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A rally in the Brazilian real has prompted a scramble to cover bearish bets on the coffee and sugar markets by hedge funds, leading to a sharp rebound in both commodities.
“Funds and other speculators have been buying out short positions due to trend changes in the Brazilian real,” said Jack Scoville at brokers Price Futures Group in Chicago.
Brazil is the world’s largest producer of both commodities, which have always been closely correlated with fluctuations in the country’s currency.
This is because both coffee and sugar are traded in the US dollar. A lower real encourages Brazil’s farmers and exporters to sell more and maximise their returns while a stronger real means that they will refrain from selling as they will receive lower returns.
Over the past year, hedge funds and speculators have taken the cue from the currency markets, increasing their bearish positions against both the coffee and sugar markets to record levels as the real has weakened, battered by the rout in emerging market assets and political uncertainty. Increased supplies from good crops have also weighed on both the coffee and sugar markets.
However, Brazilian markets earlier this month have been cheered by a better than expected result for Jair Bolsonaro, the far-right former army captain, in the first round of the country’s presidential elections. Mr Bolsonaro, who is regarded as business-friendly, is seen to be in a strong position to win the second poll on October 28.
As a result, the real has rallied about 13 per cent since its latest low in August and is trading at R$3.7 against the dollar. Arabica coffee, the higher quality bean, has jumped almost a third since it reached a 12-year low in September to a four-month high of $1.23 a pound, while sugar is up 37 per cent from its September low at 13.48 cents a pound, a seven-month high.
The latest data from the US Commodity Futures Trading Commission shows that in the week to October 9, “net short” positions held by speculators in sugar has more than halved from the previous week while that of coffee fell 16 per cent.
“The Brazilian real move seems to have been exacerbated by algorithmic trading, as there was very little fundamental news during the period,” said analysts at Rabobank.
Given the high supplies in both coffee and sugar, some observers questioned the durability of the rally in both commodity markets.
“The potential for considerably higher prices is limited in our opinion,” said Commerzbank, warning: “If the real came under pressure again, this would also have a negative impact on the coffee price.”
Given that there are farmers and exporters waiting for higher prices to sell their crops, there would be a cap on prices.
Rodrigo Costa at Brazilian coffee trader Comexim said: “Given the volume of coffee that is seated in warehouses in Brazil and hanging on trees in Colombia, Central America, Africa, and Asia, a rise above 120 cents per pound seems unlikely to be sustained — at least in the next six months.”