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Looking to the Futures

Supply Constraints Drive Coffee Futures to 13-Month High

Key Points
  • Coffee Market Could Enter Supply Deficit During Off-Year Dip in Production

The front-month coffee futures have spent much of 2019 below $1.00 a pound, wreaking havoc on producers struggling to break even. But November’s rally in coffee futures was the biggest one-month gain in over three years as global demand has exceeded expectations and supply issues dot the globe. The futures market can be an efficient lens to observe the convergence of coffee supply and demand data around the world.  

Public data from the CFTC released November 26 revealed that after two years of bearish coffee futures positioning, money managers had finally swung to a net bullish setup. This Commitment of Traders Report, released every Friday at 3:30, segregates investors away from hedgers and other market participants, revealing positions held by each class.   

If today’s early gains hold with the March coffee contract hovering near $1.265, we’ll see it moving higher ten days in the last 12 sessions, grinding out a strong price spike in excess of 18%. To illustrate the impact of the leverage that comes with futures trading, a long position opened November 19 with initial margin of $3,960 could have been closed this morning, sweeping roughly $11,000 back to cash. Needless to say however, a short position would have had bitter inverse results.   

Supply & Demand

Sizing up the global coffee fundamentals, analysts expect steadily increasing consumption, citing China as a main driver. Even with trade negotiations pitting China versus the U.S., the pursuit of a western lifestyle exists and a growing coffee culture exists. According to U.S.D.A. data, China’s consumption has grown nine fold over the last 10 years.

In a November report from the International Coffee Organization (ICO), a supply deficit of 502,000 bags was predicted for the 2019-2020 coffee year. Factors attributing to the equation in the near term include Brazil’s lower “off-year” production and poor weather in Central America and Asia. Recent weakness in the Brazilian real could offset some of the supply issues as it entices producers to export stockpiles quicker if they anticipate a falling real. Next year’s higher yielding “on-year” should help balance the market over the longer term.

Revisiting the on-year, off-year characteristic of arabica coffee crop cycles, there’s a unique “every other year” bumper crop followed by lower production in off years. The supply surplus on the heels of 2018-2019’s “on year” should pivot to a deficit with the smaller 2019/2020 crop. When Reuters polled analysts last February, the general consensus pegged bean prices recovering by the end of 2020’s by as much as 25%, which currently looks to be a fairly accurate call. It’s worth noting that all things being equal, known seasonal patterns or other repeating cycles typically do not provide opportunities to extract abnormal returns in the futures markets.

CFTC Data

Money managers have been covering shorts and trending to more bullish positions recently, with 3,315 net long contracts according to data released last Friday from the CFTC. As of November 26, net long positions existed for the first time since April 2017, marking a sixth consecutive week of increasing net bullish holdings amidst a market tone that’s as bullish as it’s been for a long time. As recently as mid-October the same crowd was carrying over 65,000 net short positions.

Coffee Futures

The Coffee C futures contract, the world benchmark for Arabica coffee, is on pace to set new volume records in 2019. The contract prices physical delivery of exchange-grade green beans, from one of 20 countries of origin in a licensed warehouse to one of several ports in the U. S. and Europe, with stated premiums or discounts for ports and growths.

While coffee is considered a relatively free and open global market, it is not without some extraordinary price volatility. According to the ICE, it is subject to supply disruptions such as freezes in the Brazilian highlands, and to new exporters buying market share via lower prices, as was the case for Vietnam in the late 1990s and early 2000s. Asian crops have been impacted by drought recently. With the intraday volatility of coffee futures being fairly high, the contract has been attractive to day-traders over the years.

Margin requirements for March 2020 coffee futures are currently set at $3,960 representing roughly 8.5% of the contract value. Options on coffee futures contracts are also available with strikes spaced 2.5 cents apart. Implied volatility is currently in the mid-20’s for short-dated, near-the-money options. For more information about coffee futures, call Schwab Futures at 877-280-6040.

Price Forecasts

When Bloomberg asked coffee analysts to provide yearly coffee price forecasts, the average estimates point to a market that may stabilize and move higher. Mean estimates for 2020, ‘21, ‘22, and ‘23 are $1.07, $1.07, $1.25, and $1.30, respectively. Current long-dated coffee futures reflect higher prices, with contracts expiring in 2022 trading from 1.38 - $1.42.

Looking back to the futures prices early this year, a strong contango setup existed. Contango is a situation where the futures prices are higher than the spot price, and can be present when spot prices are expected to rise over time. Prices for coffee have moved higher recently, even exceeding the upward sloping forward curve observed earlier this year. The contango setup still exists today as seen below.

Technicals March 2020 ICE Coffee C Futures

Hightower futures research encourages caution on rising stochastics and an RSI above 70, but bullish observations exist including daily stochastics and moving average analysis. Trading Central futures research observes upside potential as long as 123.15 is support. With RSI near 70 and March coffee above the 20, 50, and 200-day moving averages, they see a positive configuration existing. Bloomberg data shows that coffee is up about 19% quarter-to date.     

Resistance 2      128.90

Resistance 1       127.80

Pivot                    123.38

Support 1           122.75

Support 2           120.90

20-day SMA       122.80

50-day SMA       123.17

200-day SMA     123.21

10-day RSI          72%

Contract Specifications

Trading Calendar

Employment Report                                        12/06/2019 8:30 a.m. ET

Coffee Futures Options Expire                      12/13/2019

 

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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.

Hedging and protective strategies generally involve additional costs and do not assure a profit or guarantee against trading losses.

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