Coffee: After a dramatic sell-off, coffee could start to percolate again soon…

November 13, 2014

As posted on CQG.

Coffee: After a dramatic sell-off, could start to percolate again soon…

The price of coffee has been extremely volatile lately. Back on October 6 active month coffee futures made new multi-year highs at $2.2550 per pound- a pretty astounding price move considering that coffee traded below $1.20 on January 2, 2014. A drought in Brazil, the world’s largest producer of coffee beans lifted prices and has kept them high for most of the year.

The technical picture

The rally to above $2.255 per pound encouraged speculative buying in the futures market, the price seemed set to challenge all-time highs established in May 2011 at $3.0625 per pound. Then, all of a sudden, the music stopped.

20141113 Coffee

As the chart illustrates coffee made a new high in October just a few cents above the April highs and then tanked. Open interest built to almost 174,000 contracts on the rally in September and early October only to disappoint the longs when prices turned south. Since the highs- open interest, the number of open long and short positions, has dropped to just under 164,500 contracts. The price correction lower has flushed some speculative longs out of the coffee futures market. Momentum and relative strength indicators are currently saying that coffee is oversold. Daily historical volatility has dropped to the lowest level in many months. In addition, there is a gap on the daily chart. The low price on Friday October 17 was $2.0850. Coffee only traded up to a high of $2.0635 on the next trading session, October 20. This created a gap on both the daily and weekly coffee charts. In the world of technical analysis, price gaps usually are filled.

The fundamental picture

Supply and demand fundamentals that lifted coffee prices in 2014 remain issues. Although there has been some rain in Brazil, overall dry conditions continue to plague the country. Brazil is approaching the December start to its summer rainy season with a severe water shortage. More than 10 million people across Sao Paulo state, Brazil’s most populous region, have been forced to cut water use over the past six months. In coffee growing regions, last year’s drought has damaged many coffee producing regions. To add insult to injury leaf rust, a devastating coffee fungus, is plaguing growing areas in Central America. The supply side in the coming months, given fungus and dry conditions, is certainly weak at best.

On the demand side, worldwide consumption of coffee continues to increase with population growth. In Asia, coffee popularity continues to grow at the expense of tea with trendy coffee shops springing up everywhere. I was in New York City last week and I could not help but notice that there are now more Starbucks and Dunkin’ Donut shops around the city than bars. On some blocks there are more than just a few coffee shops with coffee consumers lined up for their daily, or hourly, fix.

The bottom line

Coffee futures can be very volatile. The price has come down dramatically over the past month. Right now, coffee futures are oversold and volatility has dropped. Lower volatility means lower option prices. I believe that coffee prices will start to percolate again soon. This may be the perfect time to pick up some call options on coffee futures; the fundamentals are still strong from both a supply and demand standpoint. The rally that began last year may really start to reassert itself, particularly if those expected December rains in Brazil fail to materialize.

CQG Article: Coffee: After a dramatic sell-off, could start to percolate again soon…

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