The new year begins with a mystery, and that mystery is the case of the missing GCA stock deficit.
We have a heard a lot about the 21/22 deficit, the current bull market is really a continuation of that story. Yet curiously enough, the impact of this deficit is missing from one of the most timely, relevant and visible sources of data: the GCA stocks. I have several theories as to why, but we will return to the GCA shortly. First, let’s start at the source of the deficit (Brazil), and examine the facts. According to Cecafe, Brazil coffee exports reached 5-year lows last month and we have been underperforming for several months now. On first pass, this largely confirms the deficit that we would expect.
Our own estimates have a 34% decline in the Brazil Arabica crop and a 25% decline in the total Brazil Coffee crop based on the drought-induced crop failure last year. If we include just the new crop exports (Jul – Nov) of 2021 and compare them to the same period in the prior year (2020) we see that the exports are matching expectations: 15 mm bags in 2021 vs 20mm in 2020 = 25% reduction (the same as our total coffee decline in Brazil).
Anecdotally, though there are still some question marks here.
First, we have been hearing about container shortages and logistical problems in Brazil causing massive delays that have not yet been alleviated. This implies that at least some of the decline in volume is due to shipment issues rather than lack of supply.
Whether that means exports are down 5% more on delays or 50% more I don’t know, but presumably exports should pick up as shipping problems are alleviated in 2022.
Second, reports from several sources has stated that business is extremely slow in Brazil because farmers are refusing to sell. This has been the report for months (and according to Cazarini for 2 years).
There may be some overlap here: i.e. farmers are reluctant to sell because they have less coffee. However, it is very different to say that business is slow because farmers are holding out for better prices rather than business is slow because farmers have nothing left to sell. Holding back coffee is a common strategy for the Brazilian producer and can be very effective in raising prices.
Ultimately though, that strategy is a game of musical chairs. No one wants to be left without a chair when the music stops. In other words, no producer wants to be the last one to sell if prices start falling.
The next datapoint that confirms the deficit but raises additional questions is the ECF Stocks. The European market is the largest consumer of coffee (33% of global consumption). If we apply the deficit proportionally then a 10 mm bag deficit implies a 3.3 mm bag stock draw in Europe.
Unlike the GCA stocks, the ECF stocks are actually on track to hit this target. From Jul (14.3 mm bags) to October (13.3 mm bags) this market dropped 1 mm bags and at this rate we will hit our target of 11.5 mm bags just before the next Brazil crop in April of this year. Again, it appears that the Deficit is confirmed!
However, one point worth noting is that the European stocks were starting from much higher levels than the GCA stocks. The large surplus in 2020 enabled the Europeans to build a record stockpile of coffee, and even with the impressive drawdown we are still well above previous year's levels.
Some of this extra volume may be statistically illusory as the reporting methodology was changed last year, but even if we normalize the volumes and just apply month on month % changes to the previously reported numbers, stocks are still above the 5-year average.
This relatively large surplus in Europe is important because it contrasts with what we see in the GCA stocks.
Unlike the ECF stocks, the GCA stocks started the 21/22 crop year well below the 5-year average and unlike the ECF stocks they have not seen a significant draw down at all. At 16% of the global consumption, we would expect the American share of the deficit to amount to about 1.6mm bags. Yet unlike the ECF stocks, American coffee stocks are relatively flat in November (5.84 mm bags) vs July (6.07 mm bags).
So why did the deficit fail to impact the GCA in the same way as Europe?
It could simply be that since the GCA stocks are lower, the Americans are paying up for coffee and the Europeans are drawing down their stocks. That would make sense, except that if that were the case, we would expect the European stocks to be exceeding the expected drawdown (because they would have forgone some of their imports to let the Americans pay up for it) rather than simply matching it.
There are several other possibilities as well.
On the bullish side, it could be that the deficit hasn’t hit the American market yet. It takes some months for the shipments to hit the warehouses in the USA and it could be that we haven’t seen the worst drawdown yet. This is possible, but I do have some doubts because Europe is geographically further away from Brazil and we are seeing the drawdown there. It could also be as simple as origin stocks drawing down to accommodate US demand.
On the bearish side, it could be that the deficit is not as bad as expected. Either there is more supply available (made up by other origins, or larger than expected origin stocks in Brazil), perhaps demand is poor, maybe not recovered as we had hoped, or some combination of all of these.
The reason why all of this matters, and why I am so focused on the GCA stocks is because I use the GCA stocks in my price models. The GCA stocks are historically the most visible, relevant and timely source of stock data. Whether people realize it or not, the GCA stocks are important in many trader’s mental price models. The fact that they are not drawing down as expected casts some doubt on the bullish market.
For the time being, I remain a bull. I am pushing my expected GCA draw forward, and assuming that the Brazil deficit hasn’t hit the GCA stocks yet, but that it will in the coming months. However, there are only a few months remaining until the next Brazil crop. If the data does not bear out the deficit, then we will have to admit that we are wrong.