European Central Bank meeting on 9 September 2021
9 September 2021
Cotton World Markets and Trade report on 10 September 2021
10 September 2021

An interesting spread on coffee

I am taking another cue from an email I received to analyse a spread on coffee that I find very interesting. The spread in question is the one that is numbered KC3 in my book, more precisely KCH22-KCN22. The spread has a bearish seasonality and is, therefore, to be sold. Below you can see the chart with the 5- and 15-year seasonal patterns. The entry period is from mid-August to mid-September, the exit period is in January.

KCH22-KCN22 daily chart

KCH22-KCN22 daily chart with seasonal patterns (SpreadCharts.com)

Before I do all my graphical analysis, I would like to focus a few lines on the fundamentals of coffee. In the Brazilian winter (Brazil is the largest producer of Arabica quality coffee) there was a frost that put this year's crop at serious risk. Futures prices rose sharply on the back of this concern, reaching levels not seen since 2014.

Adding to this was rising transport costs and political unrest in the world's third-largest coffee producer, Colombia. However, as the weeks go by, the damage caused by the frost does not seem to be as severe as initially estimated.

"The frost events that hit coffee fields in Brazil in recent weeks will cause a loss of around 4% to production in the next season," according to forecaster Tropical Research Services (TRS). " "The frosts were moderate events, not as severe as we saw in 1994 and 2001," said Steve Wateridge, the company's global head of research. Wateridge said TRS had sent people on the ground in Brazil into the affected areas after the frosts and checked the situation of the trees.

After the highs in July, the price of coffee fell, bounced back to test $200 and then started to fall again. I personally believe that the price can continue to fall, but it will not return to the levels of the beginning of the year. In my opinion, the price will settle between $140 and $160. However, there is room to go down and this is good for my operation because by selling the spread, I am selling the closest delivery and buying the one furthest away.

Also, as you can see from the chart below of the Seasonality by month, the spread in the months of September to January, except for November where it usually bounces, is bearish.

KCH22-KCN22 Seasonality by month

KCH22-KCN22 Seasonality by month (SpreadCharts.com)

However, it was not that chart that made me like the spread but the Continuous histogram.

KCH22-KCN22 Continuous histogram

KCH22-KCN22 Continuous histogram (SpreadCharts.com)

There are two things that struck me. The first is that the spread has only spent 4.03% of the time over the last 20 years in backwardation, i.e., above zero. Considering the minimum percentage and the current value of the spread, the risk is very small.

The second is that the spread peaked (at the close) at -0.60 at the height of the frost emergency at the end of July and this tells me that, even though other problems should occur with the Brazilian coffee crop, I have plenty of time to close my trade with, in the worst case, a minimal loss. This is also thanks to the characteristic of the spreads on coffee that have very slow movements.

The price level is high compared to previous years (and it couldn't be otherwise given the winter frost in Brazil) as the Seasonality stacked chart shows.

KCH22-KCN22 Seasonality stacked

KCH22-KCN22 Seasonality stacked (SpreadCharts.com)

I conclude my analysis with a look at the COT net position of coffee.

KC COT Net position

Coffee COT Net position (SpreadCharts.com)

The net position is at the resistance level of 40K. Therefore, if there are no external events (such as the recent frost in Brazil), it is likely that the net position, and with it the price of coffee, could fall in the coming weeks.

SpreadCharts

I am taking another cue from an email I received to analyse a spread on coffee that I find very interesting. The spread in question is KCH22-KCN22; it has a bearish seasonality and is, therefore, to be sold

David
David
David is a trader with over 25 years of experience (two years as a fund manager) in currencies and commodities. He collaborates with a major European commodity investment company, and he is the author of several successful books about trading and financial markets.

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