Wednesday, April 13, 2011

Speculation in the Coffee Market - Apr 13th

Speculation in the Coffee Market
Concepts in Futures Trading
April 13th, 2011

Coffee continues to outperform most other commodities, holding up relatively well during yesterday’s broad selloff, and leading the pack to the upside this morning.  This rally is supported on many fronts; increasing demand from emerging economies, declining stockpiles, and a weakening U.S. dollar.  As will be discussed below, there is room for this uptrend to continue going forward.

July Coffee Futures – ICE
Courtesy of Bloomberg

Declining Inventories and Ending Stocks

Closely watched ICE warehouse stocks, those deliverable against Arabica futures, have been on the decline for 29 consecutive months, and are now about a third of what they were in the fall of 2008 when they began to fall.  World ending stocks have been trending lower since 2002.  Generally, the world coffee market alternates between years of surplus and years of deficit, due to the bi-annual coffee crop cycle.  Coffee yields vary from year to year, producing more beans one year, and less the following year.  This past season was the good crop, meaning the 2011/12 crop will be smaller, and significantly so.  While coffee production worldwide is steadily increasing, it has not kept pace with rising demand from growing economies.  Brazil, the world’s top producer, is now the third largest consumer, after the EU and the U.S.  The trouble with coffee, unlike some other agricultural commodities, is that it takes years to develop new growing areas, so production cannot quickly respond to rising prices.  That is the fundamental backdrop, but today’s blog is about another aspect of the coffee market:  Speculators.

CFTC Commitment of Traders

One of the things that commodity traders watch closely is the weekly Commitment of Traders report released by the CFTC.  Traders who take positions exceeding reporting limits, set individually by the CFTC for each particular market, must report their holdings.  This information is made public each week, and gives traders a clear indication of who is buying and who is selling.  The group that is of most interest is the Non-Commercial Large traders, usually interpreted to represent the large speculative community of CTAs and other hedge funds.  This group is viewed as a good indication of the sentiment of the speculators trading the market.  Below is a chart of the net position of this category of traders, overlaid against the price of coffee.

CFTC Large Non-Commercial Traders, Net Position
Courtesy of Bloomberg

The chart shows that large speculators amassed a sizeable long position in this market during the summer of 2010, and have been liquidating their positions throughout 2011.  During the liquidation, coffee prices have held up, and have actually risen over 16 percent.  This is often construed as a bullish development, as the market continues to strengthen despite shifting sentiment and selling pressure.  In this situation, those traders that focus on sentiment will anticipate the speculative community will turn bullish once again, realizing they exited the trade too early, and push the market up further with renewed buying. 

I present this chart to illustrate a concept, not to recommend a specific trade.  Stay tuned to Futures Commentary for a follow-up discussion once this divergence of sentiment and price action resolves itself.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

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