The latest GCA stock report and came in well above expectations and a lot of pundits (including myself) were surprised. I have been holding off on commenting too deeply on the stocks because I wanted to give some time to reflect. Now that I have taken time to talk to people and do some research, I wanted to offer a view: the higher than expected GCA stocks are more bearish than lower stocks, but not as bearish as I initially expected.
I won't keep you in suspense, essentially I believe that the GCA paints an incomplete picture of what's going on right now because of unusual supply chain times and the limitations of what the data shows, also I think the month on month focus is overstated vs the year on year.
I'll go into this in more detail, but here is a brief outline of what I will cover: 1) what was expected in this report and why,
2) why it is bearish
3) why its not as bearish as I had initially thought.
Why I Expected a Stock Draw There were several factors that collaborated to anticipate a stock draw, specifically the following four:
1) seasonality - the GCA stocks follow a seasonal pattern that is influenced by the Brazil Crop. Most years, August is a draw. In the below chart you can see that the 5 Year Avg change is -1.2%.
2) global deficit - a reasonable expectation for the 22/23 crop year is a deficit of 10 million bags. The deficit has to come from somewhere and that somewhere is stocks. If the USA has a proportional drawdown of their stocks it would mean a draw of approximately 1.6 million bags
3) logistical problems - it is no secret that there have been global supply chain problems over the last year from Covid supply disruptions. Out of Brazil, the situation is critical with freight costs marking new highs seemingly every week.
4) cert stocks - Over the same August period, cert stocks marked a draw of 11k bags. Certified inventory is not a 1 to 1 correlation with non-certified stocks by any stretch but they are both destination market coffee inventory.
GCA Stocks from CTA's Monthly GCA Stocks Report
I wasn't alone in expecting a draw in stocks either. A friend of mine recently wrote on social media:
"Are we facing some weakness in coffee demand? GCA report last year at the same period we faced a reduction of 310K bags and an average of 5 years it's a reduction os 122K bags .... in top of that we have to consider all logistic problems to move coffee from origins to North America !!!"
Why it is Bearish
The initial conclusion drawn by many in the industry was that demand is weak. This was commented to me by more then 1 friend in the trade after the GCA stocks came out. In other words, the weak GCA stocks reflected what they saw in weak demand.
Weak demand is certainly bearish, but there is also a more immediate reason that this data point is bearish. Stock represents present supply and there is more supply than people thought.
In our most basic model of understanding market forces, popularized by our old friend Adam Smith, we understand that more supply = lower prices. In economic terms this is what we call a supply shift. When supply increases, the Supply curve shifts to the right and prices drop.
I use a price model to determine an approximation of fair value and when the new data came out, my daily and weekly subscribers were treated to an updated model that was immediately 4c lower than previously estimated.
However, the larger concern is not that there is a temporary larger shift in supply, but rather that demand is worse than anticipated. If demand is materially weaker than we are expecting, than that 10 million bag deficit could be an 8 million bag deficit. This changes the math a bit.
Why it is Not THAT Bearish
With the above in mind, there are a some key factors here that mitigate the bearishness of the surprise GCA number.
First and foremost, on a year on year basis, the GCA stocks are still down significantly (9.1% to be precise). So although a little bit higher than expected the GCA stocks are still showing significant draw and this does not materially change the expected deficit. Even if demand is worse than expected, the market is still going to have to cope with a global shortage of coffee.
GCA Stock Seasonal from CTA's Monthly GCA Stocks Report
One of the more interesting comments on the GCA number was from a friend of mine who works in origin. He mentioned that what the stocks do not show is percentage sold.
So while the stocks definitely increased, some portion of this coffee has already been sold to consumers. Although this sold-coffee is supply, it is not supply that is available on the market. In the aforementioned trader's view, the percentage of destination stocks that are already sold is increasing and the available (unsold) supply is decreasing.
Finally, we have to come to logistics. In June we had a number that surprised the opposite direction. June stocks were a draw when everyone expected an increase. At the time, many of us were going on about how bullish this was, but then when July was reported we saw that June was just an abnormality in an otherwise normal season.
I attribute the difference to the abnormal situation with logistics causing supply disruptions. So I don't want to read too much into the higher GCA number until we see more data points. If we continue to see higher prints then we will have to adjust our numbers and our thinking to the reality. Until then, I think we should expect some fluctuation and abnormality in the numbers.
This also brings me to my final point. Talking to the consumers they seem appropriately concerned about availability of coffee this year. I think it is plausible that roasters are buying as much as they can now, knowing that there will be a substantial draw. From this perspective it makes sense that we have a bit of a final increase in the season. This jives with what my friend stated about the percentage sold increasing as well.
With the logistical slowness it could be that what we are seeing in the stocks now is essentially coffees purchased a while ago that are finally showing up.
Conclusion
I often remind myself not to be married to a position. When the facts change my view changes. For now, the increase in stocks is another weight on the bear's side of the scales. I have adjusted my valuations accordingly. However, I don't want to make the mistake of switching sides too quickly on mercurial information. For now, my general bullishness is intact, but some of the sharpness is coming off of that position.
Feel free to let us know what you think in the comments below or by email.