Friday, September 5, 2014

Coffee fundamentals defy dollar strength

By Andrew Wilkinson

Coffee volumes surge as weather threat sinks in

What do you trust most: the prospect of a continuation in the rally for the dollar or the weather in Brazil?

Investors lit a fire under the U.S. dollar (NYBOT:DXZ4) earlier in the week, lifting the dollar index to its highest since last December, and driving the euro down to its lowest price in a whole year. The typical flip side to a strong dollar is a wholesale weakening in commodity prices, most of which are priced in terms of the USD. A weakening dollar therefore tends to make commodity alternatives look more appealing.

A period of dollar strength could have the same effect on commodity traders as swimming against the tide. Perhaps the clearest illustration of the dollar-commodity dynamic was shown by the sliding price of gold, which fell to its weakest since June 2. It is worth noting, however, that it is difficult to disentangle the impact on the yellow metal of rising treasury yields at the same time investors were second guessing the timeline for monetary tightening at the Fed, as both factors tend to undermine the price of gold.

Still, gold traders might have been envious of coffee traders at the same time as prices for Arabica futures rose in spite of the currency impact. Coffee futures (NYBOT:KCV4) trading on the ICE exchange in New York surged by 4.1% to $2.0995 per pound at the start of this week before giving most of that back on Wednesday. It was the most expensive price since May, save a price spike one month ago, and accompanied by the highest volume on record for the year-end contract. The current price leaves Robusta coffee prices about 20% higher than it was just six weeks ago.

Chart shows December coffee futures

Coffee prices jumped due to dry weather in Brazil – the world’s largest producer – as traders projected lower crops resulting from an ongoing moisture deficit ahead of a time crucial for flowering. Earlier in the year too, the coffee market responded to hot, dry weather in Brazil and the negative implications for crop yields by sending coffee prices sharply higher (see earlier article from July 14).

Because it was difficult to judge the full extent of the damage from the adverse weather conditions, the market retreated, at least in the short-run. Coffee prices fell as shipments remained strong. However, as Ms. Ganes of J. Ganes Consulting noted in her Softs in Focus monthly report recently, the additional supply may be welcome, but warned that, “What need[s] to be considered are both sides of the ledger because if consumption growth is even stronger, a shortage could exist.”

Ms. Ganes points out, by way of example that Colombian output of coffee was battered for several seasons due to disease and poor weather, but production has now recovered. The weaker Brazilian crop for this year and expectations for a smaller crop in the 2015-16 season means that additional Colombian coffee supplies should have no problem finding a home. Yet, “the rise in production is not sufficient to offset problems elsewhere”, notes Ms. Ganes. She also argues that it was Arabica production that was impacted by the drought and not Robusta production, where Brazil even raised its exports to meet demand in the face of ongoing issues in India, Indonesia and possibly Vietnam.

Ahead, those shortages may ultimately weigh on Brazil’s ability to meet growing demand for the more popular Arabica bean. The 2015-16 forecast of 46 million bags for Brazil is 14 million lower than the abundant 2014-15 crop forecast predicted after trees flowered that season. That number of bags, states Ms. Ganes, is greater than all of Colombia’s production, which is why she suggests Brazil may have little choice but to curb its exports ahead. Brazil may not be able to rely on stock overhang because it will have been utilized in the face of unusual climatic conditions across many of the global growing regions. “The only way to ration this more limited supply and push hard on the brakes to slow the flow of coffee would be through higher prices”, Ganes suggests. “The market is beginning to acknowledge that business won’t be as usual in Brazil and there is little other coffee available to make up the shortfall”.   

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