Coffee Supply and Demand Made Easy

Understanding the #SupplyandDemand (S&D) balance sheet is essential for any professional #trader, but can also be extremely daunting. For many #coffee and #commodity #traders and #analysts, we have a deep insecurity in our relationship to the fundamentals because of its complexity and the extent of the many unknowns.

Despite (or perhaps because of) the difficulty of mastering the #SnD, it is a prized skill in our profession and a key driver to price discovery in the #coffeemarket. The #fundamentals are not only prized because of the impact on the #coffeefutures market, but also because it helps us to plan our #trading decisions across different markets and origins.

For many of us in the physical #commoditymarkets, the fact that supply and demand drives price is a given. We observe it year after year.

If there is a massive #surplus (such as the #Brazil driven surplus of 20/21), this puts important context to any deficit that may come after. When #Ethiopia experiences a drought and a delayed #harvest, we see #differentials spike as #consumers and traders fear a shortage.

Therefore, having a clear and reliable view on crucial data, such as #production, #demand, #exports (and others) is critical for making informed decisions.

Our premium clients receive our global S&D as a service from us in our Fundamentals Report, and in this article, we will share details on this report (and others like it) and how you can use it inform your trading.

Even if you are not a subscriber, our intention is to provide some insight into how to think about Fundamentals and to use these essential reports.

The S&D Pyramid

Our first step in understanding S&D, is having a clear and easy to read format.

Having clear numbers and visualizations will not only help us to understand the impact of S&D on price and availability, but also enable us to spot errors quickly.

Supply and Demand numbers are often guesses, estimates and provisional numbers, so we never want to take any number as gospel, but the first step is understanding what the numbers are.

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The crux of delivering information quickly, and with depth, is for reports to be pyramid shaped.

We summarize the big picture right up front, but this summary is well supported by a cascading foundation of data.

The tip of the pyramid is the stocks-to-use ratio. This distills the entirety of Supply and Demand into a single number: stocks divided by annual use. A low S/U ratio is bullish prices and a high S/U ratio is bearish prices.

Comparing a S/U ratio to prices over time is the essential starting point for any trader wanting to make sense of whether current prices are under or overvalued.

Think of both prices and S/U ratios as reference points and observe where they cluster together. When prices were at $1 where were S/U ratios? Where were they at $3? Where are they now?

Just below the S/U ratio in importance, but still near the top, are two closely related concepts: Supply and Demand #Balance and #Inventory levels.

Balance is simply total supply #minus total #demand. This is actually where many traders think of the top of the pyramid, as it shows the market in #surplus or #deficit.

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However, the important context for interpreting a surplus or deficit is the inventory levels. A big deficit may not actually be very bullish if there is an existing over-abundance of inventory.

In our report, the first summary is divided into global production and consumption from the two main different types of coffee: Arabica (divided into Milds and Naturals) and Robusta. This provides a quick insight into how the global S&D has been developing (going back to 2016/2017), and what is likely to be the way forward.

A chart provides a visual interpretation of this. I like to use bars for production and lines for consumption to easily differentiate. Below the S&D charts, we include a bar chart of the balance. This is what many consider to be the crux of the fundamentals for any commodities trader: surpluses and deficits over time, along with their respective sizes.

Digging Deeper

Having a grasp of the top-level of global S&D is super important, and a great place to start in our understanding.

However, if you stop here you will be exposing yourself to a major vulnerability. If we don’t understand why a market is in surplus or deficit, then we won’t know what to watch or what conditions might indicate something important has changed.

Since this is coffee, there is a good chance the issue is Brazil. So here is a pro-tip. If someone asks what you think about the Fundamentals and you have no idea, just say “I think it's all going to come down to Brazil.” There is a good chance that you will be right. (Substitute #Vietnam if you’re talking #Robusta).

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In all seriousness, there is often one or two origins that are the problem area and by scanning production data by origin you can identify it pretty quickly. What you are looking for are patterns and deviations from normal.

Once you identify a pattern, you want to dig deeper. Talk to experts who trade that origin, or who work there.

I had a mentor once who said, “Fundamentals is a journey not a destination.” This is where the journey comes in, becoming an expert in the Fundamentals is a million small conversations about the nuances of production and demand all over the world. I’m a few hundred thousand short of a million conversations, so not sure that I qualify as an “expert” yet. However, it is something that I aspire to.

Production in Vietnam increasing every year? Why is the trend increasing? Is it planted area or productivity? Both? Why is Colombia stagnating in production? Digging deeper into these topics will introduce you to what are the indications that the trends will change. Either returning to “normal” or getting off track.

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Exports and Imports

While Production is the sexy number that everyone likes and wants to know. The exports and imports are important supporting information. For exporting countries, the exports are the confirmation of production.

Customs data is often more reliable than crop estimates, so looking at exports will often provide confirmation of whether crop estimates were right or wrong.

Exports are also a solid indication of demand. Since someone has to have purchased the coffee for it to be exported, we can sometimes look at ebbs and flows in exports to indicate when demand is increasing or decreasing.

Keep in mind that exports are not 100% reliable either. Some countries have multiple sources that provide export data, and sometimes this information conflicts. When it does, we need to rely on a judgment call and experts in country to help make sense of the data.

Imports in exporting countries are also important for differentiating when origins are exporting coffee grown locally, or whether they are importing coffee for re-export. Subtracting imports from exports (net exports) will help to get a more accurate number to confirm production.

Imports are also useful for importing countries, not only for confirming demand, but also to imply exports from origins without reliable export data. If we are missing export data from a country, we can simply sum the imports from that country to derive what are called “mirrored exports.”