19 February 2020

In two days that looked like a flashback to Dec 2019 (when coffee prices jumped 40% in the span of a month), prices on Thursday and Friday rose 8.6 cents, to finish up 10.85 cents on the week at 111 cents/lb basis the May contract. With the March-May congestion from the roll behind us (when funds sell the market to move their positions forward one future contract), some serious buying emerged. The idea that has been circulating in the market was that coffee differentials at origin were approaching unsustainable levels for ordinary business. To recap, differentials are a premium or discount offered for a specific grade of coffee above that of the futures price. Many coffees outside of microlots and fair trade certified coffees are priced off of this mechanism. When futures prices fall, differentials typically rise as farmers are resistant to sell their coffee at lower prices. Across millions of producers, this resistance is a sign of tightening supply. Clearly, if supply was ample, farmers would be more desperate to unload their coffee regardless of the price environment. For roasters, differentials are even more important as many commercial green buyers are judged by their performance in buying quality coffee for the best differentials possible (relative to their competition). Therefore, the most optimal resolution to this stagnation in business where farmers don’t want to sell and roasters don’t want to buy is that the futures price has to go up. But as financial markets go, just because it is logical, doesn’t mean it necessarily happens without someone taking action. From Thursday and Friday’s market rise, it seems that someone has indeed taken decisive action by buying a lot of futures.

11 February 2020

This week, coffee prices fell 4.3 cents from Friday to Friday to close at 98.35 basis the March contract. All of the selling really came on Monday, as a class of hedge funds called CTAs, who sell on the back of price momentum finished exiting their long position, and started to go net short. The initial selling created panic which was further spurred by the tenuous macroeconomic situation resulting from the spread of the Coronavirus. This resulted in some investors who had held on to a long position since the rally in December, to finally liquidate their position as those gains turned into market losses. For the rest of the week, the coffee market was largely quiet as some serious buying interest emerged that helped to counteract CTA selling. This upcoming week, the focus will start turning toward the May contract. As market participants most often do not actually deliver or take physical product from the futures contract, continuing a position in coffee will mean getting out of the March contract and getting into the May (called rolling your position).

04 February 2020

This week, coffee prices, like all other commodity products were affected by the Chinese Coronavirus outbreak. Futures basis the March contract fell 8.95 cents from Wednesday to Wednesday, as news of the new virus spread malaise across all markets, sending investors into protection or “risk-off” mode. As of writing, there are 8,246 recorded cases of Coronavirus, of which 8,123 are in China. While these numbers are exceptionally small for a country with a population of 1.4 billion, the rapid spread of the virus has many officials concerned. From a financial standpoint, the cost of containment is what is being priced into markets at the moment. For example, during the SARS outbreak in 2003, Crude Oil demand dropped by as much as 500k barrels/day as the Chinese government placed restrictions on travel. Travel restrictions and health laws are already affecting coffee specifically, as Starbucks has decided to shut down more than 50% of its stores in China. As travel restrictions continue to be imposed, China- a country that is increasingly supported by consumer spending as opposed to industrial production – becomes more and more economically paralyzed. We hope that the medical community as well as government health officials are able to contain this plague and find successful treatment options for those affected.

14 January 2020

This week, coffee futures continued their sharp decline, falling more than 7 cents to close at just below 115 cents/lb as of Monday’s close. The main driver behind this sudden and sharp collapse has been the increase In the amount of coffee ready for grading on the ICE Arabica exchange. As in any commodity futures contract, ICE Arabica is backed by an actual physical supply of coffee that can (but is not necessarily) exchanged during the delivery period. This means that a holder of 1 Arabica future taken to the end of the delivery period would receive 37,500lb of coffee under the guidelines of the ICE Arabica contract. The total sum of coffee held under the guidelines of the ICE Arabica contract are called the ICE Certified stocks. ICE Certified Stocks, which currently stand at 2,065,315 bags of Washed Arabica coffee, are highly visible to the market, and are therefore treated as highly liquid surplus coffee. As a physical product, ICE Certified stocks serve as a cheap source of low-quality washed Arabica that often act as a last resort in case of pricing or supply issues with coffee at origin. In 2019, when prices were massively suppressed, prices at origin became more and more expensive via differentials, thereby making the alternative ICE Certified stocks more attractive. Part of the reason for the late 2019 increase in futures was the assumption that prices needed to go up to make coffee at origin more lucrative to use than ICE Certified stocks, or else the market risks of running out of the specific product that underlies the futures price. At the very end of 2019, 129,000 bags were put up on the exchange for grading, or testing to see if the coffee can become part of ICE Certified stocks. This signal to the market, showed that perhaps prices going from $1 to $1.32/lb had done their job at freeing up excess coffee to enter the exchange. Last week, as prices continued sliding, a further 56,000 bags were put up for grading, showing that even at 1.17/lb coffee was finding its way to the exchange. With the market clearly building its readily available coffee supply, any concerns about coffee supply can quickly be negated, thereby significantly dwindling bullish confidence.

7 January 2020

Coffee prices collapsed 1.15 cents on the week and are down nearly 5 cents on Monday at 122 cents/lb as of writing. The first week of the year started out on a bit of a sour note, as a US drone strike in Iraq killed an important Iranian general. The increase in tensions and potential escalation into armed conflict sent money flows scattering towards safe assets. Unfortunately for coffee, this means that the strength we have been seeing in the Brazilian currency has been abated. Speculators betting on less Brazilian farmer selling due to appreciation in the Real seem to be getting it wrong, and are starting to head for the doors. To bring in more downside pressure, the Bloomberg Commodity index is expected to sell between $362 and $541 million of coffee futures this week, as part of their annual portfolio rebalancing. While this is typically well published in the market and is largely a result of coffee futures increasing more than other products in 2019 (ending the year with 25.7% returns vs. 8.5% average for the Commodity Complex), the actual rebalancing could not come at a worse time. Instead of buying into the Index rebalancing, speculators seem to want to get out of their long investments due to geopolitical pressure.

24 December 2019

Coffee futures rose 0.4 cents to 133.7cts/lb from Tuesday to Tuesday in incredibly wild action that was unlike anything the market has seen in the last 5-6 years. Last Tuesday to Thursday saw prices rise steadily on the back of continued momentum buying, rising 8.85 cents in 3 days with little resistance. A typical bull market. It is so strange that animals, specifically Bulls and Bears, have come to represent market dynamics. As the popularity (or infamy) of the Bull statue on Wall St shows, these animals are the best representation of situations such as the one we are facing in coffee today– strong, brash, and often thoughtless. Charging forward at increasing speed, it sweeps away any who dare oppose it. Many players agree that there has been no specific reason that coffee prices should have continued rising these last few weeks, but they kept rising nonetheless. As soon as the Bull stops running, however, he is vulnerable, and on Friday, we saw the Bear take over. The Bear, unlike the bull, is often nervous and skittish. Bears in the wild prey upon weaker animals and tend to avoid conflict unless cornered. Once cornered, they can be extremely vicious, tearing apart their opponents in blind rage. It is inadvisable to run once you see a bear in the woods, as they will often give chase. In the same vein, the coffee market saw a slowdown in buying on Friday and held off a critical level of 140 cents/lb. Then the bear came out. In the next two hours, we saw prices collapse 11.1 cents, the largest single down day in 4 years. Everyone went into the weekend thinking the Bull market was defeated and prices were headed lower in a straight line. They were extremely surprised to find Monday, that prices regained steadily throughout the day, climbing 12.05 cents in the largest daily gain in 5 years. Today, we saw the bear take over again, with prices falling 7.8 cents from today’s open to the close. Clearly, we are witnessing a battle taking place in the market as the bull fights the bear for dominance. Our experience tells us that the bear’s emergence most likely means this rally is nearing its end, but at the moment, we’d rather drink eggnog on the sidelines.

About Our Market Report

Ilya Byzov, Quantitative Trader at Sucafina North America (SUNA). Byzov began his career as a trainee in market risk. After over three years of Friday “culinary explorations” with co-workers who worked in green coffee trading, Byzov transitioned to the world of green coffee. He joined SUNA about 1.5 years ago. When he’s not hard at work interpreting the market, Byzov enjoys running with his dog and making paella.