Helileia Vastatrix and Coffee Futures

Over the past several months there have been a flurry of panicked press releases and hastily arranged meetings to deal with an outbreak of Helileia Vastatrix or more commonly
Coffee Leaf Rust or Roya. The International Coffee Organization calls it an epidemic, The Specialty Coffee Association of America calls it a devastating outbreak while the participants who trade Arabica Futures appear dismissive.  The purpose of this post is not to examine the degree or veracity of the claims, but to review how the Futures Market is treating the claims.

I have covered the incredible rise and fall of the C over the past few years, and have been critical of both the forces driving the price to unsupportable levels in 2010-11, and the efforts by large players to support the price in the face of price deflation. Last year in Portland at the Specialty Coffee Symposium a Costa Rican Official claimed a 30% reduction in harvest numbers for 2013 due to lack of pruning, planting and heavy rains. This year, the 30% number was again trotted out in reference to the Roya outbreak, and many reports of vast devastation were circulated. In both cases, the claims failed to move the price of the C in any significant way. Today the Futures Market Price for Coffee to be delivered in March of 2014 is $1.50.  There is no doubt that a 30% reduction in harvest numbers from affected producing countries would create a massive shortage of coffee worldwide, throwing Supply and Demand out of balance. The Shortage would drive prices up well beyond the $3 level we witnessed back in 2010-11 where there we no Supply or Demand shocks effecting change. So why has the price not moved up if the market believed and expected that the harvest would fall significantly. In order for there to be no impact resulting from a supply shock there would need to be an equal demand shock compensating for the reduced supply. In other words, demand for coffee would need to plummet (without a price increase causing it) at the same rate that supply decreases. That scenario is highly unlikely.

A quick glance at the Options chain going forward or the Futures pricing beyond Q1 2014 reveals a normal time premium (contingency for unexpected shocks) but nothing even remotely approaching numbers necessary to compensate for a huge supply shock. Again, the Market is expecting a price of approximately $1.50 for Arabica delivered in March 2014.  These are the numbers produced by the most sophisticated coffee traders and financial analysts in the world leveraging ALL of the known information regarding the arabica harvest. They read the reports on Leaf Rust, rain, pruning and planting...so what gives?

 I'm speculating (guessing) that the world of arabica traders doesn't believe the claims or severity of the outbreak or some combination of other factors. I'm concerned. As recently as last night I posted to my twitter feed a prediction that the price would break out of the narrow trading range it's been bound by when it breaches $1.44 spot. I have formed this opinion based on a conventional strategy used by chartists who view a 3% increase over the recent high within a narrow horizontal trading range as being a strong indicator of sustained upward price movement.  When this move happens it will be blamed on Leaf Rust, but don't believe it because leaf rust has failed to move the market to date.  The move will be driven by the price breaking through a key chart indicator, the search for alternative investment vehicles while the Equity Markets are falling, and relative weakness of the USD.

My advice is for all those involved to be careful when reading reports assigning specific numbers to harvest losses which are wildly speculative and often formulated with the intention of influencing market price.  Remember that the C is a zero sum game.  When the market functions rationally, a shortage (or perceived shortage) of supply always results in an increase in price thereby benefitting producers who are unaffected by any production problems.  Conversely, when there is an abundance of coffee in the supply chain, the prices drop and all parties are harmed.  Without diminishing any difficulties facing growers who are battling leaf rust, if there are significant supply shortages, the price will rise and growers unaffected by leaf rust will benefit from the price increase.

*NOTE:  The C, in the three trading days since I wrote this piece, pushed over $1.43, bristled at the breakout price and retreated strongly to (at present) $1.378.  I believe this validates my assertion that the  Market does not believe in the Leaf Rust narrative, and that the $1.44 price level is significant.  If over the course of the next few weeks the price retests the recent high of $1.43, the breakout price will reestablish at approximately $1.47.  Time will tell, but there is little doubting that currently Arabica Traders do not believe Leaf Rust will adversely impact Arabica Supply next year.