today we’re going to dive into one leg of our cascade trade, the one which is playing out as we speak: the impact of high energy prices on the market for sugar, through a single, critical linkage. Brazil.
As opposed to prior pieces, this one is going to be relatively straightforward, and hopefully not too long.
The story is simple. Brazil dominates world production of sugar, and it looks like substitution demand for ethanol on sugarcane (the raw material that acts as feedstock for traded sugar) will entirely consume the “production surpluses” that were consensus a matter of months ago. When combined with the smaller impact of Indian ethanol substitution, and the potential shock from an El Niño with below-average rainfall, we remain bullish on sugar.
