Mark to Market

Mark to Market is a term whose frequency of use increased in late 2008 with the collapse of complex derivatives and options based on ill advised mortgages to American home buyers. Basically GAAP (Generally Accepted Accounting Principles) compelled financial firms to reduce the value of paper they held at Book Value (Purchase Price) as market conditions deteriorated and residential real estate values plummeted. The concept of Mark to Market was created to determine the credit/debit status of Margin traders in the Commodity Markets but is important in valuing the contracts and commitments of coffee brokers and roasting companies (less so the inventory of retail companies).

Coffee growers, brokers and buyers typically use the Commodity price for coffee as a baseline to determine specialty coffee prices. An example would be where a Specialty Coffee is determined to be valued "C" plus a fluid amount depending upon quality (ie "C" plus $1.20). This method of valuing specialty coffee is a simple linear equation, easy to understand with a transparent and logical baseline. If a coffee was purchased at "C" plus $1.20 at harvest, and the commodity price falls after the date of the contract, the coffee is worth less and should be reflected that way in your balance sheet.

Most brokers continuously adjust their pricing with the rise and fall of commodity price...most.
One exception is the purveyors of ultra high end coffee. These coffees don't come to market through normal channels, and so there may be an argument to be made that it's value is delinked from the commodity price, however there is very little transparency or logic in this type of valuation. If the commodity price fluctuates freely and the price of ultra high end coffee remains constant, the value of high end coffee is arbitrary and based on purchase price rather than market conditions. Currently many ultra high end coffee sellers would have secured their inventory while the "C" was floating near historical highs in 2011. Beginning late 2011 coffee commodity prices began to deflate, theoretically reducing the value of all coffee under contract. The problem for newer brokers working on bank loans and margin is that they cannot reduce the value of their contracts without jeopardizing their debt to equity ratio displayed in the Balance Sheet. The reality is that the broker uses a formula to determine purchase price, whether it is a simple equation or differential calculus, there is a formula. If there is a formula to determine value at purchase, then the same formula should be used to reduce the value as the price of the underlying commodity deteriorates.

I have been sampling some self declared ultra high end coffees recently whose pricing is completely detached from the realities of our current market. While considering the value gap I came to the conclusion that the coffee was not poor quality but poorly bought, handcuffing the marketability going forward. It is clear to me that some of these coffees are looking for naive buyers who are captivated by scarcity and marketing material rather than realistic value propositions. My advise is to check your coffee prices as they track throughout this past year, if your prices haven't fallen for similar purchases at a rate that tracks the "C", then you are likely paying for your brokers mistakes and you need to make them aware of the inconsistencies. Paraphrasing Benjamin Graham, "Price is what you pay...Value is what you get".