Confusion In The Coffee Market (But Not For Long)

Confusion and uncertainty are the watchwords in the coffee market right now. At least that’s apparently the case based on the lack of a consensus on how COVID-19 will affect bean prices. I’ll make the case here, however, that while prices might remain directionless in the near term, coffee’s intermediate-term (3-6 month) outlook is bullish based on currency-related factors.

If there’s one thing that is certain in the industry right now, it’s that no one is certain how the global pandemic will ultimately impact the java market. Read through the latest commentaries and industry forecasts and you’ll likely come away scratching your head, wondering in amazement at the diversity of opinions and lack of clarity surrounding the intermediate-term market outlook. Such is not normally the case in this particular market, but these aren’t normal times.

For instance, in its latest Coffee Market Report, the International Coffee Organization (ICO) noted that 2019/20 global coffee consumption was estimated to be 0.7% higher than the previous year. It added, however, that COVID-19 represents “considerable downside risk to global coffee consumption.”

ICO further acknowledged that while global growth and rising unemployment could put downward pressure on prices, demand is projected to exceed production this year, noting that “disruptions to the supply chain both in shipping and harvesting could lead to temporary shortages in the supply, putting upward pressure on prices in the short term.” Confused yet?

In so many words, ICO is admitting that no one in the industry seems to know exactly what impact global virus-related shutdowns will have on coffee consumption and prices. There are as many bearish as bullish factors hanging over the market right now, so perhaps a sideways or range-bound trend can be expected for coffee prices until the effects of the global economic slowdown have been completely discounted. Already, in fact, a lateral trend can be readily discerned in the graph of the ICO composite price indicator, below.

Source: ICO

The latest S&D Coffee & Tea Market Report, meanwhile, has also acknowledged that confusion abounds in the java market right now. With Brazil’s harvest beginning this month and Columbia’s mid-crop harvest soon beginning, the widely publicized global bean shortage may soon be alleviated. Yet as S&D observed, while more coffee should soon be available due to upcoming harvests, “at the same time supply disruptions from the virus are still unquantifiable.”

S&D further noted that while shipping ports are open, they’re not running at normal levels due to health-related distancing rules. Thus, the question as to how much the pandemic will impact prices remains unanswered from a supply-and-demand perspective.

In the final analysis, coffee market stasis will likely be broken due to currency factors and not supply-related factors. Specifically, the U.S. dollar in which coffee is priced is almost certain to weaken in the coming months due to an explosion in monetary and fiscal stimulus to the tune of trillions of dollars. More specifically, the combination of record-breaking levels of money creation, combined with lower production of goods and services because of global shutdowns, is a recipe for inflation (i.e. dollar weakness). In his latest blog, Scott Grannis touched on this theme when he wrote:

With so much money being dumped into the economy—money which now is desperately needed and wanted—it might be difficult for the Fed to withdraw it when things improve and the demand for money returns to normal. There could be a significant excess supply of money at some point which would almost surely result in rising inflation.

The following graph shows the acceleration in the growth of M2 money supply, which underscores the alarming extent to which the threat of inflation has increased. Eventually, this massive money creation will put downward pressure on the dollar, in turn putting upward pressure on commodity prices which are priced in dollars – including coffee.

M2 Money SupplySource: St. Louis Fed

Turning our attention to my favorite coffee trading vehicle, I’m currently long the iPath Series B Bloomberg Coffee Subindex Total Return ETN (NYSEARCA:JO), which tracks the coffee futures price. I’m using a stop-loss slightly under the 35 level for this short-term trading position, and I recommend that all coffee futures and coffee ETF trades be followed up with a conservative stop-loss to prevent excess losses from unforeseen market volatility. For now, JO remains above my stop-loss and hasn’t yet broken its short-term rising trend that began in February. So, even with all the aforementioned confusion abounding in the market, a bullish short-term bias on coffee isn’t unwarranted from a technical perspective. Short-term volatility will, however, likely remain a risk until the lockdowns are lifted.

iPath Series B Bloomberg Coffee Subindex Total Return ETNSource: BigCharts

To conclude, the overall international demand for coffee is still strong enough to support the market even in the face of the pandemic. Supply chains are still being disrupted due to the virus, which is another potentially supportive factor in the near term. However, as South American bean harvesting season is about to get in full swing, some of coffee’s supply-related pressures could be alleviated, thus resulting in a sideways price trend for coffee. I further expect U.S. currency weakness to intensify in the coming months, which should support a rising intermediate-term trend and push coffee prices up and out of their current ranges.

Disclosure: I am/we are long JO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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