Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
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Supply pinch tilts risk higher for coffee
Ole Hansen
Head of Commodity Strategy
Summary: Arabica coffee, in a downtrend since February, continues to see a tug of war between traders focusing on demand worries and those looking for higher prices in response to increasingly supportive supply fundamentals. In this update we take a closer look at some those supportive fundamentals while deciphering the potential signals being presented by the current price action.
Arabica coffee has spent the past six months drifting lower after reaching an 11-year high back in February. In the months leading up to the peak at $2.60 per pound, the price had more than doubled with adverse weather in Brazil raising concerns about production. In the months that followed, however, the focus switched to the risk of a global economic slowdown, and with that the prospect of softer demand for the more expensive high quality bean.
After finding support at a key level below $2/lb the December futures has risen steadily in recent days with the situation in Brazil once again attracting some attention. This recent article from Bloomberg, titled “World’s Top Coffee Crop Shrinks in a Market Thirsty for Supply” confirms months of worries about supply with Brazil’s Conab now expecting the current on-season crop to be the lowest since 2014. Even their estimate of 35.7 million 60 kilogram bags, may end up being too optimistic according to commentators.
As Bloomberg reports: “Brazil’s drought and cold curbed flowering last season and severe frosts in July 2021 led farmers to cut down coffee trees at a time of high costs for agricultural inputs, notably fertilizer”. In addition, Columbia another top producer has seen its crop being reduced by too much rainfall.
While an economic downturn may negatively impact demand for the more expensive bean, compared with Robusta, key fundamentals paint an overriding bullish picture for Arabica. The futures curve is currently pricing in the highest level of tightness since 2010 with the one-year backwardation, or roll yield achieved by holding a long position for one year, having risen despite recent attempts to sell it down. In addition, stock levels at warehouses monitored by the ICE futures exchange has declined to a 23-year low while speculators have cut their net long by 70% since February.
All developments that may underpin the price over the coming months, but first as per the chart below the price action needs to become more assertive. The first month contract has been trading within a wide declining channel since February, however, after finding support at $1.96/lb the important 38.2% retracement of the 2020 to 2022 rally, the potential for a test of the upper falling trendline, currently at $2.30/lb has risen. First though it needs to break above the 50-day moving average, currently at $2.21/lb. If rejected the medium term downtrend would likely resume with focus on a downward extension towards $1.75/lb.
Robusta, the cheaper coffee variety traded in dollars per metric tons may potentially show the way. After also finding support at the 38.2% retracement of the 2020 to 2022 rally it has done better than Arabica by breaking higher through its falling wedge like pattern. A daily close above $2160/tons is needed for confirmation of a bullish reversal that could send prices higher towards the previous peak around $2450/tons.
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