Sugar hits sweet spot as downtrend comes to an end

SINCE hitting a high of 23.90 in October 2016, sugar has been stuck in a brutal downtrend. It has fallen by 58 per cent over the past two years to the current low of 9.91. Nonetheless, the severe bearish sentiment in sugar might also be the reason for a significant rebound as the outlook appears extremely dreadful - and a short squeeze from the speculator perspective is imminent.

Despite the downtrend accelerating in August as sugar broke below the critical 10.00 psychological round number, the bulls stood ready to defend that level and succeeded in keeping the 10.00 psychological round number intact.

The market is clearly respecting the 10.00 psychological round number with the recent bullish rejection shown by the highlighted box. The historical price action around the 10.00 support area also signalled why that level is particularly important. Back in 2015 when sugar was also going through a relentless bear market, it was at the 10.00 psychological round number that halted the sell-off and initiated the uptrend in August 2015.

To be more specific, there was a bullish engulfing bar rejection off the 10.00 psychological round number with an oversold relative strength index (RSI) that signalled the end of the bear market shown by the up arrow.

Interestingly, the weekly RSI seemed to work well in signalling a reversal higher when the RSI dips below 30. RSI measures momentum. A reading above 70 represents an overbought condition while a reading below 30 represents an oversold condition. Do note that having a weekly oversold environment is a rare occurrence. Throughout the past 10 years, there were only nine occurrences of the RSI falling below 30. More importantly, each time the RSI signalled an oversold condition, a mean reversion higher in sugar followed. On average, sugar rebounded 20 per cent after the mean reversion was confirmed.

Hence, with the RSI hitting the oversold condition at 28 once again recently in August, we believe the mean reversion higher is inevitable. With the benefit of hindsight, the strong bullish rejection off the 10.00 psychological round number since Aug 24 has lifted the RSI back above the 30 oversold line that signals the start of the higher mean reversion. Therefore, based on the average rebound of +20 per cent, expect sugar to rally higher to test the 12.72 area followed by 15.50 resistance area.

Another crucial evidence supporting a rebound in sugar is the extremely pessimistic outlook on the commodity. The last time we had a net short environment in sugar futures was in April 2014 to August 2015. The short positions built up during that period and hit a record high of -48,642 contracts. It ultimately resulted in the inevitable short squeeze in sugar price, forming a definitive bottom in August 2015. A strong bull market took over after that with price rising from 10.13 to 23.90 over 58 weeks representing a +130 per cent move.

Thus, there might be a replay of that now as the speculators have been net short on sugar futures since June 2017, and the shorts continue to pile up. To make matters worse, the current net short positioning in the sugar futures is at a record -117,000 contracts, 140 per cent greater than the 2015 record short amount. Hence, when the short squeeze occurs, expect sugar to rise violently with the expectations of the 10.00 psychological round number acting as a solid floor. This could be the point where sugar forms a meaningful double bottom.

Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice.