Sugar prices have finally found their bottom, as the market uncouples from the ever-weakening Brazilian real, Morgan Stanley said.
"We think sugar prices are unlikely to revisit their seven-year lows from August," said the bank, forecasting that demand will outstrip supplies in 2015-16, which began at the start of this month.
Raw sugar futures rallied in New York last week, as the front-month contract reached four-month highs.
Last week speculators increased their positive bets on the price of sugar to the highest level in 14 months, indicating a shift in investor sentiment.
Unsustainable pricing
Brazil is the world's biggest sugar exporter, and weakness in the currency has weighed on raw sugar markets.
A lower real means the sellers will accept lower dollar-denominated prices for their sugar, as their dollar cost of production falls.
But Morgan Stanley points out that sugar prices have fallen further than the real.
"Prices at the August lows near 10 cents were unsustainable for global production in the long run, a fact that seems unlikely to change with further real depreciation," Morgan Stanley said.
Fuel policy
Pegging expectations of this season's deficit, the extent to which supply outstrips demand, at 3.7m tonnes, Morgan Stanley noted the effects of fuel policy in Brazil.
Sugar recently got a boost from the news that Petrobras, Brazil's state owned energy company, would be lifting gasoline prices.
This encourages consumers to favour ethanol fuel, which encourages mills to divert cane to ethanol production, reducing sugar production.
"To meet the demand, mills have been diverting more of the cane crush toward ethanol and away from sugar production, lowering the year-to-date sugar mix to the least since 2008, in line with our forecasts,"
And there are also expectations that an additional tax levy, on top of higher Petrobras prices, could increase ethanol demand.
The tax has is being mooted as Brazil struggles to contain its government overspending.
Indian dryness
And Morgan Stanley downplayed the effects of potential changes to Indian export policy, which could mandate mills to export 4.0m tonnes of sugar, weigh on global prices.
"With Indian sugar exports uneconomic, the Indian government's announcement last week that exports would not be subsidized in 2015-16 lifts much of the overhang on sugar market sentiment related to the uncertainty around the mandate," the bank said.
Morgan Stanley noted that Indian supply was being squeezed by dry weather, irrespective of the export policy.
"The trajectory of India's production is more important to the global supply and demand picture than India's export policy."
Morgan Stanley's comments come as Rabobank notes a "growing consensus" that sugar production will fall short of demand in the 2015-16 sugar season.
Rabobank maintains its own forecast for the sugar deficit demand, of 4.8m tonnes.
"Looking purely at the fundamentals, it seems like the worst of the current down cycle could be past," Rabobank said.
El Nino boost
This year's El Nino effect has added risk upside to sugar prices.
The effect is associated with heavy rains in the Americas, and dryness in the western Pacific.
Rains can disrupt harvest progress, as well lower the sugar content in cane, while dry weather threatens the growth of next season's cane.
"There is clearly scope for further weather worries to impact production and price expectations in the coming months," Rabobank said.
Source: www.agrimoney.com