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September 09, 2004

Coffee - Time to Invest?
by Bonneuil Report

For much of the last decade, coffee prices have remained under the costs of production. When this happens, there is naturally little or no incentive to produce coffee. This has recently resulted in many coffee trees being less cared for or simply uprooted to open acreage for other agricultural commodities. And even worse, coffee producers have gone into extreme financial difficulties or even bankruptcy. There are many examples of these eventualities in the coffee producing areas of Africa and Latin America.

Is this the time to invest in coffee? Let's examine below.

Technical Indicators

One key technical indicator is the Commitment of Traders Report (COT) for coffee, shown below in the graph. The COT Report graph is derived from position numbers of three key trader groups provided by the Commodities Futures Trading Commission (CFTC). The CFTC classifies the three types of traders as follows.

• Commercials - Producers and end users of the commodity or futures market they participate in are referred to as commercials. This group is the reason the commodity and futures markets exist, to allow "commercials" an opportunity to defer or hedge the risk of doing business. The commercials are shown in blue in the graph. The commercials represent the smart money group that will often get aggressively net long or short prior to major trends.

• Large Speculators - Defined as those traders who hold a specified number of contracts or greater in a given market, but are not commercial traders. The CFTC sets the minimum number of contracts that can be held before the speculator is required to report that position. Any speculator participating in a market that is required to report to the CFTC is known as a non-commercial or large trader. The large speculators are shown in green in the graph. This group follows trends and usually mimics the market price movement.

• Small Speculators - Any market participant who is neither a commercial nor non-commercial is a small speculator. This group is not required to report to the CFTC but can determined by the contracts left over after the commercials and non-commercials have been accounted for. The small speculators are shown in red on the graph. This group is usually wrong at the major turning points.

As can be seen from the COT Report graph, the commercials net position has grown in the last few months to a net long position that is the largest in the last 9 months. This is an extremely bullish indicator for the next few months.

It can be seen in the COT Report graph that for other times when the commercials went to a relatively high value of net long position, the peak of their position holding coincided with the low in the prices for the immediate time period but that then proceeded to rally to higher prices. For examples - see the commercials net long position peak around mid November 2003 followed by rising prices for the next several months or see the commercials net long position peak round mid March 2003 followed by rising prices for the next couple months.

Thus this powerful technical indicator is now appearing to indicate a strongly bullish scenario for coffee prices in the upcoming few months. Let's look at some additional technical indicators for any confirming indications.

Another technical indicator is the coffee seasonal chart. A multiyear seasonality chart depicts the relative strength of coffee prices throughout the year, month by month. Many technical analysts trade around these historic seasonality behaviors. The relative seasonal strength appears to depict a strengthening in the prices from a relative factor of currently, in the mid to late August timeframe, of very low relatively to relatively high by the end of the year. This appears to indicate a relatively high strength and statistical historical probabilty of rising prices from now through the end of the year.

This seasonality indicator coupled with the above COT Report indicator is currently providing confirmation for higher coffee prices in the months to come. Let's look at two more technical indicators for added confirmation - moving averages and Moving Average Confirmation Divergence (MACD).

Three moving averages most often looked at by technical analysts are shown below in the graph below in blue, red, and green colors.

The graph shows the basic three moving averages of 4 days, 9 days, and 18 days. The 4-day average is show in blue; the 9-day average is shown in red; the 18-day average is shown in green. Generally the indicator works as follows: if the faster moving average is higher than the lower moving average, prices generally move to higher levels.

Note that the 4-day average is currently (as of 9/1/2004) at 73.06, the 9-day average is at 73.00, and the 18-day average is at 71.73. The fastest average is indeed higher than the middle average, which in turn is indeed higher than the slowest average; this has just recently occurred and it is a bullish turn of technical indicator. This further confirms a potential upcoming rise in coffee prices in the upcoming timeframe.

And yet another technical indicator is the Moving Average Convergence Divergence (MACD) indicator, shown below in the graph. The MACD histogram depicts the difference between the two moving averages in pink. Generally the histogram indicates that when the spread is below the zero line but starts to move upward towards the zero line, the downtrend is losing momentum and may provide an change indicator in pricing trend. The MACD histogram works well on the weekly graph, which is depicted below.

Although the current MACD graph does not yet depict the faster average to be moving higher than the slower average, the MACD histogram appears to be slowing and perhaps just about reversing - this is a potential confirming indicator, and potentially sets the stage for the indicator to turn strongly positive at some time in the very near future. Further, from the much larger size of the histogram relative to other previous histogram sizes, the indicator appears to show that a fairly large rise in prices may be around the corner.

International Coffee Organization

The International Coffee Organization (ICO) is based in London and consists of 55 coffee producing and consuming member countries. The ICO is the top coffee authority in the world, but its effectiveness has been hampered without the backing of the United States since 1992, when the United States left the ICO in opposition to the ICO quota system, maintaining that the quota system went against the concept of a free market. There are some that surmise a 50 cent per pound increase in coffee prices should the United States rejoin the ICO.

Demand Considerations from Asia

A fundamental consideration, in addition to the basic lowering supply and increasing demand statistics mentioned above, is a growing demand from Asia and especially from China. Witness the growth of coffee consumption and the emergence of Starbucks and other brand café houses all over the city island state of Singapore in recent years; if this is any indication of the growth and interest in coffee in the region, then if China increases its current per-capita coffee consumption from about 200 grams to the same levels as in Japan (about 2.3 kilograms), then coffee consumption in China could be almost 3000 million kilograms compared to about 100 or 200 million kilograms for many Western countries. This would represent a massive increase in coffee demand resulting in much higher prices. In general, China has already been driving the demand for commodities and coffee would represent yet another such commodity in increasing demand.

As noted investment advisor Marc Faber has mentioned "In fact, I regard the purchase of a basket of commodities as the safest way to play the emergence of China as the world's dominant economic power"[1] and most recently Marc mentioned "investors should be long a basket of agricultural commodity futures consisting of wheat, corn, sugar, coffee, and orange juice futures& [2]

Summary

In summary, coffee represents a good value buy now, based upon the technical and fundamental indicators and considerations presented above.

[1] "Tomorrow's Gold", Marc Faber, CLSA Books, 2002
[2] "Should you buy what China buys?" Marc Faber.

The Bonneuil Report
info@bonneuilreport.com

Disclaimer: Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading. This articles does not constitute a solicitation for the sale or purchase of any security, futures contract, option, or other financial instrument. Those acting on this information are responsible for their own actions. No claim is made that recommendations will be profitable or that they will not result in losses. Copying, re-broadcast or dissemination of this article, in total or in part, is expressly forbidden without prior written permission from The Bonneuil Report.

© 2004 The Bonneuil Report

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