Coffee Market Surges 49c in a Single Day – Post Rally Analysis

The coffee market began the week with an extraordinary 49c/lb single-daily rally, the largest one in history on a cents-per-pound basis. When swings of this magnitude happen, questions naturally arise, and you may be asking yourself:

“Why such a major rally? Why now?”

“Was it because of frost scares in Brazil? Was it because of the El Niño?”

In this article, we'll share our interpretation of what happened and explain the market mechanisms we believe were behind this rally that caught many people off guard.

In summary, we believe that adverse weather in Brazil provided the initial bullish catalyst. Once prices broke through a certain key technical threshold, it might have triggered a powerful wave of trend-following buying and short covering from specs.

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The Bullish Catalyst

The bullish catalyst appears to have been adverse weather in Brazil. Although the crop is widely expected to be massive and record setting, since the harvest began, conditions have been far from ideal, with frequent untimely rainfall disrupting fieldwork, slowing bean drying, causing beans to fall from trees (in some cases/regions) and raising quality concerns.

Notably, just when the weather was starting to clear in Brazil (last week), precipitation forecasts came back to wet mode again for Jul-Aug, indicating that problems were not necessarily overcome.

Since Brazil is in winter, some might have thought that frost fears sparked the rally, but that wasn't the case. Temperature forecasts showed no risk of frost ahead of the rally, and the presence of moisture in the air (from rains) actually contributes to mitigate frost risk by limiting overnight cooling. 

In hindsight, the “real” initial bullish catalyst seems to have been almost a month ago, when NOAA officially declared El Niño on June 11. 

El Niño is often associated with dryness in key stages of cherry growth of a few important Oct coffee crops like Vietnam, Colombia and Central America (although the strength of this relationship is debated), hence a certain concern/attention is somewhat justified.

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At the same time, weather models were pointing to a drier-than-normal Aug-Sep period, when rains are needed to help coffee cherries mature. This might have landed some support to the El Niño concerns.

The Breaking Point

The breaking point appears to have come when coffee surpassed its 9-month bearish trend channel on Jun 30. For months, prices had remained confined within this channel, so the breakout, combined with a subsequent move above the 200-day SMA provided a strong bullish technical signal.

Moreover, an inverse head-and-shoulders formation (a bullish formation) was seemingly completed by Jun 30, and this likely strengthened bullish conviction and might have attracted additional buying.

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These breakouts matter because many systematic and trend-following specs / hedge funds use technical signals to determine when to enter or exit positions. So, a break above a long-term downtrend and the 200-day SMA might have been interpreted as evidence that the downside trend was losing momentum, encouraging fresh buying.

Speculative Trend-Following

The breakout of the 9-month trend may have incentivized technical buying. We don’t know yet who was participating in the 49c Jun 6 rally (need next COT report for that), but we do know that the breakout above the 9-month downtrend towards 300c was fueled by spec buying, primarily short covering of May-Jun positions.

This is something we had been warning about, since the embedded May-Jun shorts would be vulnerable to mounting losses and forced to cover above 280c. According to the latest COT, specs bought 7.2k lots during Jun 24–30, 5.7k lots being short covering of May-Jun positions. This explains why prices rapidly rallied after effectively breaking above 280c.

The subsequent breakout above the 200-day SMA may have attracted more technical buying from specs while forcing the remaining Jan–Feb speculative shorts to cover as losses mounted. We estimate by the COT reports that roughly ~6k lots of spec shorts were remaining above 300-310c.

Once prices moved above 310c, these positions likely began facing mounting losses, potentially forcing short covering and creating a self-reinforcing bullish dynamic. It’s possible that commercial short covering also took place, as some hedgers could have been forced to liquidate too.

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These may have contributed to the rally towards 350c, but ultimately, these are just possibilities and not confirmed. We will need the next COT report to confirm if this happened and to which extent.

Conclusions

One thing we often see in aviation is that major accidents are rarely caused by a single event, but rather by a combination of factors that build up over time until they lead to the accident. I believe the same logic applies to major moves in the coffee market: significant rallies are rarely driven by a single factor, but rather by multiple factors gradually adding up and reinforcing each other.

It wasn’t just El Niño, and it wasn’t just worsening weather conditions in Brazil. It wasn’t just technical factors or short covering either. Rather, it was seemingly the combination of all these elements that ultimately fueled the rally.

Managing Risk

Ultimately, this rally caught many people off guard and serves as a reminder of the importance of having a comprehensive risk management strategy in place, one that includes tools to manage unexpected market moves.

For example, short holders could have used call options as a way to manage their risk. So, rather than simply covering shorts, buying calls would have offered them upside protection. Given the magnitude of the rally, those options could have not only locked in profits but made significant money.

This is the type of risk management that we teach in both our Coffee Traders Course and our coffee Options Course.

Our next Coffee Options Course is approaching (July 22-24) and if you’re interested in participating, feel free to register here. Whether you’re new to options or looking to strengthen an existing hedging program, you’ll leave with practical tools and frameworks that you can apply immediately.