Why Arabica Coffee is Heading Higher…Much Higher

The darling of this year’s commodity markets, arabica coffee, which at one point reached a return of 90% since the start of the year, has been taking a beating lately. On Friday, the July 14’ ICE coffee (KC) contract experienced its biggest one-day drop since 2011 of more than five percent, this after jumping 12 cents higher Thursday following Brazil’s Confab bureau announcement which cut the total coffee production estimate to 44.7 million bags.

The volatility has been wild in the past few months to say the least and it will probably continue, especially as the long-awaited harvest reports from Brazil start trickling in later this month.  If these initial reports come in more positive than expected, we can expect coffee to keep grinding lower in the short term.

Looking at the July 14’ coffee chart, major resistance sits at the March low of 166. If that breaks, the technical momentum could quickly end this bull market faster than it started. Yet I believe the reality of the dwindling supply situation will reassert the bullish trend and push prices back well above 200.

Did coffee double top or is this a pause in the long-term bull trend?

Did coffee double top or is this a pause in the long-term bull trend?

But don’t take my word for it.

Judith Ganes-Chase, a long-time soft commodities analyst, told Agrimoney.com last week “In all my 30 years of covering commodities, I have not seen anything like this before” in reference to the supply concerns for coffee. She argues that the remaining estimated stocks for Brazil are not of good export quality, meaning that the supply cushion expected to absorb the drought losses may be worthless to buyers.

If she’s right, we may very well see prices top 300, perhaps even test the all-time high set in 1997. But right now the market is focused on global stocks estimates, with other analysts claiming the Brazil drought is already priced in along with other bullish news including El Nino, roya problems in South America and the replanting of robusta trees in Vietnam.

If you’re a long-term bull like me, sit on the sidelines for now until we can establish another upturn. For the bold, try to ride out the uncertainty with a very wide stop.

The risk is big but the reward could be much, much larger.

Wake Up and Smell the Coffee Bull Market

Last fall I wrote about the possibility for a correctional bounce in arabica coffee after a nine-month-long bear trend that took the price of coffee down around $1.00/pound. That little correction turned out to be a major turning point for coffee, setting off a bull trend that more than doubled the front-month contract price by March.

When coffee analysts and traders were unanimously bearish (including yours truly) last November, it marked a major bottom. Weather served as the main agent of change, as is often the case with agricultural commodities. The major growing regions of Brazil experienced a serious drought at the beginning of the year, setting off a dramatic and swift rise that may well run coffee to $4 or higher.

In just a month, talk of another year of oversupply has turned to one of scarcity.

After hitting almost $2.10/pound, coffee experienced a near perfect Fibonacci correction to its 68.1% retracement level. Some recent rains and some choice comments from Starbucks CEO Howard Shultz in Reuters where he said the market “significantly overreacted,” to the Brazil drought news helped knock down the price. And just last week Starbucks announced the reduction of some retail coffee prices. Ironically, the May arabica coffee contract shot up more than five percent on Friday (the day the Starbucks pricing news hit the press) breaking out of its two-week-old consolidation pattern.

According to analysts, there was nothing fundamentally noteworthy to precipitate the advance, arguing that the jury is still out on the level of crop damage in Brazil.

The May Arabica Coffee Daily Chart Looks Poised For Another Run Higher

The May Arabica Coffee Daily Chart Looks Poised For Another Run Higher

Will the breakout on Friday I’m willing to take a chance and go long, placing my stop below the March low. However, for this one I’ll be looking at the iPath DJ-UBS Coffee Subindex ($JO). The volatility can be extreme during coffee weather events and I’ll be better able to manage my risk…I hope. Coffee opens hours before the stock market and price action can lead to big gaps.

Coffee Consolidates; Where will it Go Next?

A few weeks ago I made a bullish case for Arabica coffee based solely on the technical aspects of this particular market. From a fundamental perspective, Arabica coffee remains decidedly bearish. Despite devastating flooding in Vietnam this past weekend, which mostly affected Robusta coffee plantations, it does not have any obviously bullish tailwinds.

The market sentiment was best summed up in Bloomberg last week by a broker in Brazil:

“There’s so much coffee around, all over, that it will take at least one year and a half for supplies to diminish and prices to start rebounding,” said Roberto Higgins, a director at Guide Investimentos SA Corretora de Valores, a broker in Sao Paulo. “There’s nothing bullish in this market.”

Despite the bears, the market may be setting up for a bullish breakout this week.

On the daily chart $KC_F the front-month coffee contract has consolidated after touching a low of around $1 per pound hit on November 7, bouncing between multi-year support and resistance at $1.06.

In the March 2014 contract, prices appear more bullish. Holding a premium of about four to five cents above the December contract, March registered a new November high close at $1.0955 today, briefly touching above $1.10.

If the March contract can extend its winning streak and close above resistance at $1.10, the market may attract more technical buying and short covering, propelling the market into the teens. A failed breakout will allow the market to test the multi-year low set a few weeks prior.

March Arabica coffee consolidating near multi-year lows

March Arabica coffee consolidating near multi-year lows

I’m betting that the market will break out this week, but I’m not confident, as an increase in volume has not accompanied the two-day rise. Midweek is looking like a make-or-break period for coffee prices.

Full Disclosure: I’m long coffee.

Previously: Coffee Futures Losing Streak Hits Nine Months and Counting

Coffee Futures Losing Streak Hits Nine Months and Counting

I have never once traded coffee, but for those that have shorted the front month ICE coffee “C” contract during the past few months or even years, life is good…very good. It would be tough to imagine any scenario where a short didn’t make at least some money.

Life is also good for coffee purveyors, especially Starbucks. The Seattle-based company can lower prices to garner goodwill with customers while maintaining its healthy markup…or not. Starbucks just capped off the company’s best year in its 42-year history, said CEO and Chairman Howard Shultz at the fiscal Q4 earnings conference call last week. Store foot traffic also increased by 5%. Outside of China, customers clearly are not pining for reduced-priced coffee.

For coffee producers, the red ink is quite concerning and all signs point to more selling. The front contract has lost two thirds of its value since peaking in May 2010 at $3.08/pound. But looking at the historical context of coffee, today’s price of $1.04 remains higher than five years ago when prices touched $1.02. (See the five-year monthly chart for reference, below).

Coffee's rise and fall, 2008-2013

Coffee’s rise and fall, 2008-2013

Looking at the technicals, the chart looks like a bubble that popped, and with coffee mired in a deep bear market with seeming no end in sight, is the bottom near?

Your guess is as good as mine.

As the market is vastly oversold, one could not be surprised by a technical bounce sooner rather than later. However, I am not one to make that bet, at least not yet. Should the market continue its trend, battle lines will be drawn at long-term technical support at $1.02 and $1.00. Breaking these multi-year support levels may precipitate more selling and the fundamentals—barring any weather-related disasters or freak warehouse fires in the near term—will back up these sellers. The chart itself denotes a rather orderly selloff extending more than two years; the downtrend looks strong.

But, the time for me to short has passed. I have missed the trend, as they say. Instead, I will sit patiently with my morning coffee and wait for a bounce. I may need to get comfortable. It could be awhile…

Have any thoughts on good old “C”? Leave them in the comments below.