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Reflections in a Cup: Guessing Game on Coffee Prices

Guessing game on coffee prices


September 3, 2008
By Stuart Daw

Topics

With coffee being such a popular
drink, if not a national fad due to the “Starbuckian Revolution,” it
becomes an item of interest subject to national news coverage.

With coffee being such a popular drink, if not a national fad due to the “Starbuckian Revolution,” it becomes an item of interest subject to national news coverage.

In such a circumstance, one holds one’s breath at the very mention of the beverage coming out as a news item – will it be good news or bad?

On the bad side was a TV interview last week in which the guest was telling a horror story about how he had been hooked on coffee at the rate of 20 cups daily, and how he had to enter a rehab program to gradually kick the habit.

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Then just yesterday came the good news: a Harvard Study has determined that drinking seven cups of coffee daily helps avoid heart attacks.

These two conflicting stories are in themselves enough to give coffee speculators heart murmurs. The first announcement would drive them to call their commodity brokers and shout an order to “sell, sell all my coffee holdings,” for surely it would drive consumers away from the drink.

But the second announcement would mean a second call to the brokers. “Buy; go long, world consumption will go crazy in the battle against heart disease.” 

I cite these examples by way of illustrating the trouble with writing commentary on the coffee market today. For by the time it goes to press, the whole market picture may have changed. I say may have, when it surely will have changed, except that the change may have been up and down many times within a narrow range, possibly winding up exactly where it started.

It’s hard to recall a situation quite like the present, where supply and demand are roughly in equilibrium, but due to the uncertainties in the economies of most countries, exacerbated by exploding oil prices and the U.S. sub-prime situation, speculators with high stakes accounts in the market are responding to each rumour, however trivial, in a very skittish way.

But for some commodity funds, the rationale for their enthusiasm is the long-range perception that world consumption will outpace production. So, content to suffer any short-term sagging of prices, they have their eye on the long-term picture, beyond the time frame common to those who actually take delivery of green coffee, the roasters.

Want the coffee market to rise? Then you must find a way to scare people into thinking there is an impending shortage.

Want it to fall? Plant a story, or cite some real happening that can work in your favour. Examples could include such things as Brazilian domestic consumption being slightly down this year, and of course any reference to a worldwide business retraction with resulting lower coffee consumption.

But the main attempt of the rumour mill is to push prices upward against such downward pressure, and the quickest, easiest way is to cite any threat of frost in Brazil.

A report over a week ago of a cold front approaching from Argentina affected the market, but the resulting light frost in southern Parana province didn't reach far enough north to hit the coffee plantations, so it died as a threat, at least temporarily.

Another report yesterday from Brazil trumpeted the news that the current Brazilian harvest is “40 days behind schedule this week.” Still another warned: “Due to the sporadic flowering season late last year, coffee beans are becoming more scarce.” So by 10 a.m. the market had jumped over five cents per pound.

And what can appear to be good news for buyers may not really be so. In a report issued by the USDA on June 13, this year’s world production will reach a record level of 140.6 million bags (60 kg), up 18.2 million over last year.

But the holdover from last year’s production was the lowest in the USDA database since 1960/61, at 33.2 million bags, and this year will only expand by 6 million, one-third of the increased production, to 39.2 million bags (producing countries holding 17.2 million, importers 22 million).

The main problems facing the coffee sector include higher costs of fertilizer and pesticides, labour expense on the rise as well as transport costs due to soaring oil prices, and a weak U.S. dollar affecting incomes in many countries (selling coffee priced in falling US$, but having to live by spending inflated local currency). Conversely, if it strengthens, the growers might sell for less US$ and still do okay in conversion to their own currency.

A peek into the reports coming in from a few coffee-growing countries might help to explain some of the uncertainty.

India, typical of other coffee countries, is beginning to experience shortages of skilled labour, in a product that is not easily mechanized.

The Indonesian government has encouraged its farmers to replace coffee trees with cocoa by providing free seeds as well as five-year loans.

Kenya producers have responded to price instability by sewing corn, beans and tree crops among coffee trees. This is known as intercropping, and does not bode well for either quantity or quality of production.

In fact, many coffee growing regions in Kenya increasingly engage in more profitable enterprises such as dairy farming. Parenthetically we should mention that in our opinion Kenyan products are currently wildly overpriced.

Venezuela’s coffee prices are controlled by the government and have not been raised for over three years. Production has fallen as a result.

Guatemala continues to recover from Hurricane Stan in 2005, and prices are not high enough to justify investment in new plantings.

From all of this, one can readily understand how difficult it is to make the right choices in such a market. It helps to pay close attention and be alert to its daily machinations.

But however prudent one may be, one can still suffer the fate of one medium-sized U.S. roaster that just announced a loss of over $2 million for the quarter ended April 30, 2008, as opposed to a profit of over $300,000 in the same period last year.

The explanation? In part: “The losses were due to sharp increases in cost of sales that resulted from higher coffee prices and losses on options and futures contracts.”

It’s a tricky business, in which we have seen in the past 20 years the top three U.S. roasters east of the Continental Divide disappear into a large bakery company, P&G sending Folgers the way of all flesh into a jam and jelly operation, while a large Canadian foodservice roaster went under the hammer to a
frozen dessert outfit.

“One by one, our loved ones leave us!”