Sugar ETPs Looking Sweet

June 06, 2011

While oil prices have stalled amid reports of ample supplies, sugar reached a seven-week high on Friday.

I know what you’re thinking: Why should investors be interested in sugar? We’re bombarded with oil market news every day, but we never hear about sugar. It’s not surprising. Annual sugar production in dollars makes up less than 1 percent of the value of oil output, and no commodity affects pocketbooks in the developing world as much as oil.

That said, we should care about the softs—sugar, coffee and cotton—because they offer diversification within the commodity landscape. Exposure to them amounts to another way for investors to protect themselves from inflation. Whether taking a broad-based approach with a multiple-commodity security or concentrating exposure on sugar or another single soft commodity, prospects look bullish.

And, importantly, futures price curves for the softs are currently avoiding the large contango costs that can plague a commodities portfolio. A “normal” futures curve that’s in contango features rising prices over time. That means each time fund managers roll exposure from an expiring contract to the next month, they have to pay up, which kills returns, especially over the long haul.

Upward Pressure On Sugar Prices

Much of the recent action in sugar is linked to production and shipping issues.

Brazil, the world’s largest producer of sugar, has seen inventories drop. Output in Brazil’s Center South region, where sugar production is concentrated, slumped 17 percent to 1.55 million tons in the first half of May.

Adding to the worries, Thailand is suffering from congestion at its ports, despite a record 9.6 million tons of sugar produced in that Southeast Asian country over the past year. Last week, vessels in Thailand were lining up to load as much as 400,000 metric tons of sugar, and ships were waiting for almost 2.25 million tons in Brazil.

If ports are able to relieve congestion, the price of sugar may decrease. But, if problems persist, as we often see in commodities, sugar prices should continue to escalate.

Ticker Fund 1-Month Return AUM
(in millions)
SGG iPath Dow Jones - UBS Sugar Sub Total Return ETN 13.11% $65.70
SGAR iPath Pure Beta Sugar ETN 10.66% $6.30
JJS iPath Dow Jones - UBS Softs Sub Total Return ETN 6.05% $67.12
GRWN iPath Pure Beta Softs ETN 1.66% $7.15

 

 

 

 

Sugar Returns The Sweetest

The largest return has come from the iPath Dow Jones – UBS Sugar Sub Total Return ETN (NYSEArca: SGG), which is the closest investors can get to tracking the raw price of sugar.

SGG tracks an index that follows front-month futures contracts, and rolls its exposure over to the next month’s contract before expiry of a given front month.

The iPath Pure Beta Sugar ETN (NYSEArca: SGAR) meanwhile provides protection for long-term investors looking to avoid the risks of roll costs that come with a market that’s in contango.

While this fund may be a great choice for long-term investors, the sugar market is currently in backwardation, meaning that the priciest contract is the next one to expire. That’s a state of affairs that suggests bona fide tightness in supplies, and that allows fund managers to profit each time they roll exposure to a less-expensive contract—exactly the opposite of contango.

Many investors will see problems in investing in a commodity they know little about.

To the extent that such cautionary impulses are sensible, at the very least, sugar’s recent performance argues for the benefits of picking a broad commodity fund that’s diversified across commodity sectors.

The United States Commodity Index Fund (NYSEArca: USCI), which seeks to invest in commodities that exhibit the least contango, is currently invested in all three of the major softs. USCI is an ETF based on an equal-weighted index that invests in 14 commodities, and softs now make up over 21 percent of the portfolio.

Compare that with the iShares S&P GSCI Commodity-Indexed Trust (NYSEArca: GSG), which has no exposure to softs and is 69 percent invested in energy—almost half of it in crude oil. The GSCI may resemble the market for commodities in some respects, but it sorely lacks in diversification.

Diversification makes more sense the longer the holding period, so we looked at six-month returns on USCI, GSG and the PowerShares DB Commodity Tracking Index Fund (NYSEArca: DBC), a $6.29 billion ETF that’s easily the biggest multicommodity ETF on the market.

 

Ticker Fund 6-Month Return AUM
(in millions)
USCI United States Commodity Index Fund 9.76% $478.13
GSG iShares S&P GSCI Commodity-Indexed Trust 7.46% $1,718.91
DBC Powershares DB Commodity Index Tracking Fund 13.56% $6,289.10

 

At the end of the day, the point is that while oil may be the lifeblood of the global economy, a whole slew of other commodities are in a bull run too.

So, integrating softs, such as sugar, into an investment portfolio makes a whole lot of sense, whether through a super-focused single-commodity ETN like SGG or a diversified ETF like USCI.

 

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