Something to consider: Are you indirectly playing energy by buying sugar and cotton?
As a garments manufacturer you have the choice to fabricate clothing with polyester or cotton, your most likely concerned about the bottom line and will choose the less expensive alternative.  Being that polyester is derived from petroleum and crude oil and is ridiculously expensive you may opt for cotton.
Sugar is not only consumed as a food, but as the world gets greener we will consume more alternative fuels  »  ethanol  »  sugar.

Cotton
2008 has brought renewed optimism to the cotton market with cotton analysts saying December 09’ cotton futures could easily approach or top a dollar a pound. Current prices on the board for that contract are at a 25% discount to that, trading at approximately 80 cents/lb. Let us first say don’t buy cotton tomorrow, but rather look to establish a long in December 08’on pullbacks and have an initial long position on before planting starts, in about 1 month, then look to add to it. Old-crop cotton is in great demand after harvest as mill consumption rises. Once planting begins, however, attention turns to new-crop at the expense of old-crop.

The potential movement higher or optimism in cotton has a lot to do with grain prices. Wheat and soybeans have already made new life time highs and corn is within spitting distance of its high reached in 96’, so I ask if you were a farmer what would you be planting? O.A. Cleveland, a professor at Mississippi State University, said in order to maintain a soybean-to-cotton price ratio of 10 to 1 (the estimated breakeven price ratio between the two competing crops), at soybean prices of around $13 a bushel, “cotton has to be at least $1.10 to $1.15 or maybe even higher.”

Most analysts believe high cotton prices might be more than a fleeting trend. Based on the current supply and demand picture globally, the growing insatiable consumption from emerging markets, and the influx of new money into commodities we expect to see higher cotton and grain prices for several more years. Cotton in fact has room to catch up to other markets as it’s trading 6 cents below the average price we have seen in front month cotton for the last  33 years.

As we have readily pointed out in recent reports, although many of our trade decisions are made based on technicals, do not ignore the fundamentals; ie. supply and demand. The big news from the latest crop report was that foreign stocks fell 740,000 bales while US supplies increased 200,000 bales. In China cotton stocks were lowered 1.5 million bales, and Chinese production from 2007 was lowered by 1 million bales. The National Cotton Council’s early planting intentions survey pegged US cotton acreage just below 9.4 million acres for 2008, down sharply from 10.8 million acres in 2007, and significantly down from 15 million acres two years ago. So stocks are going to be tighter than they’ve been in a long time, and if the market encounters any weather problems, increased fund buying, or larger than projected demand we should see higher prices.

Strategies run from the basic to the complex. The simplest thing one can do is buy December 08’ call options or futures on breaks.  For the more sophisticated traders you could implement bull call spreads or trade old cop against new crop. For front month cotton there is a gap in the chart from October that makes us a bit leery of recommending clients to take a heavy long position as it may be a bit premature. However looking at the December 08’ contract (which is the month we would advise trading) we have been in a 8 cent trading range since August and we’re closing in on the lower Bollinger band and the 100 day moving average which all should serve as support.  Although it is impossible to say exactly where the line in the sand is; perhaps 75 perhaps 72, at current levels cotton needs to be on your radar. On two occasions December 08’cotton had traded below the 100 day moving average in the last 6 months; in August that lasted 4 days and in November for 5 days so we are assuming that a penetration of the 100 day moving average should be short lived. Obviously I need to point out that past performance is no guarantee of future results. Just ask the New England Patriots!

Bottom line with growing open interest in December 08’ cotton in combination with the current fundamentals & technicals we are forecasting higher prices in cotton in weeks and months to come and suggest  you allocate a portion of your commodity portfolio to cotton. Our first target is to re-visit the contract high of 80.56 followed by a push to 90 cents/lb.

Cotton chart:

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Sugar
Again I will play the broken record and advise a long play in sugar #11. 
The two largest producers in the world are Brazil and India and production costs in both countries are about 14 cents per pound and current prices are below that. It is our belief that the two biggest producers will not continue producing sugar at a loss so something has got to give.  Demand for ethanol is growing at a feverish pace, whether you agree with the economics or not. Unless energy prices move considerably south the current economics with sugar at 12 cents/lb do not make sense.  Even though the last 2 years we have had a global surplus in sugar, whispers are starting to be heard that we could have a deficit in 08-09’. So with potentially tight supplies and growing demand this could be a recipe for higher prices.

Brazil currently produces 5 billion gallons of ethanol a year, and the government’s goal is to increase production by more than 50% in the next three years, to 8 billion gallons. Ethanol refiners will demand more sugar but farmers will not continue to produce below production costs. This is the story domestically in Brazil but over and above that ethanol exports to the US, Japan, and China are increasing.  Demand for ethanol is growing globally as governments are increasing the amount of ethanol that can be mixed or blended with gasoline. 

In India the government sets an artificially high price that millers have to pay to farmers so essentially the millers are loosing money when sugar prices are low.  Because of the three year growing cycle in sugar and the fact that prices have lost roughly 50% of their value since the 06’ highs, we expect less sugar to be produced in India which accounts for approximately 18% of world production. If we are correct with this assumption prices should rise, but understand if buying sugar one must have a longer time horizon. In the past, when sugar started rising from a price below production, it rose 100% or more, on average. That being said 20 cents/lb seems like a fair estimation.

You could approach sugar from the long side with either futures or options as the options presently appear fairly priced and the current margins are not yet excessive in our opinion, which is tough to believe because sugar is traded in NY. The key here is to get some time and allow the trade to work which for stock investors should hit home with the old adage of BUY and HOLD.  Currently, October futures are trading just above 13 cents/lb and are ripe for a correction which is supported by technicals and the fact that February is typically not a strong month for sugar.  A well capitalized trader could buy futures on pullbacks but not with both hands just yet. More conservative traders could start to look for entries in longer dated call options or use put protection against long futures.  We would suggest being cautious as sugar prices could pullback 100-200 points without doing any long term damage to the charts. All things considered we are o.k. advising a long entry even though a 200 point correction would be a move of $2240 against you per contract. Nominally this is the same as wheat moving 45 cents or gold moving $23 against you which both have happened in recent weeks in a 24 hour time frame. Other words the reward we feel is worth the risk but you need to make that assessment yourself. In the front month on weekly charts sugar is bumping up against resistance of 12.80 with next resistance just above 14 cents/lb with stochastics at a reading of 77.  Looking at a longer time frame; the monthly chart appears prices have a lot more potential upside and with a penetration of the 06’ high of 19.73 the next significant resistance is not found until 28 cents/lb.

Our target for sugar in 08’ is 15.50/16 and 20 cents into 09’. We understand this is not the first or last time you have heard this but the goal of this brief article is to spell it out once again and show an investor that is willing to take a risk how to potentially capitalize on a trend of higher prices in agricultural and soft commodities that we feel has legs.

Sugar chart: