ETF Talk: Feeling a Global Sugar High

For the first time in 28 years, sugar prices have topped 21 cents per pound. That’s an 88% increase year-to-date! If that isn’t sweet enough, some analysts are projecting that the price of sugar could reach a staggering 40 cents per pound, making this investment even more appetizing.

Many investors have been piling into the commodity in expectation of an even further price increase. If you’re thinking about doing the same, you have several options. One investment that I’ve been watching lately is the iPath Dow Jones AIG Sugar Total Return Sub-Index ETN (SGG). The investment seeks to replicate as close as possible the Dow Jones-AIG Sugar Total Return Sub-Index. The index is intended to reflect the returns that potentially are available through an unleveraged investment in sugar futures contracts, as well as the rate of interest that could be earned on cash collateral invested in specified Treasury Bills.

The graph below shows just how well the exchange-traded note (ETN) has responded to increased sugar prices. In fact, it’s up 55.4% this year.

So, what exactly is behind this price hike? The simple answer is that the sugar supply is shrinking as demand is rising. The world’s consumers simply are seeking more sugar than farmers are producing. According to the International Sugar Organization, world demand will exceed output by as much as 5 million metric tons for the 12-month period ending September 2010.

The short supply can be blamed on several factors. One of the biggest problems for sugar crops this year has been abnormal weather patterns in the world’s largest sugar-producing nations, including Brazil, India and China. The world’s largest sugar producer, Brazil, has been drenched by four times the normal amount of rainfall. While in India, the world’s second-largest sugar producer, rain has been scarce with the country plagued by severe drought.

China, the third-largest sugar producer, will have smaller harvests this year due to reduced planting. The same trend is seen in Russia and Mexico, forcing the world’s biggest sugar exporters to begin importing.

And then there’s also the fact that the world is consuming more sugar in general. Sugar consumption usually increases as per-capita income climbs. So, as conditions and incomes rise in developing countries, sugar consumption only should grow.

A shortage in sugar supply has caused concerns for the management teams at giant food companies such as Kraft Foods (KFT), General Mills (GIS) and Hershey Co (HSY). In a joint letter to Agriculture Secretary Tom Vilsack, the corporate leaders wrote, "we may well virtually run out of sugar."

Their hope is that this petition might convince U.S. government officials to ease import restrictions that have been in place to protect American farmers from global competition. The result of these import quotas has been that U.S. food companies pay higher prices for sugar, as seen in the graph below.

It is unclear whether sugar prices will continue to rise, despite the forecasts of analysts who predict that the prices for that sweet commodity likely will climb higher. However, market booms ultimately go bust. When the price of sugar reaches its peak, those still invested in it are vulnerable to the inevitable downturn. As a result, investors should enter with caution. If you think that prices will continue to climb, SGG could be a very sweet choice.

For those of you who want specific advice about which ETFs to buy and sell, check out my ETF Trader service by clicking here. As always, I am pleased to answer any of your questions about ETFs. To send me your questions, please click here. You may see your question answered in a future ETF Talk.