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Lay of the Land

#Coffee has confounded both bulls and bears with a sideways movement after one of the most dramatic bull markets in a generation.


Since the initial rally 260c, certified inventory has fallen to 23-year lows and calendar spreads have inverted to levels not seen since the Brazil frosts of the 1990s. So where is coffee headed to from here?



My view is that coffee probably has one more rally left in her, but then she is done, and the bear market will start.


However, price predictions are a bit misleading. Predicting commodity markets with certainty is foolish, markets are complex and there are multiple potential outcomes. Instead, a good analyst discusses probabilities.


In this article, I will discuss describe the lay of the land, how we found ourselves where we are, and also share why I believe that the likely outcome is a rally followed by a sell-off. I will conclude by highlighting what I think are other potential outcomes.




Fundamentals

When evaluating the fundamentals I like to start top to bottom to ensure that we do not lose the forest for the trees, and in coffee, the top of the forest is the annual #Supply and #Demand Balance sheet.


The long-term #fundamentals have the #coffeemarket in a two-year deficit after the surplus of the 2020 crop, and looking forward to a return to surplus in the 23 crop year.




Coffee has a biannual cycle due to the biannual nature of the Brazil crop where the market tends to alternate year of deficit with year of surplus. However, we find ourselves in a scenario of 2 years of deficit because the off-cycle 21 crop in Brazil was devastated by drought and the current on-cycle 22 crop was doubly ravaged by frost and drought.


This has crushed global supply and ignited coffee prices to 200c and beyond.




Destination inventories in Europe, the USA and Japan all saw massive drawdowns, not only from the deficits but also from covid-induced lockdowns that skyrocketed freight prices and snarled logistical efforts to ship coffee.


Supply problems in #Colombia and #CentralAmerica further accelerated the deficit and triggered rallies in differential prices across key washed coffees.


The combination of high freight prices, high differentials and slow transit times triggered another phenomenon: certified stock consumption (more info on Cert Stocks here). With all of the delays and added expense to import coffee, it became financially attractive to decertify coffee and sell it for consumption.


This certified stock draw triggered impressive rallies in calendar spreads leading to the largest #backwardation since the #Brazil #frosts of the 1990s.



On top of all of this is the speculator.


Usually, the spec long helps to accentuate rallies, and they did so in this case, especially at beginning of the rally during the frost. However, #volatility has knocked out the spec, and low hedging combined with low spec activity has dropped open interest and liquidity down to 2017 levels which has exacerbated volatility.


This is the present moment in which we find ourselves.


However, while there is a lot going on, the truth it was fairly predictable.


Numerous #analysts, #tradehouses and pundits discussed the historic deficit, the frosts, the droughts and how it would trigger a dramatic rally.


In my own work, on Jun 28th when coffee was trading in the 160s, I wrote about how there was a major frost predicted and that the market seemed to be discounting it. I concluded the article with the following statement:


"The #deficit year this year will be drawing down global stocks to very low levels and the market will be relying on a large #22/23 crop to replenish those stocks. If the #22/23 crop is compromised, then we may be in a situation where we need to price ration coffee. If that is the case, it will be a heck of a bull coffee market."


This did indeed happen, and it has been a heck of a bull market.


We are now in the worst of deficit. The 22/23 crop is being harvested, and there is evidence that it may be even worse than people thought.





However, if all of this was predicted over a year ago, the question is where will the futures market go now? The answer is it will look forward 1 year.


The conventional wisdom is that high prices plus coffees biannual nature mean we would have a massive 23/24 crop and