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Sep 18, 2006

Sugar's smart money proved foolish in 2006 commodities collapse

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When the world's smartest investors earlier this year said buying sugar was the easiest way to make money in 2006, they would have been better off buying stocks in Jordan where the Amman SE General Index is down 23%.

Andreas Meyer, who helps manage $200-million at Merit Alternative Investments GmbH in Vienna, said last March that sugar would rise another 40% after it doubled to 19,90 cents a pound over the previous 12 months. Michael Coleman, managing director in Singapore for Aisling Analytics Pte., who was just as emphatic back then, now says his assumptions “have proved wrong.'' He and Meyer won't go near sugar for at least the rest of year because they say it would lose them more money.

Sugar fell 34% from March 31 to the end of August, the biggest five-month drop since 1999 on the New York Board of Trade. The swoon is part of the commodity market's worst quarter since 1981, as measured by the Reuters-Jefferies CRB Index. What went wrong was that unexpectedly benign weather led to bumper sugar crops in Brazil and India, and a drop in gasoline prices reduced demand for alternative fuels that use sugar as a staple.

“The cyclical story in commodities is behind us,'' said Jack Ablin, chief investment officer at Harris Private Bank in Chicago, which manages $50-billion and sold its 2% investment in commodities this year.

Prices for hard assets from crude oil to New York apartments have fallen this year as central banks in the US, Europe and China raised interest rates to rein in inflation.

Financial investments are gaining amid forecasts that inflation in the European Union and US will be subdued.

The US economy, the world's largest, will expand 2,9% next year, rather than the 3,3% anticipated earlier, the International Monetary Fund said Sept. 14. That would be the weakest since 2003. World growth will slow to 4,9% in 2007 from 5,1% this year, the IMF said.

The European Central Bank and the Bank of Japan have signaled they're ready to push borrowing costs higher, while the US Federal Reserve last month paused after increasing the benchmark overnight lending rate at 17 straight meetings to 5,25%.

“It would be reasonable to think that non-oil commodity prices will not sustain the level we see today,'' IMF Managing Director Rodrigo de Rato said in a Sept. 12 interview. Oil prices will stay “relatively'' high, he said. Sugar's decline this year stemmed from a mixture of good weather and classic supply and demand. Brazil, the world's biggest grower, had a record crop, and India, its closest rival, may follow suit. At the same time, high prices led buyers to seek alternatives or curb purchases. Demand for ethanol, a fuel made from sugar cane, fell as gasoline declined.

“The supply response has been bigger than expected from India, Brazil and Russia,'' Coleman said.

Favorable weather has hurt other commodities. Corn and soybean prices have dropped 17% since peaking July 12 after fields from Nebraska to Kentucky received as much as three times the normal rainfall in August. Cooler US temperatures drove natural-gas prices to a two-year low last week when demand for air conditioning waned. Crude oil plunged as concern eased that hurricanes may disrupt Gulf of Mexico supplies.

“If there are any lessons to learn, it's that commodities are volatile,'' said Christopher Wyke, who helps manage Schroders Plc's $100-million commodity fund in London.

Sugar prices have fallen so much the state of Louisiana sent Dane Revette, the director of energy development, to last week's OPEC meeting to pitch the idea of plowing under sugar farms to build an oil refinery. Sugar ended last week in New York at 13,12 cents a pound.

“We are in a correction phase for sugar that could go on until the end of the year,'' said Merit's Meyer, who set up the Commodities Opportunities Fund in January. “It was speculation that killed sugar prices. I still think that sugar will outperform bonds, stocks and oil, but over two to three years.''

At C. Czarnikow Sugar Ltd. in London, the world's biggest sugar broker, there's little demand as the new Brazilian crop floods world markets.

“They're not even half-way through the current export program,'' said Peter de Klerk, an analyst at Czarnikow. “This problem is not going to go away in the next week or two. You would imagine a pullback would invite buying, even from some speculators. It just hasn't happened.''

Jim Rogers, the author of “Hot Commodities,'' is staying bullish. He says sugar is still about 85 percent below its record and that demand for cane to be converted into ethanol as an alternative to gasoline will keep prices rising.

“I never heard of a bubble when something is 85% below its all-time high,'' Rogers said last week in an e-mail.

“I have certainly often said and still say sugar has a long way up to go over the next 10 to 15 years, but have always cautioned that it is rarely good to buy something that has tripled in two to three years.''

The CRB index is down 11% since the end of June, heading for its biggest drop since the three months ended June 30, 1981. The index is down 7.5 percent so far this year and about 2,6% from 12 months ago. Investors in the energy- weighted Goldman Sachs Commodity Index have lost 6,2% this year.

In the 19-member CRB, 10 commodities are higher and the rest have dropped. Gold has risen 14%to $558 an ounce in New York, after peaking at a 26-year high of $732 in May. Crude has increased 6,1% to $65 a barrel after peaking at a record $78.40 in July. Singapore rubber is little changed, after plunging 35% in the past three months.

Gold may slide to $550 and oil below $60, said William O'Neill, a partner at the commodity research firm Logic Advisors LLC in Upper Saddle, New Jersey. He's the former head of futures research for Merrill Lynch & Co., the world's largest securities firm.

“We're going through a catharsis,'' O'Neill said. “From a speculative standpoint, I'd like to see prices stabilize before buying.''

“There is more downside potential,'' said Brent Harris, 46, who runs the $14-billion Commodity Real Return Strategy Fund for Pacific Investment Management Co. in Newport Beach, California. His fund is tied to the Goldman Sachs index and has lost 4,8% this year.

As in sugar, demand for other commodities is slowing because of high prices. Record copper costs are leading builders to use plastic rather than metal pipes. In oil, the number of miles driven by the average American is falling for the first time since 1980, according to Ben Dell, an analyst at Sanford C. Bernstein & Co. in New York.

Buying oil “has been a great trade for three years,'' Dell said. “People don't want to let that go.''

Between 1970 and 2000, rallies in commodities markets lasted about three years, with prices rising 45%, said John Normand, global currency and fixed income strategist at JPMorgan Chase & Co. Slumps would last the same period of time, with prices falling 42%. The current rally has lasted 51 months with prices rising 171%, he said.

Some bulls aren't giving up simply because sugar has dropped and oil and metals are retreating.

The decline in sugar prices “is an instructive lesson on how volatile commodities are,'' said Hilary Till, research associate at the Nice, France-based EDHEC Risk and Asset Management Research Centre. “The current bull-run in commodities will be over when an adequate supply cushion emerges for oil, brought on by changes in consumer behavior and greater use of alternatives. That hasn't happened yet.''
Edited by: Bloomberg
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