Coffee Talk: Is This a Repeat of 2014 or 2011?

It isn't often the commodity world is dominated by coffee talk, but in true 2021 fashion that is exactly what has unfolded. This has been a year full of boom and bust commodity moves. That isn't unusual for the asset class, but the pace of the price swings has been unprecedented. In late May, I wrote a piece titled Coffee Is Up to Bat in anticipation of the 2021 bug biting the Arabica market but I certainly didn't expect the rally to be this unruly. In hindsight, I should have -- this is the post-2019 era in which there are no financial rules or rationality. Buyers act now and ask questions later. I suspect many readers are not familiar with, and have yet to trade, coffee in any capacity... although, I assume the majority drink it regularly. Coffee futures traded on the ICE Exchange are written against 37,500 pounds of Arabica coffee. Often referred to as the C market, this coffee future does not include higher-end specialty coffees. Instead, this is a commercial grade, but still delicious, coffee. If you are in awe at the contract size, I am right there with you. I purchase 10-ounce bags of whole coffee beans for the office, a single futures contract represents about 60,000 of such bags! Coffee futures are quoted in cents per pound which each cent representing $375 to a trader. Thus, if coffee futures move from 200.00 to 201.00, it has gone from $2.00 per pound to $2.01 per pound and a trader long the market would have made $375 but a short trader would have lost that amount (before considering transaction fees, of course). The margin to participate in coffee is currently $8,250 per contract, double what it was last year. Even so, with coffee at 200.00, the contract value is $75,000 (200 cents x $375), so there is quite a bit of leverage built-in. This can work both for and against traders but can be tamed by simply over-funding an account. For instance, trading a single coffee futures contract in an account funded with $75,000 accomplishes the goal of eliminating leverage. A happy medium is somewhere in between. In mid-2019, coffee prices were so low South American farmers were taking their lives in frustration over their financial ruin (sadly, this is not an exaggeration). Two years later, the surviving (no pun intended) farmers are no longer suffering from low prices but are facing a problem nearly as dire: freezing crops and dismal yields. Some large farms are expecting 70% to 90% of their previously expected yield to be ruined. To be fair, farmers are known for talking their book. They tend to overestimate crop damage and are often too optimistic about future prices. In any case, we doubt the rally is over. Exacerbating the chaos, Brazil has been battling social unrest and shipping ports are suffering from COVID-related staffing issues. The question we have is, is this a repeat of 2014 or 2011? In 2011 a freeze caused coffee futures to explode higher from a 2008 starting point of 100.00 to 300.00 in late-2011. However, the party was over by September 2011. Over the next few years, coffee prices dribbled lower toward 100.00. In 2014, a freeze pushed prices from the 100.00 area to a peak of 225.00, followed by a slide back to ground zero (100.00). Source: QST It should be noted that the 2011 rally was longer and larger than the 2014 rally. There are multiple reasons for this, but a big one is likely improved technology and more efficient growing methods. Remember, coffee crops are planted, cultivated, and harvested each year, so a supply issue can be alleviated in a few growing cycles. Further, although it might not seem so in a relatively obscure commodity such as coffee, the coffee trading industry is more sophisticated than it was in 2011 regarding transparency and market access. While it is difficult to acquire accurate and timely fundamental updates from South American growers (they don't have the logistics or infrastructure to compile and share data as we do in the United States), it appears as though the damage is expected to be at least as significant as that of the 2014 crop. With that in mind, along with the idea that commodity trends have seen follow-through thus far in 2021, we believe there are new highs ahead. We are looking for the run to extend to 225.00ish and will reassess there. We can't rule out a run to 250.00 but it won't be a comfortable ride regardless of the side being played. In both 2011 and 2014, there was volatile consolidation for several months before selling finally succumbed in September and October, respectively. So be nimble and try not to overstay your welcome.

Coffee Talk: Is This a Repeat of 2014 or 2011?

In a year full of boom and bust commodity moves, let's spill the beans on coffee's unruly rally.

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