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Weather-Driven Rallies - Coffee Goes Bananas

The top performing commodity so far this year has been coffee, which erased almost two years of declines within a few weeks in a rally driven by news of a worsening drought in Brazil. As the Guardian reports:

"Don't panic. But there could be a global coffee shortage. Usually, during this time of year, the delicate arabica coffee plants in the mountains ofBrazil, where most of the world's coffee comes from, are maturing. White, fragrant flowers have appeared, followed by cherrylike fruit, each containing two seeds: arabica coffee beans, the most popular in the world.

But last month the worst drought in decades hit Brazil's coffee belt region, destroying crop yields and causing the price of coffee to shoot up more than 50% so far this year. The drought is historic, forcing more than 140 cities in Brazil to ration water. Newspapers reported that some districts are receiving water only every three days.

For now, retail prices for coffee are stable. Roasters typically have enough supplies to cover themselves for a few months. But if the price of the arabica beans continues to rise, consumers could start seeing the cost of their morning coffee creep up later this year, according to Jack Scoville, a futures market analyst specializing in grains and coffee, among other commodities.

(emphasis added)

Coffee prices are traditionally driven by the weather. The usual pattern is for prices to rise sharply when there is unexpected frost in one of the major Brazilian growing regions. Droughts are actually a bit of an exception, but the current dry spell is happening at a decisive time of the year, when the coffee plants apparently need moisture the most.

Since coffee prices are always weather driven, the rallies tend to be swift and spiky, and are as a rule followed by long, drawn-out declines. Coffee, so to speak, becomes a 'get rich quick' scheme every few years. The current rally has been big, but if the drought continues, it could easily become even bigger, considering the historical trading range. It is also worth mentioning that global coffee demand continues to grow, a side effect of economic growth in emerging markets.

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Coffee, daily, the active May contract. The rally since the low in early November has erased almost two years of declines.

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Coffee, monthly (nearest contract): there have been several spike rallies due to unfavorable weather in Brazil over the years - usually they are followed by long, drawn-out declines. The recent rally has been big, but if the current dry spell continues, it could get even bigger.

Gentlemen Don't Trade Oats

"Gentlemen don't trade oats!" Allegedly this is an old saying from the CBOT dating back to the 1880s - we are however not 100% sure about the source. All we know that along with "oats know", it has become one the sayings every trader has heard at some point. More recently we read that the idea behind the saying was that the market in oats was very easily manipulated, hence gentlemen should stay away. The second saying is meant to indicate that oats tend to lead rallies and declines in the grains complex.

Anyway, so far this year, oats are not only the second strongest commodity due to delays in rail shipments from Canada. The delays are due to the recent cold weather and the need to move very large wheat and canola crops. Apparently there is now a shortage of rail cars as a result. Oats have actually hit at least a 25 year high and probably an all time high.

First the daily chart showing the "active" March contract (on Friday, 217 contracts traded, hence the quote marks).

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Oats, daily (March contract). Oats have been on a tear due to problems with rail shipments.

The long term monthly chart shows that this is probably an all time high (we're not sure where oats traded in the 1970s, but all grains have made new all time highs over the past decade or so, and oats are probably no exception).

Of course oats seem rather overbought by now, and as soon as rail shipments resume, front month prices will probably readjust rather quickly.

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Oats, monthly (nearest contract) - entering uncharted waters.

Gold Misbehaves

Below is a complete list of the year-to-date performance of all U.S. listed futures contracts (including financial contracts). It is noteworthy that the best performing futures contract not influenced by the weather is actually gold. Gold? Wasn't it 'certain' to go down due to 'tapering'?

Actually, we are beginning to lean toward a higher short term target than the previously mentioned $1,360 level - and it has nothing to do with recent geopolitical upheavals (price increases due to geopolitical news are always given back quickly once the situation calms down again; we have no idea why anyone would think such news are a good reason to buy gold in the first place).

The idea is actually based on an anecdotal observation. When gold suffered a brief pullback last week, a veritable flood of bearish commentary poured forth in the mainstream financial press (we counted altogether six different such comments and/or articles on Thursday alone, and we didn't even have much time to look around on that day, so we have probably missed a few). It seemed as if almost all the analysts who have expressed their bearishness late last year felt the urgent need to come out to reaffirm their stance. When a routine pullback is immediately greeted with so much skepticism, it is usually a sign that the rally has further to go.

Meanwhile, large speculators have continued pulling back on their gross short position in the gold market, while adding slightly to their longs. Contrary to standard lore, we regard this as a bullish sign.

Readers may recall that we frequently expressed our misgivings about the growing big trader gross short position last year, noting that it was not a bullish sign. In the meantime, the gross short position has declined to just over 60,000 contracts, leaving big speculators about 110,000 contracts net long, which is still 140,000 contracts below the highs seen in the course of the bull market. Small speculators finally went net long as well, but their net long position is still one of the smallest of the past 13 years.

Having said all that, it should be pointed out that the rally that failed at the $1,430 level in the second half of last year saw very similar developments in trader positioning. We believe though that this level is actually a target that could be reached in the course of the current rally (after some to and fro near $1,360, the initial target).

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The complete list of year-to-date gains and losses in U.S. listed futures contracts.

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Gold, April contract. The recent pullback was greeted with an unusual number of bearish pronouncements.

Mind, in the short term there could still be a further pullback in the cards - but as long as the $1,270-$1,290 area holds, we think gold is good to go further. The targets are simply derived from where rallies stopped previously, as these levels should provide strong lateral resistance.

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Possible targets for the recent rally in gold. Given that there is so much skepticism, the higher of the two targets actually appears to be attainable.

Conclusion:

Quite a few commodities have 'woken up' this year, but there is nothing that indicates that the market's views about global economic growth have improved. On the contrary, economically sensitive copper is one of the biggest losers year-to-date. Mostly the rallies seem weather-related, or are actually tied to signs of economic weakness rather than strength (gold, treasuries). The big exception in the industrial commodity space is crude oil, which has strengthened markedly again (natural gas prices have been driven by the cold weather as well). Crude oil inventories have recently delivered a few downside surprises, so the strength seems largely related to supply issues.

Charts and tables by: BarCharts

Source: Year-To-Date Commodity Winners