Tags: Coffee | Bonanza | Brewing?

Coffee Bonanza Brewing?

Friday, 23 September 2005 12:00 AM

Dear MoneyNews Reader,

As Hurricane Rita prepares her witches' brew for Texas and its surrounding states this weekend, I have been reflecting on my

In it, I made the point that orange juice speculators might be unprepared for a more active hurricane season. Since that time, orange juice futures expiring in November have risen by 4.2%.

Commodity futures markets continue to intrigue me as the months go by. In particular, I've been watching a strange situation unfold in the coffee market - one I believe may present speculators with an opportunity.

Coffee plays second fiddle to oil as a foreign exchange generator for many developing nations. It is also the second most active futures market after oil.

The origins of coffee stretch back to the development of global trade in the seventeenth and eighteenth centuries. Of course, these days we have a number of coffee landmarks in the United States - places like Seattle, which gave birth to the 1970s "latte" culture, and Hawaii, where the first coffee tree was planted in 1825. Today that region provides some of the finest coffee in the world.

Coffee beans are a common primary product in lesser-developed nations, and coffee organizations have long been trying to permanently boost the price of this sought-after commodity. During a price slump between 2002 and 2004, the revenues of several producing nations failed to exceed production costs.

Today, as the popularity of coffee continues to grow, enhanced global demand is helping to boost the price of beans, thereby increasing coffee revenues in poorer nations.

In Brazil, per-capita consumption of coffee runs at 5.21 kilograms as the locals consume almost 40% of their own coffee crops. Demand increased 15% in the three years leading to 2004.

On average Europeans consume the same as Brazilians. Colder nations tend to drink more coffee per head. Finland, Denmark and Norway suck down almost twice as much as the French and Italians for example. But U.S. consumption is slightly lower - Americans drink 4.26 kilos per head.

On the one hand, the world is anticipating a shortage of perhaps 8 million 60-kilogram bags this year. On the other hand the price of Arabica coffee on the New York Board of Trade has slumped 13% since the year began.

Coffee prices, as measured by London's International Coffee Organization, are illustrated in the following chart, which depicts a slow-developing bull market for beans since July 2003. The ICO's composite measure takes the average daily price of a variety of beans grown around the world.

Since July 2004 coffee bean prices have jumped sharply from 57 cents per pound to more than $1 a pound.

The New York Board of Trade has a different standard of measurement on its benchmark "C" futures contract, but the story is the same.

There, coffee beans jumped from $0.85 to $1.51 per pound (a 77% spike) between August 2004 and March 2005. Since then, peak coffee has fallen back to $0.87 per pound. A single "C" coffee futures contract is worth 37,500 standard bags of Arabica beans from central and southern America, Asia and Africa.

I'm left wondering whether this recent low is a fantastic time to start looking further forward and speculating on coffee futures. Let's take a look at some of the driving factors in the coffee story.

But we have to tread carefully as we evaluate the current state of the market. Don't forget, we already saw a big run-up in price as traders evaluated supply and demand factors.

So the big question is: Has all available news been meaningfully discounted, and if so does an opportunity genuinely exist?

In 2004 coffee production totaled almost 115 million bags - a 10.6% increase over 2003. In August this year the ICO boosted its forecast for global coffee production to 108 million bags. So right off the bat, we will have less beans to play with than we did last year.

So have a look at where your coffee comes from:

These countries consume approximately one-quarter of the coffee that they grow. In 2004 that figure was 29.9 million bags, leaving 90.7 million bags available for export to other coffee-loving nations. Plus, some coffee goes into storage.

As at the end of August, LIFFE and NYBOT (these are commodity trading exchanges in London and New York) held 8.2 million bags in certified storage. Interestingly, coffee-exporting nations began 2005 with the lowest in-hand supply in 25 years. The amount of coffee held between 2003 and 2004 alone slipped by 29%.

So we have a mix of rising demand and a potential shortfall in the coffee stockpile that is unlikely to be satisfied by the dwindling supply.

With that, here's where coffee ended up last year:

This week India, the world's fifth-largest exporter of coffee, announced an expected 5% decline in output thanks to heavy rains followed by insect damage in August. 

That news comes hot on the heels of speculation surrounding the state of coffee beans being stored at the Port of New Orleans. The Louisiana facility is the nation's leading commodity-handling port.

While Hurricane Katrina left her mark all over the southern states, she took an especially harsh toll on the all-important Port of New Orleans. In its August report, the ICO detailed that warehouses there are holding 1.6 million bags of coffee, which represents 27% of the total volume of U.S.-held supplies.

This week officials from the New York Board of Trade are set to inspect the New Orleans warehouses to get a better handle on the state of inventories held there.

A local business contact here in South Florida wondered just how bad the state of coffee stocks in New Orleans was. As the largest private producer of coffee in the United States - which includes his 1,100-acre Hawaiian plantation - John Parry of Gold Café confirmed my analysis and approach to this $180 billion dollar-a-year futures market.

Having actively dealt in coffee beans for more than 25 years, John described how the futures market has changed slowly during the last decade.

He identified three distinct evolving characteristics that have in part caused a parting of the waves when it comes to supply and demand:

He noted the rise in the daily trading range as evidence that major players were toying with the market.

This final point helps to explain the proliferation of a second-tier market. This lower-level arena, while reliant on pricing from the New York "C" futures contract, is developing its own head of steam. John estimates that this portion of the market stands at a healthy 30% and is growing rapidly.

This market segment is important because it commands a premium above the benchmark "C" contract of as much as 30% -- and even more. But that premium is dependent on the quality of the bean.

John is a purist and insists on only the highest quality product.

His roasting plant is a testament to his stringent standards. Here he maintains strict control over his inventory, packaging only the highest-quality products for shipment. But first and foremost, he starts by buying only the finest coffee beans. He has cultivated relationships with local farmers in Costa Rica, Guatemala and Ethiopia over the years and when we met, he described the individual microclimates that made him pick one particular plantation over another.

As I dug deeper into the specifics of the coffee business, I began to realize that prices have fallen out of line with what's going on in the real world.

John agreed with me, explaining that this week we have seen coffee at its lowest price in a year.

"It's hardly rocket science. You don't need to be that bright to realize that this is a great buying opportunity," John said.

"Can it fall much further? Possibly so, but the farmers will be operating at a loss."

For that very reason, just a couple of years ago many farmers switched to growing mangoes and other fruits on their plantations.

It remains to be seen whether the NYBOT officials' visit will confirm damage to stocks in New Orleans.

But regardless, traders are focused on a potential increase in the supply of Brazil's milder Arabica variety as the flowering season approaches following a frost-free winter there. In Vietnam - the largest supplier of the bitter Robusta bean - crop gathering will begin in several weeks.

These two events have recently dragged prices lower. To my mind, weak prices are the result of developing nations' lack of collective bargaining power when it comes to selling their coffee.

But at the end of the day, the rising global demand for coffee will inevitably force prices higher. Add in demand growth for the specialty bean, and the fundamentals could be slowly shifting toward the prospect of a bullish coffee market.

As I search for reasons why a fundamentally imbalanced market might be ignoring both demand increase and falling supply position, I note one final piece of evidence in the futures market: Many of the speculative longs may finally have been shaken out of the market.

The Commodities and Futures Trading Commission (CFTC), measures the number of industry and speculative positions reported across the coffee market. For every buyer there is a seller, and as activity increases, open interest grows in the marketplace.

According to weekly data, open interest among coffee bulls has been falling steadily since the market hit its peak in March.

That means that longs have been taking profit and then exiting the market. And bullish views have been hard to establish since other traders - both commercial and speculative - are already long and trying to get out of the market.

Hence the recent price declines.

But it looks as if open interest has fallen significantly now and a fresh bout of buying might actually see prices stick.

December 2005 coffee on the New York Board of Trade closes the week at $0.93 per pound after registering a low of $0.86 this week.

If my analysis holds up, we could see a significant rally before year's end - into the $1.05-$1.10 region.

As John Parry told me, while he'd like to lock his costs in at current prices, he can't hedge his bets too far forward in time - just in case he's wrong that we are seeing a low point for coffee prices.

As John so eloquently stated - you can be right about the market and buy during the troughs, but you might also be wrong and get dragged down, having paid too much.

For him, it's all about being able to roast another day.


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Dear MoneyNews Reader, As Hurricane Rita prepares her witches' brew for Texas and its surrounding states this weekend, I have been reflecting on my In it, I made the point that orange juice speculators might be unprepared for a more active hurricane season. Since that...
Friday, 23 September 2005 12:00 AM
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