How to profit from El Niño; The sweet future of sugar

One of the first rules of investing is diversification across asset classes (as well as within asset classes). The exemplary well balanced portfolio should consist of stocks, bonds, commodities, real estate & currencies, just to name a few. But with interest rates at all-time lows, bonds are very unattractive and Real estate prices have already recovered substantially since the recent crisis. So one might look for chances in commodities.

Yet, the commodity segment is also facing hard times over the recent years. The Bloomberg Commodity Index lost more than half its value since 2011. The decline in oil weights heavily on this index, but also precious metals such as gold and silver lost significant value. So what are the opportunities in the commodity market? The answer is El Niño.

El Niño is an irregular recurring climate event, where ocean water temperatures in the Pacific Ocean near South America get unusually high. The effects of El Niño are immense as water in Western South America contains less nutrients due to warmer water. Moreover, it causes drought in Asia and Australia. And finally it also causes extremely heavy nonseasonal rains in South America. All these effects have a negative impact on agriculture as harvests fail (or at least harvests are worse than usual). Brazil (~40% of worldwide production), India (~18%), Thailand (~5%), Mexico (~3%), Colombia (~2%) & Indonesia (~2%) are all among the largest global producers of sugarcanes and these countries are all heavily affected by El Niño. As The US National Weather Service stated that this year's El Niño is on its way to become the biggest El Niño ever recorded (since 1950), we may expect that harvests will be bad, cutting sugar supply and driving sugar prices up.

Another trend that makes sugar an interesting investment is the growing ethanol fuel production in Brazil, worlds largest sugarcane producer. Sugarcanes can be used in the process of creating ethanol fuel and recently more sugarcane grinding mills in Brazil start to prefer ethanol over the production of sugar. As a larger part of sugarcanes is processed into ethanol instead of sugar, supply of sugar will go down, increasing the price of sugar.

The sugar price has been going down since 2011, but there are signs that the bottom has been reached as sugar prices recovered a little in September 2015. The recovery is an indication that the bottom might be reached, yet sugar is still trading at half its value from 2011. For that reason, we think it is sensible to step into the market while entry is still cheap and future prices look bright.

In conclusion, the effects of El Niño worldwide and Brazilian trends in the ethanol industry makes sugar related investments especially attractive as we expect sugar prices to rise.