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coffee trends – November/December 2010

The ‘Other’ Commodities


December 7, 2010
By Brian Martell

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In recent months much has been said about the meteoric rise in the price of coffee. Thirteen-year highs have been reached and surpassed; differentials are extremely resistant to downward pressure and reflect the growing call from roasters that the ICE is becoming “irrelevant.”

In recent months much has been said about the meteoric rise in the price of coffee. Thirteen-year highs have been reached and surpassed; differentials are extremely resistant to downward pressure and reflect the growing call from roasters that the ICE is becoming “irrelevant.”

With all that is going on in the coffee world, it is easy to bypass two other very important commodities to the coffee and vending industries: sugar and cocoa. Sugar has been on a steady rise in value over the last three months, increasing by more than 65 per cent. Sugar’s rise has, like coffee, been speculative with the “perceived” prospect that demand is outstripping supply (but more on what really is happening further on in this article).

Cocoa has been under the same pressure but with a twist reminiscent of the Hunt brothers back in the ’70s. A commodity trader out of the U.K. reportedly paid more than $1 billion for 214,000 tons of cocoa, about seven per cent of the total world supply, in a bid to influence the price of cocoa on the ICE (Intercontinental Exchange).

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Anthony Ward, the British trader, made his buy back in July to try to corner the market. It looked as if he might have made the all time killing many traders dream of as the market tightened and prices rose on an already short supply coupled with Ward’s gambit. Less than three weeks later, however, the market started to slide, leaving Ward with an unrealized loss of more than $150 million.

Of late, cocoa is back on the rise with a month over month increase of more than seven per cent from September to October; Ward may yet realize a profit on his buy, but as of the date of this article, he is still under water. Ward highlights some of the perils of the commodities markets and what they mean for processors. His thought pattern was that the world was going into a phase of tight cocoa supply but that the price had not spiked with the usual buildup to the holiday season. What he may not have counted on was that there are always warehouses somewhere full of cocoa nibs waiting to be sold when the price is right.

In the meantime, those who use the commodities market to hedge the cost of their raw material requirements (cocoa processors in this case) must endure the gyration and adjust their prices to wholesalers accordingly, which sometimes translates into increases in prices to the end consumer or thinner margins than usual.

Sugar also has seen a meteoric rise in value as noted earlier but is experiencing what commodity traders call a Contango or an inverted market (spot price is lower than the closest terminal month on the futures exchange and the price at further off months gets progressively lower). The reason for a Contango has largely to do with what macroeconomists call a “correction,” but applied on a microeconomic level whereby one commodity starts to drift lower in price when more information becomes available about the best prediction of future supply and demand.

Sugar’s relatively high price is being tempered by reports that the Brazilian harvest will bump the world supply higher by a few points than world demand. The result: a falling price for sugar. But in the meantime, processors are hit with a sugar price that they have to pay which is well above what it should be.

These wild fluctuations, combined with different suppliers to consumer markets bringing on inventories at different times, have made for almost insane differences in the cost of sugar. At one point, the cost of sugar of equal quality being sold at the supermarket was les than what a processor buying millions of pounds per year was paying at the wholesale level; all because of a favourable price of a contract released to the retailer that coincided with a steep increase in the commodities market price.

Producers of chocolate or products with a high sugar content are still in the position of having to cover their costs of raw materials to ensure their gross profit margin does not dip below the point where they are no longer able to cover their fixed costs. What invariably happens is that prices for their products face increases that mirror the commodities market but usually with a lag based on their hedged positions.

In essence, they are hoping for stability where none exists.

Indeed, the temptation to ride out the storm can lead to what Stuart Daw used to call commodity loss selling, or in his eloquent explanation: “If you buy coffee for a dollar, sell it for two, and then have to replenish your inventory with coffee that costs you three, did you make a dollar or lose a dollar?” The same can be said for all commodities.

In closing, while a stable price for commodities is one of the reasons future markets were invented, stability is sometimes the least visible aspect of the coffee, sugar and cocoa markets.

Questions or comments? Visit Brian at www.heritage-coffee.com.


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