The #Arabica #coffeemarket has rallied to unprecedent highs this morning, surpassing all-time highs of 330c by hefty 16c while breaking towards 348c on the highest of the day. In this article, we analyze this historic market rally, and walk through the catalysts and timeline.
Insights From the Fundamentals
Today’s breakout was likely sparked by a major tradehouse publishing a reduction of its Brazil Arabica 25/26 forecast by 11 million bags. The timing here is critical. Brazil reportedly has very limited inventory and farmers are currently dictating prices amid the coffee scarcity. The global market had been hoping that the 25/26 crop would offer some relief. Unfortunately, harsh weather during the previous harvest has been making agronomists more and more pessimist about the prospects for 25/26. The announcement from the tradehouse has cemented this pessimism and put a particularly steep number on it.
As a result, this disappointing crop outlook bolsters concerns about tightness extending into 2025, with the expectation that the upcoming crop won’t offer much relief to the situation that Brazil finds itself in.
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For our own part, we recently (late November) took a trip to Brazil’s South Minas , the heart of the Arabica growing regions. We confirmed with our own eyes and sources on the ground that Brazil has limited stocks until the next harvest, and that the crop was significantly damaged by drought and heat. We sent a detailed report to our clients (LINK TO premium blog) elaborating on our findings.
While this is a fairly bullish mix, forecasting the future is an uncertain science that deals in probabilities rather than certainties. Even when prices were above 300c, the market was still evaluating prospects and trying to separate hype from fact. Conventional wisdom is that November is usually early to be making bold predictions about the crop, but at this point it seems that extensive damage is becoming more clear.
When testing technical resistance at the chart’s all-time high of 330c this week, the market needed a catalyst to break through that threshold, which seems to have come with the public confirmation of a crop that’s much worse than initially expected.
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To add to the confusion, Brazil exports and public inventory levels (certs, Europe, Japan) are prime examples of the disconnect between public data and the reality on the ground. Even though stocks are tight, Brazil exports continue to exceed average levels by a wide margin. However, this isn’t a sign of abundant supply, but rather of high prices inspiring deals months ago. Numerous delays have shifted exports forward that would have been shipped in August and September.
If the inventory in Brazil is as tight as the sources suggest, then we should see exports dramatically decline in the coming months. This is very similar to what we saw in Vietnam last year. Exports were very high out of Vietnam on account of old business being done forward, but stocks were reportedly very low. Sure enough exports collapsed not long after.
Meanwhile stock levels in Europe add further confusion and disconnect with he publicly available data. Inventory levels are reported at very low levels by the ECF, but this does not match reports from ground. The ECF stock reports inventory levels at 8.67 m bags, far below the 5 year average, yet reports from European importers suggest that warehouses are full of coffee and that there is difficulty finding storage. This seems very likely as the importers were building up inventory in advance of the EUDR regulations that were expected to take effect in January.
Brazil differentials are rallying, as farmers are either sold out, or holding back sales confirming the shortage of coffee in Brazil and disappointing expectations for next year. Yet despite this, certified inventory levels are actually increasing. This is unusual as Brazil is the new de-facto quality of certified coffee as it is typically the cheapest available. With differentials rallying, and well above tenderable parity, we would expect certs to decrease as consumers pull certified coffee to consume in place of expensive fresh coffees.
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Its possible that certs are increasing on account of increased financing needs on the part of the trade. With the market rallying to historic highs, trade hedges on physical inventory positions (short futures) are demanding increasingly large amounts of credit to maintain. Many banks “like” certified coffee on a company’s balance sheet because it is easily liquidated in the case of default. Therefore, the increase in certs may be reflecting the increased demand for credit by short hedgers.
Calendar spreads behavior seems to confirm the Brazil shortage and poor expectations for the next crop. Spreads have been rallying, and so the inversion has been intensifying, particularly so in the back months of K/N (+5.5c) and N/U (+7.8c).
These contracts will be traded during the harvest, and the rally in them can be interpreted as the market expecting Brazil to provide less coffee in the 25/26 harvest.
What About Hedge Funds?
Technically, the market is decisively bullish, with no signs of weakness. The RSI above its 70 threshold and its MA underscores the strength of the bullish momentum. Moreover, the breakout above 330c today opens the market up to blue sky, an area of no visible resistance levels that tend to hinder further gains.
Hedge funds are trend followers by default. Many are outright quantitative/systematic traders who trade momentum. However, even those trading on fundamentals can only trade in size when they are trading in the direction of the trend. This is because (despite the name “Hedge Fund”) Spec trades are not “hedges” and so a hedge fund cannot pay significant amounts of margin before they have to cut positions.
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In Short, they can only meaningfully add to positions when the market is moving in their favor, or they will run out of capital.
Although the Specs are long and have no immediate catalyst to sell, they have much more room to sell than to buy by historical standards. On a multi-year view, this is a major bearish risk - but they lack the incentive to do so in an inverted market that has a well-established bull market, which would make a case for technical buying, if there’s available capital to do so.
The larger risk, as we have said before, is from the industry.
The massive rally ultimately exposes the industry to risk, leading to potentially major financial problems. Trade houses and exporters are lifting their short hedges (-7.9k lots last week) because of liquidity problems with the high prices. This may be a factor in driving the rally. There are still 98k lots of industry short hedges in the market, and the more KC rallies, the more likely it is that they need to lift those hedges.
Roasters have roughly ~57% of the coverage that they would typically have by this time of the year (judging by the 5Y avg of their positions) and so they may need to secure some coverage and actively buy from specs, even at high prices.
Although the current rally is indeed impressive, and one for the record books, the caveat is that these are not true record prices. When Arabica reached 330c in the past (in the 1970s and 2010s), the "real" price of coffee was significantly higher due to inflation, meaning that 330c coffee back then was worth much more than it is today.
Whether or not Arabica's bullish run is near its ending or closer to the middle is up to debate. As is always the case in coffee, there are arguments for both sides.
However, the true “nightmare scenario” has not been realized yet. This is a lesson we can see from the Cocoa market. In the Cocoa market, like in the coffee market we had a very long speculator position, an underbought consumer and trade with short hedges. The market became so bullish, that we saw something highly unusual, the spec liquidated longs into a rising market.
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As mentioned above, this almost never happens. The spec trades in the direction of the price, not against it. However, the cocoa shortage was so great that the trade had to buy out the spec and this was the final and most dramatic leg of the rally. The price of cocoa exploded from $4000/MT (the 30 year high) to nearly $12,000 /MT in just a few short months. This was more than double the previous 1977 high of $5,104/MT.
Now I can’t say for certain one way or another whether coffee will unfold in a nightmare scenario like cocoa did. However, it is most definitely a risk. What I can say for certain is that right now the market is trading emotionally. This doesn’t necessarily mean irrationally, but fear and greed are in full effect. When the market is this volatile, those who have not accounted for these scenarios in their price risk management plans are extremely vulnerable.
They will be forced to make rapid decisions under very difficult circumstances. They say that the market often moves to the point of maximum pain. Right now, the market is searching for where that is.
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