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Coffee Trends: The American Factor

The American Factor


February 29, 2008
By Brian Martell

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As Canadians in the coffee business it is astounding how much our trade
is linked with the United States. The world’s largest consumer of
coffee is also the seat of the most important trading component of
industry, the New York Board of Trade (NYBOT)’s Coffee Sugar and Cocoa
Exchange (CSCE), now commonly referred to as the ICE (International
Coffee Exchange).

As Canadians in the coffee business it is astounding how much our trade is linked with the United States. The world’s largest consumer of coffee is also the seat of the most important trading component of industry, the New York Board of Trade (NYBOT)’s Coffee Sugar and Cocoa Exchange (CSCE), now commonly referred to as the ICE (International Coffee Exchange).

All coffee traded anywhere in the world, whether it be on the New York Exchange, the London Exchange (for Rubusta) or the Le Harve Exchange, is all traded in American dollars. That means that if a British importer is buying coffee from Costa Rica to bring straight into the port of Liverpool, he will not consummate the deal in Pounds Sterling or Costa Rican Pesos, but rather in American dollars. Further, the largest producer of coffee in the world, Brazil, hosts the office of the United States Department of Agriculture (USDA), which constantly monitors the health, predicted crop yields and dynamics of the Brazilian coffee industry.

As coffee businesspeople, we need to be aware of, as Newton would say, the actions and reactions that may be caused by what goes on with our neighbour to the south so that we can predict future events from present occurrences.

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Consider the current situation of a strengthening Canadian dollar as compared with the American.  For the first time since 1976, we have a currency that is on par with the American which means that our ability to buy coffee at a better price relative to when the Canadian currency was trading at 64 cents to the U.S. Dollar.

But wait, it’s more complicated than that.  You see, not only is it a question of being able to buy coffee in “greenbacks,” but for producers it is a question of selling coffee (green) in USD. So what happens when the American dollar drops not only as a function of our own currency but of that of other currencies around the world, especially the producing nation’s legal tender?
 
Well, that’s the complicated part. The U.S. market being the largest importer has a counterpart in the Brazilians who are the largest exporters. So when the real (the Brazilian currency) gains strength on the USD, and the farmers who get paid in American and then convert it back to reals have to buy everything else to keep their plantations going, it essentially amounts to a cut in revenues.
 
So what is the predicted reaction to Brazilians losing revenues due to a devalued U.S. dollar?  They start withholding shipments, which causes a shortage in supply, thus shifting the curve to the right with the effect of increasing prices.
What happens at home in Canada? We end up buying green coffee at a higher price but with a better exchange rate. In the end, the cost may be marginally higher (depending on how much higher the coffee market goes relative to gains made on the American dollar) but again, we need to look at what happens south of the boarder.

In economics, there is a term used to describe how easy it is for one service or product to be exchanged for another in times of shortage. This term is elasticity and it is directly proportional to the ability of people to swap out one good for another. For example, if apples are considered to be interchangeable with pears then as the price for apples rises, people will be more likely to buy pears.  In this case, the demand for apples would be considered to be very elastic.

Coffee, by and large, is inelastic. When the price for coffee goes up, the demand for coffee does not move very much, if at all. It is part of the world’s culture and is so ingrained into our daily rituals that it is not very likely that with a 10 cent increase in its cost people will start looking at tea or hot chocolate as an alternative.

This again has a profound impact on pricing. Americans who have no choice to convert “greenbacks” into another
currency must swallow hard when the price of coffee goes up due to a devaluation of their dollar. This means that shortly, we will see rumblings in the press that the big three coffee roasters in the U.S. (KGF, Nestlé, and Proctor & Gamble) will be announcing price hikes on their retail products. This further means that the possibility of the coffee market declining due to a drop in consumption by the world’s largest consumer is not very likely.

The U.S. also holds the greatest stores of green coffee outside of the producing nations. As this inventory rises and falls so does the possibility of price fluctuations based on market conditions. In of itself, the amount of coffee held in American ports “should” not affect the price of green coffee as that price is determined by the classical “supply and demand” intersection.

But in reality, any attempt to manipulate supply through retention will be successful only if U.S. stocks are low. As the old axiom goes “possession is 9/10ths of the law” and in this case, if green coffee is on American soil in abundance, then roasters and importers can afford to wait for prices to decrease during times of price inflation.

Just as important, although not directly involved in the coffee industry, is the number of investors that look to commodities such as coffee to park their money for a quick return. Of all the trading done on the NYBOT, fully two-thirds are from those outside of the industry (mutual funds, pension funds, private investors, etc.). The remaining third is roaster activity, based on what needs to be produced, as well as a mechanism to create price stability on a company level.

The non-roaster activity is often the bane of those of us who actually buy the stuff to roast it and sell it as a finished product. But while we may complain about their ability to spike or drop the market at a moment’s notice, we do have to acknowledge that the funds do play an integral part in the market and we need to factor them into any decisions we make regarding buying strategy.

In closing, our relationship with the U.S. is not only one of fraternity, but in many ways one of economy.

Questions or comments? E-mail Brian at Brian@heritage-coffee.com.


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