Coffee Sits Near Lows

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About: iPath Series B Bloomberg Coffee Subindex Total Return ETN (BJO), Includes: ADZ, AGA, AGF, BALB, CANE, CORN, COW, DAG, DBA, FUD, GRU, JJA, JJGTF, JJS, JO, NIB, RJA, SGG, SOYB, TAGS, UAG, UBC, USAG, WEAT
by: Andrew Hecht
Summary

Coffee and sugar have been under intense selling pressure.

The Brazilian real weighed on prices.

Sugar bounces from the low.

Coffee could be next.

Demand limits losses in the coffee futures market.

The price of Arabica coffee beans that trade on the Intercontinental Exchange has been under selling pressure since November 2016 when the price reached a high of $1.76 per pound. Since then the active month futures contract on the ICE has done little but make lower highs and lower lows. Abundant supplies from producing areas around the world have weighed on the price of coffee beans. Additionally, since Brazil is the world's leading producer of Arabica bean, the fall in the Brazilian currency, the real, against the dollar has been another weight on the price of the soft commodity.

Demand for coffee beans around the world continues to grow at a brisk pace. In Asia, which is traditionally a region where drinking tea is the norm, coffee consumption has been rising particularly in China the world's second-largest economy. The price of nearby coffee beans on the ICE futures exchange hit a bearish milestone over recent weeks when it fell below the $1 per pound level for the first time in many years. Sugar is a compliment to coffee as many consumers sweeten their beverage each day with the other member of the soft commodities sector. The weakness in the prices of both coffee and sugar, both products where Brazil is the dominant producer, has created falling prices for consumers. However, both commodities have declined to the low end of their respective pricing cycles at their current price levels.

Coffee and sugar have been under intense selling pressure

The summer of 2018 was an ugly time for the prices of coffee and sugar as they both fell to their lowest prices in a decade or longer.

Source: CQG

As the monthly chart of ICE sugar futures highlights, the price of the sweet commodity fell to a low of 9.91 cents per pound in August which was the lowest level since June 2008. Sugar had not traded below the 10 cents per pound level over the past decade.

Source: CQG

As the monthly chart of ICE Arabica coffee bean futures illustrates, it had been an even longer period since coffee reached the price it visited during August 2018. Coffee futures fells to a low of 95.45 cents per pound. The last time the soft commodity ventured below the $1 per pound level was in September 2006, and the low in August was the lowest price since July 2006, in over one dozen years.

Aside from being members of the soft commodities sector of the agricultural raw materials group, coffee and sugar have another factor in common as Brazil is the leading producer and exporter of both commodities.

The Brazilian real weighed on prices

The dollar is the benchmark pricing mechanism for most raw materials because the greenback is the reserve currency of the world. On the Intercontinental Exchange, both sugar and coffee futures trade in U.S. dollars. However, in Brazil, the cost of production and amount received by growers and millers of the soft commodities are in the local currency, the Brazilian real. A stronger dollar against the Brazilian real tends to weigh on the dollar prices of coffee and sugar as the price in real terms does not decline as much.

While abundant supplies of sugar and coffee were bearish for the prices of the commodity, the falling value of the real added insult to injury over recent months.

Source: CQG

The quarterly chart of the value of the Brazilian real versus the U.S. dollar shows that economic and political issues facing the South American country and its neighbor Argentina took the real to within a whisker of its all-time low. The real was trading at the 0.32005 level against the dollar in early 2018, and it fell to a low of 0.23725 in August, a drop of 25.9% since earlier this year. The all-time low in the currency pair was at 0.23455 in mid-2015. The swoon in the value of the Brazilian real contributed to the August lows in the sugar and coffee futures markets as it cushioned the fall in the dollar-based prices.

Sugar bounces from the low

The sugar futures market has had an ugly year in 2018 as the price has done little but make lower highs and lower lows. The active month October futures contract hit a high of 15.43 cents per pound in early January. At the low, the price had dropped by 35.8%. However, the decline of almost 26% in the Brazilian currency cushioned the fall for local producers.

Source: CQG

As the daily chart of October sugar futures shows, the price has bounced even though the Brazilian currency remains not far off its recent low. Sugar futures rallied through the 11 cents per pound level on September 7, 10, and 11 and had rallied for eight consecutive trading sessions as a recovery is underway. The 50% retracement level of the move from highs to lows on the October futures contract in 2018 stands at 12.67 cents, which could be a target and level of technical resistance for the sweet commodity over the coming sessions.

Coffee could be next

Sugar recovered from the lows, and while coffee has done as well as the sweet commodity over recent sessions, the performance in sugar could be a sign of things to come for the coffee market.

Source: CQG

September coffee futures rolled from September to December, and the price of the new active month has recovered from lows of 98.65 cents to just over the $1.00 level as of September 11. Coffee has been making lower highs, and lower lows since November 2016 when the price reached $1.76 per pound, and the recent low below the $1 per pound level was a continuation of the bear market in the futures market. December coffee futures traded at a high of $1.4135 per pound in January 2018, and the 50% retracement level of the price range so far this year stands at the $1.20 level which could become a target for coffee when a recovery takes hold of the market. While the price of coffee declined by 30.2% from the highs in 2018 to the recent low, the drop of 26% in the Brazilian real has made the domestic price in the world's leading producing and exporting nation little changed over the course of 2018.

However, the recent price action in the sugar futures market could stand as an example for coffee which has declined to over a decade low.

Demand limits losses in the coffee futures market

I continue to favor both sugar and coffee futures these days as both soft commodities are at the bottom end of their long-term trading ranges. Commodities tend to fall to levels where production declines, demand increases, and inventories begin to fall causing prices to find bottoms. I believe that both coffee and sugar futures are at or close to those levels that will lead to significant price recoveries. Moreover, demographics when it comes to population and wealth growth around the world tell us that each day more people, with more money are chasing finite commodities supplies. In agricultural markets, wealth increases and dietary changes in Asia also provide support for the prices of both coffee and sugar for the future.

Sugar has displayed signs that it could have found a bottom in August as a recovery is underway. The price of October sugar futures has rallied from 9.91 cents in August to settle at 11.20 cents on September 10, a rise of over 13%. Meanwhile December coffee has only moved from lows of 98.65 to settle at $1.0125 on September 10, a recovery of 2.6%. On September 11, both sugar and coffee were trading a bit lower than the close on the prior day.

The most direct route for an investment in the coffee market is via the futures and options on futures that trade on the Intercontinental Exchange. For those who do not venture into the highly-leveraged and volatile world of futures, the iPath B Bloomberg Coffee Total Return ETF product (BJO) that replaced the old JO has been building liquidity. BJO has net assets of $57.11 million and trades an average of 43,443 shares each day.

Source: Barchart

As the chart shows, on Tuesday, September 11 BJO was trading at the $37.95 per share level, not far off its recent low at $37.31 per share.

Soft commodities like sugar and coffee have long histories as highly volatile commodities. Moreover, each year is a new adventure when it comes to production as crop diseases, and the weather can quickly turn a surplus in supplies to a deficit. Over the past dozen years, coffee has traded as low as its recent price at 95.45 cents and as high as over $3.00 per pound. Risk-reward favors the upside in the coffee market as ample supplies and a falling Brazilian real have combined to create a perfect bearish storm for the coffee and the sugar markets. I continue to believe that sugar will continue to get sweeter and coffee will percolate on the upside again, sooner rather than later, as both soft commodities had declined to the bottom end of their trading ranges during August 2018.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.