Commodity arbitrage

"Sugar may be a cheap call option on John McCain winning the U.S. presidential election (...) While Barack Obama supports domestic ethanol production subsidies, which are generally corn based, John McCain supports a more open trade policy for Brazillian sugar based ethanol", Source: Bloomberg News

Over the past ten years, Commodity markets have regained their shine as investment assets. The previous bear cycle bottomed out in mid 1999, then the market stalled for a couple of years, and finally in 2001 late October the CRB Index - the sector's benchmark - initiated a powerful bull market that reached its peak this past June 2008. Since then the index has tumbled over 25% and many argue that a new bear market is already in place. However, I disagree. I expect that over the coming months we will probably witness a rebound in commodity prices. In my perspective, soft commodities may prove to be the most exciting. These commodities are traditionally very susceptible to weather and government regulation, especifically, agricultural subsidies.

In that regard, today's Bloomberg report provides some insight on what to expect from Obama or McCain. Since Bush was elected, the U.S administration introduced a series of incentives towards corn based ethanol production despite allegations that corn is uneffective compared to other ethanol sources. In fact, one of the biggest worldwide producers of ethanol, Brazil, which for the past four decades has been on the leading edge of alternative fuels, has its ethanol production mostly based in sugar. That's precisely what McCain is calling for instead of wasting money in corn subsidies. A bit of change that Obama, quite ironically, is not pushing for at all. Below, you can see this year's market action in the CRB Index, and Sugar and Corn front month futures.

Both Sugar and Corn have outperformed the general CRB Index so far this year. Sugar is up by 12% Year to date, Corn is higher by 24% and the CRB Index accumulates a 2% gain as of yesterday. If you believe in the candidates' views and in recent election polls that show Obama leading McCain by 9 percentage points, there's an arbitrage opportunity right here: buying sugar and selling corn. Perhaps not as risk free as the title picture might suggest. But definitely a decent risk reward trade.