it time to buy coffee?
Coffee has not offered many opportunities
on the long side since the huge 2010 rally, where
coffee prices more than doubled. There have been
signs of strong emerging fundamental underpinnings
for this market throughout the first half of 2012
and now the market appears ready to take-off.
prices would suggest $2.50 per lb. coffee over
the next 12 months and $4 per lb. coffee two years
out are possible based on price cycles, commercial
net positions, micro-fundamentals and relative
value to the Continuous Commodity Index.
wet Brazilian summer that created premature blooming/flowering
for the next off-season crop had the effect of straining
the coffee tree from its normal resting period leaving
it with less energy and resources to produce a maximal
large flowering period. In this scenario, buds and flowering
are less frequent, smaller with less quality. Also,
the new buds are very susceptible to being damaged by
the ongoing harvest of the current crop thereby reducing
potential yields. Additionally, the current crop harvest
suffered from very heavy rains by having cherries fall
off the trees. The falling cherries hit the ground and
begin to ferment on the wet ground thereby lowering
quality and some spoiling altogether.
All of this
likely will continue to have a very long tail to it
as the heart of the flowering /blooming phase occurs
in the September/October timeframe. My homework strongly
suggests that this likely will have the effect of lowering
the production potential for the offseason Brazilian
coffee crop from normal trendline expectations. Trendline
expectations for this coming offseason crop would have
been about 51 million bags but given what already has
happened over the wet summer and what still might happen
for the September/October timeframe, the potential exists
for a crop no better than 45 million bags. This would
be a 10 million bag reduction in supply from this year’s
crop. Should such an outcome begin to gain traction
in the global coffee trade then coffee prices will need
to price violently higher to ration demand and begin
the long road of encouraging long term Arabica production
growth. Also Central America had a very poor flowering
season this year and the harvest that is about to begin
likely will fall well short of current expectations.
Also, the likelihood of El Nino reduced Robusta crops
in Vietnam and Indonesia next year will further exacerbate
this impending supply squeeze.
market has been hyper focused in the lost demand of
Arabica in favor of Robusta given last year’s near record
premiums for Arabica prices in relation to Robusta prices,
lost in the shuffle is that this relationship has been
flipped to where Arabica is now historically cheap in
relation to Robusta. This fact as well as the fact that
the coffee/tea price ratio is also in a similar relative
cheapness of Arabica suggest that demand growth should
reaccelerate over the next year at a time where production
could be off by as much as 10 million bags depending
on Mother Nature. Remember, the typical surge in the
stocks to usage ratio during the on-season Brazilian
crop and record Vietnamese crop was mainly in the Robusta
grade and not in the Arabica grade. Nonetheless, next
year should break new multi-decade lows and necessitate
further demand rationing.
Price cycles are bullish-coffee price cycles have tended
to see a low point in the middle of the 8 year cycle
and then see another big run back up higher in prices.
The current DNA of time and price are perfect for a
secondary price cycle bottom and surge back up. Also
two long term trendlines reside near $1.50 further suggesting
that the current retest of such lows likely will hold
and launch the next bull market in coffee. The eight-year
price cycle for coffee predicts another large run back
up in coffee prices.
price cycle for Coffee predicts another large run back
up in coffee prices
the December 2012 futures price chart a likely higher
low is developing that should breakout to the upside
no later than October 2012. This would be consistent
with typical seasonal price lows in the fall and a seasonal
pick up in coffee demand.
value levels remains very bullish and cheap. Despite
the impressive bull market in coffee during the 2010/2011
timeframe, the relative price chart barely budged and
fell way short of reaching the typical .70-1.00 relative
value level. A true coffee bull market will go it alone.
This strongly suggests that the bull market in coffee
has a long way to go.
The current level for commercial interest is one of
the most bullish net commercial positions in history
only seen two times since 1986: Nov. 28, 2003 and Dec.
12, 2008. Both set off massive bull market moves.
have loaded up on coffee and the latest surge has taken
them to historic bullish high ground. This has only
been seen two other times before in 2003 and 2008. Both
times preceded fantastic multi-year bull market moves.
If history is a guide, all-time highs could be achieved
over the next few years.
the bearish factors that have been the basis for the
bear market in coffee prices over the last year that
included Europe falling into the abyss (reduced coffee
demand), large demand switch from Arabica to Robusta,
a crashing Brazilian real, slowing coffee demand in
Brazil, record Robusta production in Vietnam and record
Brazilian crop, the commercial interests are long and
see great long term value. As always, in order to make
money in a commodity you have to see the bullish fundamental
picture coming before everyone else does and before
such bullish underpinnings begin to get priced in the
market with higher prices.
It is very
hard to buy when everything seems bearish but that is
the nature of the beast. If it was easy everyone would
be trading commodities. All my homework indicates that
a new bull market is about to begin. The same contrarian
streak that allowed me to buy the last bull market in
coffee despite widespread bearishness in 2010 is at
work here and now.
play is to go long December 2012 coffee and place an
option collar around it to reduce downside risk. With
uncertainty around U.S. elections, global central bank
money printing or lack thereof, possible Chinese fiscal
stimulus or lack thereof, possible war with Iran, possible
Europe implosion, banking system crisis and possible
worsening global recession, the macro picture offers
huge risks to any long position.
these risk factors have been in place for many years
and will remain in place for years to come. With a contract
as large as coffee and with the higher volatility typically
seen in coffee one should remain focused on risk control.
An option collar is a perfect vehicle to do this. Here
is the trade: Buy 1 Dec. ‘12 coffee futures at $1.6310
closing Friday price, buy 1 Dec. ‘12 150 put at 3.03
closing price, sell 1 Dec. ‘12 180 coffee call at 3.10
closing price. What this does is essentially give you
a $1.50 floor under your straight long position at no
cost as the buy and sell for the options are essentially
the same premium.
coffee market collapse because of a macro event then
the puts will appreciate dramatically minimizing your
loss to at most the difference between the executed
futures price and the put strike. One would then have
the flexibility to take the put option off at a large
profit and ride the coffee futures market back up. If
the coffee market takes off as the bullish fundamentals
take hold in a money printing environment, then profit
can be made up to the short call strike. Once prices
move over $1.80 the profit potential is capped. Of course
the flexibility exists that if one felt the bull market
in coffee was getting underway you could take the short
call off and let the futures run higher to capture further
What is great
here is that a substantial profit would already be in
place that would dramatically reduce the risk of being
naked long as one can apply a trailing stop strategy
to manage risk. One could also apply a different collar
at a higher strike price level to bracket it once again.
The whole point of using an option collar strategy is
that it allows for a calculated loss that is quantified
and allows for flexibility.