The price of sugar is about to rebound – here’s how to profit

Food prices are currently going up in leaps and bounds. In the last year alone, the price of corn is up 13%, soybeans 21% and wheat 22%.

There's been talk of a global food shortage. Firms are even shrinking the size of chocolate bars to hide the fact that they cost a lot more. Consumers are having to pay more to get less.

But there's one soft' commodity that remains untouched by the bull market.

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For the past two years sugar prices have just kept falling and falling. In fact, since they peaked in late 2010, sugar prices have more than halved.

But this bear market could be about to end. Here's why now could be a great time to buy into the sugar market. Here's why

Sugar production growth will end this year

So why has the sugar price fallen so drastically? The answer's straightforward: it's all about supply and demand. Harvests have been good over the past two years. This has led to a large surplus of sugar being produced, hitting prices.

However, as tends to happen, falling prices have started to impact on suppliers. In India, the second-largest global producer, some sugar millers have been unable to pay farmers. Other Indian states are trying to reduce the number of plantings.

According to sugar consultancy Kingsman, total production in India is set to fall. And worldwide, DZ Bank thinks that production will peak in the growing year ending in October. It will then begin to fall during 2013-14.

So what about the demand side?

As well as being a foodstuff, sugar is an important source of fuel. That's because it can be converted into ethanol, which in turn can be used as a petrol substitute. Brazilians have been using it in their cars since the 1970s. Indeed, by law, all cars sold have to be able to run on fuel that is at least 18% ethanol, andnine out of ten can run on pure ethanol.

Up until now Brazilian car ownership has been limited. In 2011 there were only 259 cars per 1,000 people. This is less than half the ratio in the UK (525) and just over 30% of that of the US (812).

But with the Brazilian middle class growing, car sales have been booming. The latest figures suggest that total sales were at record levels in 2012. More cars on Brazil's roads mean that more ethanol and therefore more sugar will be consumed.

Another major boost is that Brazil's state oil company has decided to raise the price of petrol. This will in turn allow ethanol producers to raise their prices. On top of that, the state has said that it wants the percentage of ethanol used in petrol to go from 20% to 25%. Because Brazil is so important as a producer, this should erase the global surplus completely.

The US may also embrace sugar ethanol

Export opportunities may also be about to open up.

Keen to wean itself off oil and to boost its environmentalist credentials, the US has been pushing ethanol. There are mandatory targets for its use in petrol refineries, and all the major car companies have agreed that all new cars will be able to use up to 10% ethanol blends.

However, up until now, the US has focused on a version of ethanol that uses corn grown in the US, for the simple reason that it's a handy bribe for the powerful US agricultural lobby.

But this policy has been criticized heavily for driving up food prices. Bodies such as the United Nations aren't happy that corn is going inside the tanks of SUVs in America, rather than the stomachs of those in developing countries.

In response, the US Environmental Protection Agency (EPA) has been trying to make sure that some of the ethanol used comes from non-corn based sources. In practice, this means sugar-based ethanol.

Of course, this move is not popular with farmers in the Midwest, and there have been moves to get it reversed. However, it's clear that the trend is towards sugar not corn-based - ethanol.

How to profit from Brazil's sugar rush

There are three ways to make money from a rally in sugar prices.

The first way is to directly bet on the sugar price through a spread betting broker, such as IG Index. IG offers access to the sugar contracts traded in both New York (NYMEX) and London (LIFFE). However, spread betting is very high risk, since you could lose more than your initial stake if prices go against you. If you are interested in trying it out, sign up for our free MoneyWeek Trader email first to learn a bit about it.

A less risky though still potentially volatile - idea is to buy an Exchange Traded Commodity. This tracks the price of sugar, but it is traded on an exchange. So you buy it through your stockbroker, just like a share. One example is ETFS Sugar (LSE: SUGA), which has an annual fee of 0.49% and is exempt from stamp duty.

However, bear in mind that you have to keep a close eye on the way these products behave, and they are only suitable for relatively short-term trades if, for example,you don't understand the terms backwardation' and contango', then steer clear.

A better idea for most investors interested in playing this sector, might be to buy shares in a sugar grower. One company that looks interesting is Cosan Limited (NYSE: CZZ). Cosan is a Brazilian company that does everything from growing sugar to exporting both ethanol and refined sugar. It should therefore do well from rising prices and any boost in demand from the US. The company also runs a railroad transportation business, an important asset in a country with dire infrastructure. It currently trades at 13.2 times forward earnings.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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