TAMPA (ResourceInvestor.com) -- Frozen Concentrate Orange Juice (FCOJ) had an exciting month at the New York Board of Trade in April. After hovering near 30 year highs for most of 2007, Orange Juice at the NYBOT plummeted nearly 16% by mid-April. But the writing on the wall was present for such a correction long before the selling started.
Before we discuss the reasons for the correction and the subsequent reasons for why the bull market should now continue, we must first understand what brought OJ to these lofty heights to begin with.
The USDA's latest FCOJ supply/demand report was released on April 10. The report pegged the 2006/2007 Florida Orange crop at 130.7 million boxes, the smallest crop in 17 years. Florida is the U.S.'s largest producer of oranges with over 90% of production going towards the manufacture of Orange Juice, much of which is used to satisfy the FCOJ contracts traded at the New York Board of Trade.
But why would prices experience such a tumble when the USDA is reporting such a bullish figure?
For one thing, FCOJ prices have already been in a bullish mode for over two years as a combination of events have chipped away at the production capabilities of Florida groves. Significant is that Florida orange production has not only suffered from loss of yields over the last few years due to trees producing less fruit, the market is also dealing with loss of trees, which will have a major impact on long term production.
The initial shock came when a total of four considerable hurricanes roared through Florida's growing regions in 2004, when the market initially began pricing the damage to the current supply. When a second round of storms battered central Florida the following year, the market again raced to new highs to account for orange production loss to the 2005 crop. What was not immediately known was the longer term damage done to Florida orange trees and its impact on future production.
What was not known then is now becoming clear. Florida groves suffered substantial long term damage, having lost over 16% of their commercial citrus trees. The state is now down to about 65 million fruit bearing trees, enough for a decent crop in a high yielding crop year but still not enough to come close to production figures of only a few years ago.
In the five years prior to the summer of 2004, Florida produced an average of 226.2 million boxes of oranges per year (1999-2003). A 2004 storm damaged crop produced only 149.6 million boxes of oranges in 2005. 2005/2006 faired only moderately better, producing 151 million boxes of oranges. This means that for two years running, Florida groves have produced roughly 34% less oranges than their previous 5 year average.
This shortfall in supply has resulted in one of the most sustained bull markets in all of commodities over the last two years. Louis Drefus's 160 million box estimate for the 2006/2007 crop back in August was already considered a bullish figure as the market began pricing in a third consecutive substandard production year. With the USDA now pegging the crop even below 2005 and 2006's paltry figures, it is evident that there were other factors at work that eroded 2007 yields.
The freeze back in February 2006, thought to be benign at the time, appears to have had an impact on yield after all. And the canker eradication campaign that has continued in 2006/2007 has cut into production yields as well.
The outlook for Florida orange production continues to point to scarcity beyond 2007. The fact that growers have been slow to replant trees does not bode well for future orange production. With Florida's bulging population, land hungry developers have made some sizable buyouts of Florida growing regions.
With production down and land prices still at inflated levels, many growers figure this is a good time to sell. Yet, their gain is the market's loss and the FCOJ contract will have to rely more heavily than ever on Brazilian oranges to fill the void. However, not only can Brazil not cover the entire shortfall, their oranges are more expensive to ship (they must be imported into the US), they are harvested at a different time of year and production has been more or less flat over the last four years.
In addition to land loss, replacement trees for remaining groves will be in short supply for the next several seasons. The canker eradication campaign mentioned above destroyed a substantial chunk of nursery stocks meaning seedlings will be in short supply. As it takes nearly 3 years for newly planted trees to bear fruit, it could be 3-5 years before even remaining groves can get back to pre-2004 production numbers.
All of these factors provided a solid fundamental foundation for the fund led rally that took prices to their March 2007 highs. However, as in any bull market, high prices will eventually begin to cure high prices. Sooner or later, prices will reach a level where commercial processors and/or end users will begin to balk. This results in a drop in demand which generally leads to a drop in price. While this was almost certainly the case in OJ, we feel the market substantially over adjusted and Juice now finds itself in a position where it is underpriced.
For while the market was clearly overbought and long overdue for a correction, last month's price slide seemed exaggerated. FCOJ contracts do not have the massive liquidity found in heavily traded markets such as sugar or crude oil. This means when funds get overly long and begin to cover positions, there are not enough buyers present to absorb all of the selling - at least not in such a short period of time. This results in the type of price move we saw in April.
The good news is that the correction has left the market at what appears to be a bargain price for investors. To be specific, we feel there is a particularly attractive opportunity for put sellers at this time.
Not only does the fund selling appear to have run its course, but technical studies are turning higher again. Fundamentally, nothing has changed in the Juice market. In fact, while bears were hoping that next year's Florida crop would begin to show production recovering, most analysts early forecasts only call for 140-145 million boxes in 2008 - only slightly higher than this year's figure and still well below pre-2004 levels.
FCOJ also has a seasonal tendency to begin moving higher during the months of May and June. This tendency corresponds to the end of the Florida orange harvest in April as well as the impending arrival of Hurricane season in the Southern Hemisphere which often brings spec buying interest into the market.
We see selling puts below the April lows as a high percentage strategy for taking advantage of steady to higher OJ prices over the next 4-8 weeks. Put sellers can profit even if the market falls back to or even eclipses April's lows. While we do not expect this to happen, it adds an extra layer of comfort to know that one can be moderately wrong the market and still stand to profit from the trade.
Fundamentally, we see fair price for September OJ near $1.90 per pound. Until Florida can grow some new orange trees, we might have to get used to these higher price levels.
Copyright (c) Liberty Trading Group 2007
James Cordier is head trader and president of Liberty Trading Group, a futures brokerage firm specializing in option writing on commodities. Michael Gross is an analyst with Liberty Trading Group.
