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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Should Venezuela Default?

by Ricardo Hausmann, Miguel Angel Santos

CAMBRIDGE – Will Venezuela default on its foreign bonds? Markets fear that it might. That is why Venezuelan bonds pay over 11 percentage points more than US Treasuries, which is 12 times more than Mexico, four times more than Nigeria, and double what Bolivia pays. Last May, when Venezuela made a $5 billion private placement of ten-year bonds with a 6% coupon, it effectively had to give a 40% discount, leaving it with barely $3 billion. The extra $2 billion that it will have to pay in ten years is the compensation that investors demand for the likelihood of default, in excess of the already hefty coupon.

Venezuela’s government needs to pay $5.2 billion in the first days of October. Will it? Does it have the cash on hand? Will it raise the money by hurriedly selling CITGO, now wholly owned by Venezuela’s state oil company, PDVSA?

A different question is whether Venezuela should pay. Granted, what governments should do and what they will do are not always independent questions, because people often do what they should. But “should” questions involve some kind of moral judgment that is not central to “will” questions, which makes them more complex. 

One point of view holds that if you can make good on your commitments, then that is what you should do. That is what most parents teach their children.

But the moral calculus becomes a bit more intricate when you cannot make good on all of your commitments and have to decide which to honor and which to avoid. To date, under former President Hugo Chávez and his successor, Nicolás Maduro, Venezuela has opted to service its foreign bonds, many of which are held by well-connected wealthy Venezuelans.

Yordano, a popular Venezuelan singer, probably would have a different set of priorities. He was diagnosed with cancer earlier this year and had to launch a social-media campaign to locate the drugs that his treatment required. Severe shortages of life-saving drugs in Venezuela are the result of the government’s default on a $3.5 billion bill for pharmaceutical imports.

A similar situation prevails throughout the rest of the economy. Payment arrears on food imports amount to $2.4 billion, leading to a substantial shortage of staple goods. In the automobile sector, the default exceeds $3 billion, leading to a collapse in transport services as a result of a lack of spare parts. Airline companies are owed $3.7 billion, causing many to suspend activities and overall service to fall by half.

In Venezuela, importers must wait six months after goods have cleared customs to buy previously authorized dollars. But the government has opted to default on these obligations, too, leaving importers with a lot of useless local currency. For a while, credit from foreign suppliers and headquarters made up for the lack of access to foreign currency; but, given mounting arrears and massive devaluations, credit has dried up.

The list of defaults goes on and on. Venezuela has defaulted on PDVSA’s suppliers, contractors, and joint-venture partners, causing oil exports to fall by 45% relative to 1997 and production to amount to about half what the 2005 plan had projected for 2012.

In addition, Venezuela’s central bank has defaulted on its obligation to maintain price stability by nearly quadrupling the money supply in 24 months, which has resulted in a 90% decline in the bolivar’s value on the black market and the world’s highest inflation rate. To add insult to injury, since May the central bank has defaulted on its obligation to publish inflation and other statistics.

Venezuela functions with four exchange rates, with the difference between the strongest and the weakest being a factor of 13. Unsurprisingly, currency arbitrage has propelled Venezuela to the top ranks of global corruption indicators.

All of this chaos is the consequence of a massive fiscal deficit that is being financed by out-of-control money creation, financial repression, and mounting defaults – despite a budget windfall from $100-a-barrel oil. Instead of fixing the problem, Maduro’s government has decided to complement ineffective exchange and price controls with measures like closing borders to stop smuggling and fingerprinting shoppers to prevent “hoarding.” This constitutes a default on Venezuelans’ most basic freedoms, which Bolivia, Ecuador, and Nicaragua – three ideologically kindred countries that have a single exchange rate and single-digit inflation – have managed to preserve.

So, should Venezuela default on its foreign bonds? If the authorities adopted common-sense policies and sought support from the International Monetary Fund and other multilateral lenders, as most troubled countries tend to do, they would rightly be told to default on the country’s debts. That way, the burden of adjustment would be shared with other creditors, as has occurred in Greece, and the economy would gain time to recover, particularly as investments in the world’s largest oil reserves began to bear fruit. Bondholders would be wise to exchange their current bonds for longer-dated instruments that would benefit from the upturn.

None of this will happen under Maduro’s government, which lacks the capacity, political capital, and will to move in this direction. But the fact that his administration has chosen to default on 30 million Venezuelans, rather than on Wall Street, is not a sign of its moral rectitude. It is a signal of its moral bankruptcy.

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Coffee set for largest shortage in 9 years

By Morgane Lapeyre

Coffee (NYBOT:KCV4) is set for the largest shortage in nine years as drought shrinks the crop in Brazil, the biggest grower, according to Volcafe Ltd.

Demand will exceed production by 8.8 million bags in the 12 months starting Oct. 1, the most since 2005-06, the Winterthur, Switzerland-based unit of commodities trader ED&F Man Holdings Ltd. said in a report e-mailed today. The surplus was 7 million bags in 2013-14. Brazil’s arabica crop will be 29.5 million bags in 2014-15, the smallest in seven years.

“The condition of the coffee trees in Brazil, just ahead of the main flowering, is poor,” Volcafe said, referring to next year’s crop. “The vast rainfall deficit in the arabica areas of Brazil has negatively impacted vegetative growth and yield potential.”

Arabica coffee prices jumped 83 percent this year as dry weather damaged trees carrying this year’s harvest. The surge forced buyers including J.M. Smucker Co., maker of Folgers, the best-selling U.S. brand, to raise retail prices.

Global production will fall 8.1 percent to 142.7 million bags, a three-year low, as consumption climbs 2 percent to 151.5 million bags, Volcafe said.

The Brazil crop estimate was raised to 47 million bags from 45.5 million bags in May, partly because of a larger robusta crop, according to the report. The arabica deficit will be 6.9 million bags and robusta 1.9 million bags.

The estimate of Brazil’s robusta output was raised to 17.5 million bags from 17.1 million bags, while Indonesia’s robusta production is seen falling to 7.5 million bags from 10.5 million bags last year. Vietnam, the world’s largest robusta grower, will produce 27.5 million bags of the beans, down from 28.8 million bags a year earlier, Volcafe said.

Production in Colombia, the second-biggest arabica grower, will rise to 12 million bags from a previous estimate of 11.5 million bags, it said. The next crop stands to benefit from the best conditions in six seasons, after a tree renovation program boosted output from 7 million bags in 2011-12, Volcafe said.

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U. S. Dollar is once again the King

By: Dan Hueber

Wheat

Mercifully, we are witnessing a little rebound this morning but it has been a rough week for the grain and soy markets as the increasing weight of larger crops caused the foundation to crumble once again.  While we do not know where the close will be today just yet, at current levels December wheat is down 30 cents from the close last Friday. 

While there has not been any real "fresh" negative news for the wheat market this week, neither has the been much positive and with Russia and Ukraine at least making plans for more cease fire discussions this weekend, you have eliminated the need for risk premium, assuming there was any to begin with.  Of course the other negative generated from the problems over there has been the collapse of the currencies of those two countries and then add in the bleak economic performance in Europe and it is understandable as to why the U.S. Dollar is once again the currency of choice for investors.  It has reached up to levels this week not seen since July 2013.

Export sales did not provide us with anything to be encouraged about either.  For the week ending August 28^th we sold just 168,700 MT of wheat or 6.2 million bushels.  This is down 58% from last week, 56% from the 4-week average and 60% from the 10-week average.  Year to date this bring sales up to 11,436,000 MT or 420.2 million bushels and moving forward, we now need to average 12.9 million in sales each week to reach the 925 million target. The Black Sea dominates.

Corn

The bearish supply news continued to pile up on the corn market this week, which brought on what appeared to be the inevitable; that being a push into lower lows for the year.  While I believe many in the trade feel the USDA will not hit us with both barrels next week, they also believe that the September report will not be the largest.  Informa will release their September estimate later this morning and The Hueber Report did issue ours yesterday pegging the corn yield at 171.6 for a crop of 14.38 billion bushels.  We are also looking for ending stocks to crest the psychologically negative 2 billion mark, looking for 2.038 billion.  If/once carryout is above 2, it will potentially be the first time we have been north of that mark since the 2004/05-crop year. 

The export sales to finish out the 2013/14 marketing year were a negative 300,000 bushels but unfortunately the new sales were pretty uninspired.  We sold 525,600 MT or 20.7 million bushels.  This number was down 24% from last week, 29% from the 4-week average and 25% from the 10-week average.  The best purchasers were unknown destination at 268.3k MT, Mexico at 103.1k MT and Columbia at 86.2k MT.  There was another sales of 120k Mt reported to unknown destination yesterday.

I am not terribly confident that corn will be able to maintain strength for the close today but at the current trade, we will have lost around 18 cents since last Friday and will potentially post the lowest weekly close for a December contract since early October 2009.  With no surprises next week, I have to imagine that prices will continue to drift lower between now and the report on the 11^th of September.  In light of the overall bearish sentiment, this appears to be a market that could set the extreme lows early in the fall but the challenge then would be to find a reason as to why we could need to rally from there. 

Soybeans

The selling in November beans appeared to have kicked into a higher gear this week, which is understandable with the onset of harvest and consistent reports of exceptional yields trickling in.  Numbers in the 70 to 90 bushel range are not uncommon.  While certainly not out of the question, to see a private company print a projection of a 4 billion bushels crop I believe was a shock to the trade.  This is not to say that others will not come up to that level eventually but I suspect many will not expect the USDA to do so.  We have yet to breech the 10.00 mark for November futures but came within a penny of doing so and unless we see some kind of surprising turn around later today, we should post the lowest weekly close for a November contract since July 2010.  

Informa issues their estimate later this morning and The Hueber Report published an estimate yesterday of 45.6 yield and 3.833 billion bushels production.  For a reference point for next week, the record production for beans in the country was set last year at 3.369 billion bushels so it is just matter now of finding out how large of a new record we can set.  We have ending stocks projected at 447 million, which would be the largest since the 2006/07-crop year.

Exports sales for 2013/14 came through at a negative 3.2 million bushels, which still leaves us 48 million bushels above the USDA target of 1.64 billion but that is somewhat of a moot point right now.  Sales for 2014/15 were also a bit of a let down coming through at 869,000 MT or 31.9 million bushels.  This was 32% below last week, 28% below the 4-week average and 20% below the 10-week average.  The major purchasers were a familiar bunch with China taking 338.3k MT, unknown destinations at 293.1k MT and Spain at 55k MT.

There are still a few forecasters keeping the potential for frost in the outlook for next week in the upper Midwest but most I have read believe damage would be slight to none even if it did occur.  As I commented earlier this week and noticed again on travels over the past couple days, I am amazed a just how rapidly many bean fields have begun to turn.  If frost cannot provide a pop, I have to imagine that prices will continue to work sideways to lower into the report.

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Another Warning Sign: Stocks Hit Highs on Collapsing Volume

by Michael Lombardi

Will the S&P 500 continue to march to new highs?

Well, my opinion towards the stock market hasn’t changed. I remain skeptical for a variety of reasons, many of which I have shared with my readers over the past few months.

But I have a new concern about the stock market, something that hasn’t been touched on by analysts: trading volume is collapsing.

Please look at the table below. It shows the performance of the S&P 500 and its change in trading volume.

Key stock indices like the S&P 500 (it is the same story for the Dow Jones) are rising as volumes are declining, suggesting buyers’ participation in the stock market advance is very low. For a healthy stock market rally, any technical analyst will tell you that you need rising volume, not declining volume.

It’s Economics 101: rising demand pushes prices higher. In the case of the S&P 500, we have declining demand (low trading volume) and rising prices. Something doesn’t make sense here.

Looking at the economic data, it further suggests key stock indices are stretched. We continue to see the factors that are supposed to drive the U.S. economy to deteriorate.

Just look at the housing market. The number of new homes sold continues to decline. In January, the annual rate of new-home sales in the U.S. was 457,000 units. By July, it was down more than 10% to 412,000 units. (Source: Federal Reserve Bank of St. Louis web site, last accessed August 25, 2014.)

Major economic hubs are struggling. The three main economies in the eurozone are begging for growth. Italy is in recession, France’s economy is teetering on recession, and Germany’s economy is showing signs of softening. Today, the European Central Bank dropped interest rates again—but those lower rates are not spurring bank lending or consumer demand.

China and Japan, the second- and third-biggest economic hubs in the global economy, are seeing their economies slow as well.

Key stock indices are completely ignoring the worldwide economic slowdown.

Dear reader, irrationality and manipulation can run longer than anticipated, but not forever. The S&P 500 reaching 2,000 doesn’t really say or mean much except for this: the higher key stock indices go, the harder they will fall and the bigger the damage they will cause to consumer sentiment and the economy.

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Here's Why the Market Could Crash--Not in Two Years, But Now

by Charles Hugh Smith

Markets crash not from "bad news" but from the exhaustion of temporary stability.

Yesterday I made the case for a Financial Singularity that will never allow stocks to crash. We can summarize this view as: the market and the economy are not systems, they are carefully controlled monocultures. There are no inputs that can't be controlled, and as a result the stock market is completely controllable.

Today I make the case for a crushing stock market crash that isn't just possible or likely--it's absolutely inevitable. The conceptual foundation of this view is: regardless of how much money central banks print and distribute and how much they intervene in the markets, these remain complex systems that necessarily exhibit the semi-random instability that characterizes all complex systems.

This is a key distinction, because it relates not to the power of central banks but to the intrinsic nature of systems.

One of the primary motivators of my work is the idea that systems analysis can tell us a great deal about the dysfunctions and future pathways of the market and economy. Systems analysis enables us to discern certain pathways of instability that repeat over and over in all complex systems--for example, the S-Curve of rapid growth, maturation and diminishing returns/decline.

One ontological feature of complex systems is that they are not entirely predictable. An agricultural monoculture is a good example: we can control all the visible inputs--fertilizer, seeds, water, pesticides, etc.--and conclude that we can completely control the output, but evolution throws a monkey wrench into our carefully controlled system at semi-random times: an insect pest develops immunity to pesticides or the GMO seeds, a drought disrupts the irrigation system, etc.

The irony of assuming that controlling all the visible inputs gives us ultimate control over all outputs is the more we centralize control of each input, the more vulnerability we introduce to the system.

Those arguing that central banks (and their proxies) can control the stock market have the past six years as evidence. Those of us who see this heavy-handed control as increasing the risk of unpredictable instability have no systems-analysis model that can pinpoint the dissolution of central bank controlled stability. As a result, we seem to be waiting for something that may never happen.

Despite its inability to predict a date for the collapse of stability, I still see systems analysis as providing the most accurate and comprehensive model of how complex systems function in the real world. If the economy and the market are indeed systems, then we can predict that any level of control will fail no matter how extreme, and it will fail in an unpredictable fashion that is unrelated to the power of the control mechanism.

Indeed, we can posit that the apparent perfection of central-bank engineered stability (i.e. a low VIX and an ever-rising market) sets up a crash that surprises everyone who is confident that central-bank monocultures never crash. In the real world, manipulated stability is so vulnerable to cascading collapses that crashes are probabilistically inevitable.

That raises the question; why not crash now? After all, all the good news is known and priced in, and all the bad news has been fully discounted. Why shouldn't global stock markets crash big and crash hard, not in two years but right now?

Markets crash not from "bad news" but from the exhaustion of temporary stability. The longer that temporary stability is maintained by manipulation, the greater the severity of the resulting crash.

As I noted in The Coming Crash Is Simply the Normalization of a Mispriced Market, this line from songwriter Jackson Browne captures the ontological falsity of permanent market stability: Don't think it won't happen just because it hasn't happened yet.

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