A bull at heart, but a bear on the chart,” is how Macquarie’s Commodities Research Division captured recent sentiment towards the Arabica coffee market. The report is referring to the recent downward curve in the price of coffee – and that a quick assessment of the market may lead one to believe that downward trend will continue. Since Arabica Futures reached record highs at over US$3 a pound in May, roasters have welcomed seeing prices slowly settle down, closing at around US$2.85 at the end of August. Speculators, who have enjoyed the ride up since around June 2010 when they moved to a net long buying position, are starting to pull out, with recent data from the US Commodity Futures Trading Commission (CFTC) showing them adding to their net short position over the last few months. With prices on a downward movement, the question now arises as to how far they will drop. As Macquarie’s quote implies, however, there is more to these price movements than meets the eye, and that it may be too early to turn to bearish sentiment just yet. When prices reached record highs in May, Starbucks Chief Executive Officer Howard Schultz lashed out against “hedge funds, index funds and other ways to manipulate the market”, blaming the price rises on speculation rather than market forces. The prices, the Financial Times reported Schultz as saying, were unsustainable. As prices start to settle with speculators pulling out, it may seem a safe assumption to think that Schultz was on target. Commodity analysts, however, note that a closer look at market fundamentals tell a slightly different story. “If we look back at the last rally, it was not only speculators who pushed up the price,” says Keith Flury, a Commodities Analyst with Rabobank. Pointing to the CFTC report, he notes that marketing position data shows that the most active category that pushed up the prices was in fact the merchant-producer-processor category. “When the price ran up, it was a signal of buying by the processing category,” says Flury. He says, however, that this increased buying may not solely be a result of an increase in demand on the consumption end. He says that many businesses were buying further into the future to cover themselves in the short-term against further price increases.
In this sense Starbucks may have fallen victim to a self-fulfilling prophecy. In purchasing extra coffee to hedge against further price increases, this may have led to a further increase, the Financial Times reported. In January, Starbucks’ CFO Troy Alstead said that they were fully hedged through to the end of September. In April, the Financial Times reported that Starbucks had purchased futures right up until almost the end of the calendar year. Flury notes that the move by roasting companies to buy so far in advance may place them in the very category Schultz was criticising. “More buying offsets price increases in the short-term, so they are essentially buying with the expectation that prices will increase. So in that sense they are speculators.” In looking at the more traditional sense of speculators – that is hedge funds and other investors not dealing in the physical product – Flury points to CFTC data showing that these speculators have largely left the market, and that they don’t have any long-term position. When coffee prices rallied from the March to May period, speculators were selling off, bringing them into a net short position. Flury notes that they now comprise only 10 per cent of what they were in March. While this category of buyers has pulled out, Flury doesn’t see prices dropping too far off the chart any time soon. Roasters, he says, have been covering off their short-term positions since 2010 when prices start to rally. Looking at the forward curve, at time of writing Flury put the September prices at US$2.66/pound, rising steadily to $2.73 eight months later in May 2012. He says that prices will likely continue to perform well thanks to a lot of covering and interest in buying. “While most roasters have traditionally covered themselves for a few months, now we’re seeing roasters cover themselves for the next 10 to 12 months, purchasing contracts through to September/October 2012/2013,” says Flury. He says that any levelling out in prices is more likely to come from the fundamentals: an increase in supply via record harvest levels. As speculators slowly draw out, Avtar Sandu, the Senior Manager of Phillip Futures Commodities’ Desk out of Singapore, confirms that strong fundamentals are continuing to play a factor on the supply side. He points to Robusta varieties in Vietnam that are attracting a premium well above stock market prices thanks to limited supply. “We’re quite surprised by this premium, as normally Vietnam’s beans sell at a discount,” says Sandu. “We keep expecting it to drop, but the premium is still holding up.” Macquarie’s report supports Sandu’s observations, noting that grade 2, five per cent black and broken beans fetched a premium of up to US$220/tonne above London’s front-month September contract. The report says that despite a large crop of over 18.5 metric tonnes, most of Vietnam’s crop has been sold and the country reportedly has very little stock to see them through the 2011/12 harvest, due in November 2012. Sandu says that much of this demand is stemming from a lack of supply in Indonesia, where an unusually high level of rain has affected the flowering of the crop, lowering harvests. As Indonesia is the second biggest supplier of Robusta coffee in the world after Vietnam, buyers have been turning to Vietnam as an alternative, explaining the unusually high prices. Macquarie reports that Indonesian exports are expected to fall by nearly a third in 2011, to around 300,000 tonnes. The Macquarie report anticipates that Robustas are due for a short-term rally. The rally is welcomed by Vietnamese farmers, Sandu says, who just five or six years ago struggled to get good prices, selling far below London contracts, as victims of a buyers’ market. “Now they’re sellers, and they’re even holding onto their coffee for a better market,” says Sandu. From now until December, Sandu predicts that coffee prices will experience mainly sideways movements. While he confirms that buyers are purchasing more forward than they normally would, he doesn’t expect that this is artificially increasing prices. While many companies like Starbucks may have purchased far in advance, it’s difficult to tell how much of their supply makes up what they’ve hedged their bets on against further price increases. “Most of these roasters are experienced buyers – it’s likely not all of their needs are covered,” he says. As GCR went to print, prices started to rise again as did the speculative position, supporting these experts’ predictions and showing signs that another bull ride may be on the way. GCR