Did Coffee Just Turn Higher?
Summary
- An ugly bear market since before November 2016.
- A recovery and then a marginal new low.
- Consumption is rising.
- Production is variable, and the Brazilian currency could be bottoming.
- JO for those who do not trade futures.
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This week, the price of coffee traded to a new low at 91.25 cents per pound. While the price was just 0.75 cents lower than the September 2018 low, coffee futures had not traded below the $1 per pound level since 2006 before last August. At the lowest price in a dozen years, the price of coffee was on sale, and this week, the price got even less expensive which is good news for the many consumers around the world and bad news for coffee producers.
Many reasons have contributed to the price weakness in the coffee futures market. The dollar is the reserve currency of the world and the benchmark pricing mechanism for many commodities, and coffee beans are no exception. However, Brazil is the world's leading producer and exporter of Arabica coffee beans, and weakness in their local currency softened the blow of lower dollar-based prices making the move below the $1 per pound level possible. Additionally, the bearish trend in the soft commodity encouraged trend-following traders to sell the commodity short to profit from falling prices.
As coffee futures fell to a new marginal low this week, there are signs that a price recovery could be on the horizon. The most direct route for a trade or investment is via the futures and futures options that trade on the Intercontinental Exchange. For those who do not venture into the future arena, the iPath Series B Bloomberg Coffee Subindex Total Return ETN product (NYSEARCA:JO) provides an alternative.
An ugly bear market since before November 2016
The price of coffee had been a one-way street lower from November 2016 when the price of nearby ICE futures traded to $1.76 which was a lower high on the long-term monthly chart. 
Source: CQG
As the monthly chart highlights, the price of coffee had been making lower highs since it traded to $3.0625 per pound in May 2011. The all-time high in the Arabica futures market came in 1977 at $3.3375. A lower high followed 20 years later in 1997 at $3.118, and the 2011 peak was yet another lower high. The price of coffee has been making lower peaks for the past four decades.
The monthly chart shows that open interest and volume have risen steadily during what has been a bear market in coffee futures which is a technical validation of the trend. Price momentum and relative strength are declining in oversold territory.
While coffee has been in a bear market since November 2016, the pattern has been in place since 1977.
A recovery and then a marginal new low
In September 2018, the price of coffee futures fell to a low at 92 cents per pound which was the lowest price for the soft commodity since 2005. After breaking below the $1 level for the first time in a dozen years, the price followed through on the downside at which point it found a bottom. 
Source: CQG
As the weekly chart shows, when the price declined to the September 2018 low, price momentum was at the current oversold level, and the price took off on the upside to a high at $1.2550 per pound, just five weeks after the low. The sharp rise of 36.4% was the first time since November 2016 that coffee rose to a higher high on the weekly chart. However, the price failed, and coffee resumed its bearish trend. This week, the price fell to a lower low at 91.25 cents per pound.
While coffee moved to an even lower level in early April, there are reasons to be bullish for the price of the soft commodity. Price momentum and relative strength have declined to near the same level it reached in September before the corrective rally. Open interest is close to a historic peak at over 351,000 contracts which could mean that there is an overabundance of trend-following shorts in the market. The metric has risen to a higher level than in September 2018 before the last recovery rally.
At the same time, a closing price for coffee at over 96.40 cents per pound on Friday, April 5 would yield a bullish reversal on the weekly chart. Nearby coffee futures were trading at 95.60 on April 4 and hit a high at 96.95 which means that a reversal could be in the cards this week. Another sharp recovery to the upside in the coffee market is long overdue.
Consumption is rising
The demand for coffee is growing around the world for two reasons. The first upward pressure on consumption comes from the rise in the global population. Each day the world adds more potential coffee consumers. In Q1 2019, the number of people in the world rose by 18-20 million to over the 7.56 billion level according to the US Census Bureau. In 2000, the number of people on our planet was around six billion, so less than two decades later the population has grown by over 26%. More people in the world increases the addressable market for all food, and raw materials products and coffee is no exception.
The second reason for the increase in demand is the shift from tea to coffee consumption in Asia, most notably, China. With around 1.4 billion consumers, China is a significant growth area when it comes to coffee demand. Thousands of coffee shops have been popping up all over the world's most populous nation over recent years increasing the demand for the soft commodity.
While consumption is on the rise because more people, with more money around the world, have expanded the addressable market for coffee beans, supplies can be highly variable as the weather in critical growing regions, crop diseases, and currency considerations can impact the annual production of coffee.
Production is variable, and the Brazilian currency could be bottoming
Over the past years since coffee reached $1.76 per pound in 2016, over $2 in 2014, and higher than $3 in 2011, supplies have been abundant and have met the growing requirements around the world. The weather conditions have been suitable for bumper crops, and crop diseases like leaf rust and others have not impacted supplies. Brazil is the world's leading producer of Arabica beans, and a decline in its currency against the dollar has cushioned the price decrease in the coffee futures market. In 2018, the price of ICE coffee futures fell from $1.3135 at the start of the year to a low at 92 cents per pound, a drop of 29.96%. 
Source: CQG
As the weekly chart of the relationship between the Brazilian currency and US dollar shows, the real declined from $0.32005 to lows of $0.23725 over the same period, a drop of 25.87%. Therefore, Brazilian producers only experienced a decline of 4.09% in the local price of coffee beans which was far less dramatic than the fall in US dollar terms.
Bumper crops, a falling Brazilian real, and no crop diseases created an almost perfect bearish storm for the price of coffee futures in 2018. The stars would have to line up on the downside for a repeat performance in 2019 which has already gotten off to a bearish start with the new low at 91.25 cents per pound this week. However, the recent election in Brazil that put Jair Bolsonaro in office with a pledge to clean up corruption could result in a rebound in the value of the real currency which would provide support for the price of coffee futures.
At the same time, global demand continues to rise on the back of demographics and Brazil's 2019 coffee crop which is nearby harvest, should be at around 55 million 60-kg bags compared to the record crop of 61.6 million bags in 2018 according to Italian processor Illy. A lower crop and the potential for a rise in the value of the Brazilian currency could light a bullish fuse under the price of the soft commodity as it is close to its lowest level since 2005.
JO for those who do not trade futures
The most direct route for a position in the coffee market is via the futures and futures options that trade on the Intercontinental Exchange. However, the recent condition of oversupply means that the coffee futures market is in a significant contango meaning that deferred prices are at steep premiums to nearby prices. Therefore, purchasing deferred futures or call options contracts involves paying a higher price than nearby prices and rolling from one month to the next requires a substantial cost in the current environment. 
Source: CQG
As the forward curve for ICE coffee futures shows, the prices are progressively higher rising from 95.3 cents for the May 2019 futures contract to $1.32 per pound for Arabica coffee for delivery in March 2022. The crops for 2020, 2021, and 2022 reflect prices for coffee that growers have not yet planted.
For those who do not trade or invest using futures markets, the iPath Series B Bloomberg Coffee Subindex Total Return ETN product provides an alternative. The fund summary for JO states:
The investment seeks return linked to the performance of the Bloomberg Coffee Subindex Total Return. The ETN offers exposure to futures contracts and not direct exposure to the physical commodities. The index is composed of one or more futures contracts on the relevant commodity (the index components) and is intended to reflect the returns that are potentially available through (1) an unleveraged investment in those contracts plus (2) the rate of interest that could be earned on cash collateral invested in specified Treasury Bills.
JO has net assets of $75.38 million and trades an average of 59,204 shares each day. JO does a reasonable job replicating the price action in the coffee futures market. May coffee futures rose from 91.25 cents on April 2 to a high at 96.95 cents per pound on April 4 or 6.24%. 
Source: Barchart
Over the same period, JO shares rose from $32.81 to a high at $34.69 or 5.73%.
Coffee is likely at or near the bottom end of its pricing cycle. A continuation of the bearish storm that took prices to multiyear lows is a low odds scenario for the futures. Risk-reward favors a long position in Arabica coffee beans at under $1 per pound.
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This article was written by
Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup.
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Andy’s writing and analysis are on many market-based websites including CQG. Andy lectures at colleges and Universities. He also contributes to Traders Magazine. He consults for companies involved in producing and consuming commodities. Andy’s first book How to Make Money with Commodities, published by McGraw-Hill was released in 2013 and has received excellent reviews. Andy held a Series 3 and Series 30 license from the National Futures Association and a collaborator and strategist with hedge funds. Andy is the commodity expert for the website about.com and blogs on his own site dynamiccommodities.com. He is a frequent contributor on Stock News- https://stocknews.com/authors/?author=andrew-hecht
Analyst’s 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.
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The author is long coffee
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