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Coffee – darkest before the dawn

 

September 28, 2018

Just a few weeks ago the price of Arabica Coffee Futures plunged to a 12-year low, the bear market in coffee has been relentless, and it is decision time for producers. Many producers have been selling at a loss due to persistently low prices, some farmers have even stopped planting coffee beans altogether and switched to coca. Recently, the World Coffee Producers Forum met in Mexico City to address what many members consider to be a crisis in the coffee market.

Coffee prices have been driven lower by industry competition and strong harvest forecasts. Exporting countries like Vietnam, Honduras, El Salvador, Costa Rica and Cote d’Ivoire all increased production by over 10% between 2016 and 2017. Vietnam, the world’s second largest producer, traditionally plants Robusta beans but has been looking to further grow its market share by diversifying into higher-end Arabica. Colombia has lost market share due to adverse weather effects but is still the third largest producer in the world. Prices have slid on the expectation for a record harvest for 2018-19 by the world’s largest coffee producer, Brazil. The Brazilian harvest is expected to reach a record 60 million bags, which would be over 40% of the total global harvest.

Turbulence in the foreign exchange market and speculative short positioning have also battered the price of coffee beans. In Brazil political uncertainties, fiscal imbalances, and poor economic data have all contributed the real’s depreciation over the past seven months, which has coincided with the drop in coffee prices. A weak Brazilian real improves returns on dollar-traded commodities like coffee, which encourages hedging and puts downward pressure on prices. As speculators unwound long positions and put on bearish bets further selling pressure ensued.

Thankfully for coffee farmers, in the short-term, market conditions may be ripe for improvement. The Brazilian real has trended sideways since the end of August, resisting further depreciation pressure and suggesting that perhaps volatility has been priced in. Producers, facing uneconomic coffee prices, may hold onto their crops instead of selling, which would create an artificial market shortage and boost prices. Furthermore, as with most soft commodity markets, the weather conditions are crucial. According to the World Meteorological Organization there is a 70% chance of El Nino developing before the end of this year, which would adversely impact next year’s coffee crops. During the 2015-16 El Nino weather event a prolonged drought impacted crops in Brazil, Indonesia and Colombia causing coffee prices to spike. Even though markets are always forward looking, it’s important to remember the past.

The coffee industry has reached an inflection point, either coffee prices will rise or growers will shift crops. If coffee producers refrain from selling whilst countries are looking to restock inventories prices could be in for a bounce.

 

Disclaimer: Please note that while Valbury Capital has made every attempt to ensure the accuracy and reliability of the information provided in this document it can give no warranty of any kind.  The information provided is intended to be of a factual nature only and is not intended to amount to investment advice or to contain any form of investment recommendation. No person should rely on or use the information provided to form any investment decision.