The "C"

I am amazed at how little some coffee luminaries know about the "C", how it functions, the factors that impact it and what strategies are useful in protecting your company from price spikes. The "C" is the widely accepted commodity price for Arabica coffee sourced from any of 19 approved countries and traded as contracts on the New York Mercantile Exchange.
The extreme lows of the "C" experienced in the recent past caused an expansion of coffee consumption and the introduction into many new markets at very low costs. The low market price acted as a disincentive to growers to plant more crops and expand capacity. As consumption surpasses production, the price naturally rises. This is not a new story, but a fact of life when playing commodities.

There are many things that separately and concurrently effect price moves in the "C". Traditionally most feel that scarcity or supply concerns are the main market mover. If you listen to news reports or read blogs all the talk is about increased consumption in developing nations plus China, Russia and India. While this does have some impact, there are other things at play which are pushing coffee higher.

As the world struggles to exit from the great recession, every developed country has injected borrowed money into their economies to boost economic activity and employment. This, along with ridiculously low interest rates is the perceived magic bullet for most economies. The thing about super low interest rates is that anyone with money to invest is not looking to place it where they can expect 0.25% on bonds. The lack of interest in the American Bond market leads to the US dollar weakening...when no one wants to buy what you're selling you reduce the price.
The result of a lower USD is that all commodities get an instant bump every time the dollar drops because the commodities and the "C" are priced in USD. For fun just watch how the USD behaves against major currencies, and watch what happens to commodity prices on the same day.

Equity markets over the past decade have not performed in a rational way, with two extreme bubbles forming as a result of irrational exhuberance attached to tech companies in the 90's, and a housing bubble collapsing the market most recently. This has caused people with money to look for actual things to purchase, rather than stocks. Commodities are things that people don't need advanced degrees in math to figure out. They are things where prices behave in a rational way in reactions to real world inputs that you can read about and understand. When the weather in Brazil is bad, the price goes up. When there is trouble in the middle east oil supply chain, the price of oil increases. No accounting scandal is going to bring down the value of your investment in any commodity.

The thing with the "C" is almost no one actually takes delivery of coffee purchased on the market although the final settlement of the contract can result in delivery. The coffee is purchased as a contract with a set delivery date in the future. As the delivery date nears, it is normal for the purchaser to role the contract into a new one with the appropriate adjustments to the account made at the time of the rollover.
An individual can participate in the commodity market in one of several different ways including Non-discretionary account, a Managed Account or Commodity Pools. The important thing to understand is most participants have no intention of ever taking possession of coffee, they are simply trading futures in the hope of making profit.

FYI: There is another cost attached to commodity trading referred to as Contango. This is a universal term which encompasses storage, insurance, loss etc.

For coffee, a typical contract is 37500 lbs, or one container of coffee. A savvy investor in coffee would be required to only put down a small deposit on the value of the contract, typically 5%. If the "C" is trading at $2.75, the value of the contract is $103,125.00 and 5% of that is $5156.25. If the price moves up 10%, then the contract is now worth $113,437.50 , a profit of $10,312.50 on a small investment of $5156.25. This example clearly demonstrates the power of leverage in commodity trading is an incredible draw for those with discretionary dollars to invest. Conversely, if the price drops, the investor will receive a "margin call" requesting more money to cover the daily losses if the value of the contract has dropped more than 50% of the initial investment.

There are many factors which indicate to me that the price is not about to drop in any significant way in the near term.
1. The American Dollar is weak and getting weaker. Printing money always results in inflation and a devalued currency, both working against a reduction in the price of coffee. The US is not likely to increase interest rates (raising the USD) which would stifle any recovery.
2. Supply is something that can take up to 3 years to address. Trees planted this year, won't produce anything this year or next and so we are stuck with the supply we have, or less if there is a natural weather event.
3. Emerging economies are doing quite well, and those that are disengaged from the American market are doing even better. Any growth in coffee consumption in those countries is not likely to wane, and put more pressure on the "C".
4. Commodities as a group of investments are doing remarkably well, and yielding excellent returns for investors, something that encourages new participants. The excellent liquidity in the "C" also benefits more participants as contracts trade at high volumes with many eager buyers and sellers. The ability to apply leverage when trading coffee makes it an attractive play when there is still room to move up.
5. Total coffee consumption is relatively inelastic to price spikes on a macro level. The real pain will be felt on a store level where individual customers will make rational choices based on price and quality. As the price at your favourite shop increases, customers will search for strategies to reduce the impact either by reducing their numbers of visits, or choosing a slightly cheaper option with more perceived value.
6. As I stated in a previous post, compared to a classic hedge like Gold, coffee has actually lost about 38% of it's value over the past 10 years leaving a lot of room to move up.

I hope this provides a little information for all to consider. Remember, there are many things in play in the coffee market which are driving prices higher. Here is an excellent source for further information on trading commodities