Tuesday, March 13, 2012

Commodities: Coffee - Don`t Forget The Farmers

I have to confess: I`m a caffeine addict, 3 or 4 cups of coffee are my daily average. Therefore I was very happy as I read the Reuters headline "Coffee flirts with 16-months low" (reuters). And on Monday coffee futures fell to their lowest in 17 months. Prices have fallen nearly 40% from peaks hit in May 2011, commented Reuters (reuters). Wow, how could that happen?

The answer: Coffee is traded on financial markets. The commodity is represented by coffee futures (delivery contracts) which are financial assets like stocks. In recent years futures on soft commodities like coffee, cocoa, cotton and wheat became a fashionable investment idea. Many investors are setting high bets on rising agriculture prices (long positions) because they are expecting that a climbing demand will meet a tight supply. In the case of coffee the rising popularity of chains like Starbucks signals a climbing demand for the delicious beans. Therefore financial investors & speculators like hedge funds, huge pension funds and ETF providers are investing billions of dollars into coffee futures.

From 2003 through the spring of 2011 this additional money has driven prices further north (futures.tradingcharts.com). Rising futures thus attracted more speculators who were just following the climbing trend (momentum players). The usual herding behavior of the hedge funds and other speculators sharpened the price hike and led to a huge rally in coffee futures. In May 2011 the coffee price on the financial market climbed to a 34-years high. Banks like the Australian broker Macquarie threw some gas on the fire and recommended even more coffee buying because they predicted a shortage amid an alleged dense supply.

But then happened what usually happens when agriculture prices rise: Farmers worldwide responded by planting more coffee plants because they expected more profit. Now Reuters has the headline "Record global coffee crop seen in 2012/13" (reuters). Expectations that the leading producer country Brazil will have a larger crop than last year are especially pushing prices down. Vietnam (No. 2) also is expected to have a record harvest. The media also report that Indonesia expects the largest harvest in 3 years and that the Ethiopian coffee production (No. 4)  is rising too. 

The surging crops in these countries are overcompensating for problems in Columbia (No. 3), where too much rain has indeed caused a reduced harvest. The (expected) rising supply is sending coffee futures south and many funds are trying to save their profits from the rally and are taking money off the table now.

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