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29 May 2024

My thoughts on coffee

I have received more than one email asking for my thoughts on coffee. Below is my analysis. I begin by showing the chart of the term structure of coffee.

Very clearly you can notice how the current term structure is in backwardation while the 5 and 15-year averages are in contango. There is certainly an anomaly in coffee prices. This anomaly is immediately explained by fundamental analysis:

“The price of arabica coffee futures has increased significantly, closing at two-week highs. This increase has been fuelled by concerns over drought in Vietnam and Brazil, two of the world's largest coffee producers. In Vietnam, rainfall in the Central Highlands region, the main coffee-growing area, was 41% below the long-term average. Similarly, in Brazil, the Minas Gerais region has received no rain for the third consecutive week, further exacerbating production concerns.

Simultaneously, the strengthening of the Brazilian Real has contributed to rising coffee prices, as a stronger Real discourages sales from Brazilian producers. Although arabica coffee prices fell on Thursday due to an increase in ICE-monitored stocks, which rose from historically low levels to a 13-month high, the overall trend remains upward due to unfavourable climatic conditions.”

In summary, the coffee market is currently facing a combination of factors contributing to significant price volatility.

I continue with the graphical analysis with a spread, specifically KCZ24-KCN25, which has a bearish seasonality until August and is among those present in my book on the best seasonal spreads. Below, you can see the chart with the 5, 15, and 30-year seasonal patterns.

I have also included the 30-year seasonal pattern to more clearly show how in the last 5 years, in the late spring-summer period, the most delicate for coffee, the price of the spread has been much more nervous and volatile. This aspect is not surprising given that we have been witnessing, for some years now, a climate change that makes, among other things, trading in agricultural commodities difficult and sometimes unpredictable.

The next chart is the Seasonality Stacked.

KCZ24-KCN25 Seasonality Stacked (SpreadCharts.com)

The spread price is above all previous 9 years except KCZ22-KCN23. Do not be misled by this aspect. First, because the only year with a higher price then had a strong rise. The second reason you will understand from the next chart, the Continuous Histogram.

KCZ24-KCN25 Continuous Histogram (SpreadCharts.com)

In the 51 years of spread quotation, the current price is not that high, rather, it is right on the edge of the 25th-75th percentile range (i.e., the zone where the price has closed 50% of the time). If you then look to the right, you cannot fail to notice that in the past the spread has reached much higher prices than the current one. Therefore, if the climatic situation worsens, it could rise significantly.

I conclude with the coffee C.O.T. chart, which you can see below.

In recent weeks, Speculators have started to take profits from their investments, and the net position has fallen from the record level of 68,340 to 52,567. However, still at very high levels, and this drop does not mean anything yet. At least until the net position returns below 40K, I do not see bearish signals. Moreover, from experience, I would not be surprised to see a drop in the net position and a simultaneous rise in coffee prices, thus forming a divergence.

This is my opinion, based on analysis and my experience. At this moment, I would not sell coffee either with futures or with spreads. This does not mean that it cannot fall, but that the chances of an increase are, as of today, much higher than those of a decrease. The climatic situation is not expected to improve, while the Brazilian Real is likely to return at least to the 5 area against the dollar, if not lower, in the 4.7000-5.0000 range, further strengthening.

I have received more than one email asking for my thoughts on coffee. Below is my analysis. I begin by showing the chart of the term structure of coffee. Very clearly you can notice how the current term

David Carli
David Carli
David is a financial analyst with over 29 years of experience (two years as a fund manager) in currencies and commodities. He collaborates with a major European commodity investment company and is the author of several successful books about trading and financial markets.

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