Coffee Percolating for 2018 Rally

January 11, 2018 Newsletter, Speculator No Comments

Coffee is a market that spends 80% of its time moving sideways or lower. Thus looking for Bull moves higher entails some risk.  Brazilian currency appreciation, La Nina and extreme oversold hedge positions by Money Managers and Large Spec traders all have potential to support a meaningful rally in 2018 above the 130’s to 140’s consensus.

When Oil collapsed in late 2014 from over $110/barrel to 26 in early 2016, Brazil went into a depression and their currency fell to record lows. Coffee also capitulated to multi-year support, demonstrating a very close correlation. Oil, Coffee and the Brazilian Real all rebounded in 2016 as the Global economy and commodities in general rebounded. These markets continued to track each other well until the 4th quarter of 2017 when Oil surged on inventory reductions while the Real moved sideways and Coffee moved closer to decade lows. Despite political chaos, Brazil and Emerging Markets should strengthen in 2018, boosting the Real and providing support for Coffee. Once the Real moves above its 3240’s resistance of 2017 we should see an uptrend underway in Coffee.

Like the Real and Coffee, Oil and Coffee also move together due to tethering of Emerging Markets like Brazil with key industrial commodities like Copper and Oil. Since September 2017, Oil has surged in part due to inventory reductions, but more recently because of fears over Iranian turmoil. So far, this $16/barrel run higher in Oil since September has not elevated the Real or Coffee. We expect some normal narrowing of this spread in coming months. Soybeans, another major Brazilian crop, should also benefit when the Real breaks higher. 

A major exogenous factor aside from currency and economic trends is the weather. Predicting the weather more than a couple weeks away lacks accuracy. Determining the relationship of El Nino and La Nina extremes with future weather and crop supplies months later is a bit of alchemy.  To indulge for a moment, there does appear to be “some” correlation with La Nina and colder extreme temperatures in the US and various crop concerns throughout the Americas, but difficult to quantify. The current La Nina should be reaching a moderate climax this month which “can” create crop troubles in the America’s in 2018. 

Will this moderate La Nina cause weather extremes in the US or Brazil affecting crop prices? The Coffee chart below shows that forecasting the timing of a poor Coffee crop is imprecise, but it may add weight to up-trends in Coffee should prices break out.

Most brokerage houses are looking for a neutral Coffee market with potential price resistance in the 130’s to 140’s. At the current 123 trade basis March, we are below 2018 consensus targets and approaching a major long term support window in the 100 to 110 area. Adding support to oversold Coffee prices is the strong correlation of Managed Money accounts. When they are holding  extreme net short positions, Coffee prices will bottom. This month Managed Money has fallen to a new all time extreme level of oversold net short holdings, which implies that prices are vulnerable to significant short cover buying whenever a trigger arrives, such as weather or a stronger Real currency. Any further price drops over the next week or two into the 110 to 120 zone will generate favorable technical entry points and a slow stochastic momentum setup for lower risk medium term entries.  

La Nina aside we have a fundamentally well supplied Coffee market with modestly lower global stockpiles. Technically we have a long term oversold market with record negative sentiment and extreme net short positions among money managers. This makes coffee very news or weather dependent in 2018. Should post La Nina weather impact crops in Brazil and prices move above 133, we should see considerable short covering potential to the 140’s – 170’s. An early warning Bullish indication for Coffee to watch is the Brazilian Real currency breaking key resistance at 3250, signifying a rebound in commodity oriented emerging market economies. With Brazil’s Business Confidence and Manufacturing Purchasing Manager sentiment levels surging to 5 year highs, there are good reasons to presume the Real will move back to rally mode and provide support for commodities such as Coffee. {Coffee is traded as a futures contract, but also as a stock ETF with the symbol “JO”}

Leave a Reply

Ready to start creating financial success? START YOUR FREE TRIAL