Today #coffeefutures traded below 190c for the first time since July 2021. Despite #coffee prices hitting a high in the 260s back in Feb and then trading in the 200s for well over a year, looking at the chart it is quite clear that we are in a bear market and have been for at least 8 months.
Despite the current bear market, #calendarspreads remain inverted, #certifiedinventory has made new lows and the most recent #Brazil crop was worse than many had expected. So what the heck is going on in the #coffeemarket?
One of my constant refrains is that market is forward looking, and the future of coffee is not assured by any stretch.
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The biggest concern right is the certified inventory. The trend is bleak. If we project out the current trend of the certified stocks, then we will hit near 0 levels in just a few short months.
The last time certified stocks hit those levels in the late 1990s, calendar spreads inverted to a nearly 50c premium, and set the stage for a market that ultimately rallied to $3.
Additionally, spec longs are not super long on a gross basis, and seasonally we often see an increase in long positions through the end of the year.
However, even with all of the bullishness there are other factors at play here that are counterbalancing these.
The biggest of these factors is the 2023 Brazil crop. As the world’s largest producer of coffee, Brazil moves the market. It rallied us up to 260, and at some point, it will likely return us back to 120.
After a dismal on-cycle crop stung by #drought and #frost damage, the #flowering that just took place looked very promising and attention now turns to the setting.
Initial conversations on the setting with friends in Brazil support expectations for a good crop, but are disappointingly inconclusive. To paraphrase one friend: “According to the bulls, the setting was terrible. According to the bears, its amazing, best setting ever.” For now, we have to assume that things are progressing fairly well.
However, we can say two things conclusively: 1) the flowering and rains have been excellent and consistent, BUT 2) the plant’s physiology is “off”.
Regarding number one, the rains have been great, and the flowerings reported very good. The follow-on rains are exactly what we would want and support a good setting of the beans.
However, in regard to #2, the plants had a lot of stress from drought and frost in 2021, and perhaps excessive dryness during the harvest period of 2022. There is also the colder than normal (not freezing) temperatures that they endured during the winter.
We don’t know what this means yet.
The stress from the frost and dryness may actually induce a better harvest this year. As a survival mechanism, the coffee plant will often have a stronger harvest if there is good rain after a period of stress. However, excessive and prolonged cold can have a very negative effect on coffee and cause unseen damage. Many farmers considered this to be a major factor to the disappointing on-cycle crop that was just harvested.
This could go either way for the 2023 crop, but for now people in the market are focused more on the idea that the Brazil crop will be excellent. For our own part, we have a view of a very good, but not record crop. Somewhere in the neighborhood of 70 million bags.
Looking at the big picture, we are in the midst of a back-to-back global #deficit but looking forward to a #surplus year next year.
I mentioned that the market is forward-looking. This is because no one wants to be left “holding the bag.” If the market is bullish now, but will be bearish in the future, there is an incentive for people to sell early rather than try and squeeze out the last few cents out of the market.
Then we have the certified inventory.
The certs have sparked an intense inversion in the coffee futures market. But the Cert draw down has itself been started by high differentials, and high freight prices incentivizing the consumption of cheap coffees.
This dynamic has started to change. Freight prices are way down. They are 25% of where prices were at the highs. There are still delays at port, so this is not as cheap as the prices would at first appear, but they are still much cheaper than before.
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Additionally, the inversion has incentivized exporters to lower #differentials. This has slowed somewhat, but we can clearly see a change in trend. With the oncoming October crops from #Vietnam and #CentralAmerica and #Colombia, Brazil will soon face heavy competition for their coffee.
The other elephant in the room is the #macro environment. This has consistently basically been a negative for coffee lately. The strong USD and weak BRL has added significant downward pressure on coffee.
This currency dynamic is largely driven by a tight Federal Reserve monetary policy to contain inflation. This has some potential to reverse. This policy has been in place for 7 months now and historically the Fed Reserve has not kept up tightening cycles for very long. Granted, we are experiencing historic inflation and (GDP notwithstanding) the US economy is humming along strong. However, there are some warning signs that the economy could be on shaky ground.
Aside from the cooling effect of global interest rate hikes, there is also strong potential for tradewars, and I have been told that Europe and China’s economy may be in trouble. Given the interconnectedness of the global economy the US Fed Reserve may soon find itself faced with a Hobbesian choice of raising rates with a weak economy or moving back to a looser monetary policy which could hurt the dollar and boost prices.
Less dramatically, the Fed may be successful in their efforts to curb inflation and move away from a tight monetary policy which would weaken the dollar and boost commodity prices.
There are a lot of unknowns in the future that we in the coffee business must pay attention to. However, ultimately, I focus on the fundamentals of supply and demand. This is where my expertise lies and what I believe is the driver in the coffee market. We are in a scenario of tightness now, and that means the potential for rallies and volatility in the short term. Going forward the market will be paying more attention to the coming surplus and the health of the Brazil crop.
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