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Robusta Inversion, Peak or Just Getting Started?

A few months back I wrote about the +22 inversion in #Robusta #coffeemarket and how that market gets "squeezed". Since then, the F/H more than doubled to a high of $67/MT. This is not simply a few trade houses "playing games" with the #stocks, but indicates some strong #fundamentals.


I would argue that despite the impending #Vietnam crop, this #calendarspread still has #bullish fundamentals behind it and could even rally to new highs.



Vietnam

Before, I talk about why this could still rally higher, let's acknowledge the elephant in the market.


Vietnam has not sold their crop yet, and when they do, that will provide significant downward pressure.


However, much like the Brazilian #farmer, the Vietnamese farmer is a price maker rather than a taker. Vietnamese Robusta is a natural coffee so there is no rush to sell it (or even process it). They can hold back their crop if they don't like the price and so the market must rally to meet their selling level if they need the #coffee.


The traditional understanding of Vietnamese selling is that the farmer will sell some of their crop before the #Tet holiday (Feb 1, 2021 this year) to finance their needs for the season and then will hold back the rest of their crop until they like the price.


Current levels are about 40k VND which is a great price (25% higher than last year at this time). However, the farmers there are bullish and so they seem in no hurry to sell.


If that changes, in other words, if the farmers decide the price looks good, then they could definitely collapse the spread, especially in the front month. That is a significant downside risk.


Bullish Fundamentals Drive Positioning

Fact is that #roasters need coffee. We have a #deficit year in coffee and #Arabica is EXPENSIVE. At 186c/lb Arabica is not cheap and Robusta at $2079/MT (94c/lb) is nearly 50% cheaper. This means that demand for Robusta to mix into blends will be strong, and is strong.


The front month spread has come off a lot in Robusta (though still inverted), and I think this has more to do with the #spec positioning.


The spec has not been shy about being long Robusta, and on both an outright and % of #OpenInterest basis they are darn-near the highs. Unlike the #trade, the spec can't take delivery, so when FND comes they just have to roll forward. This puts downward pressure on the nearby spread (X/F) and upward pressure on the 2nd spread (F/H).



While the Spec is very long, the #Roaster is very underbought. This is both bullish and #bearish.


It is bearish in the sense that the Roaster is smart money and the positioning indicates that the roaster views the market as overvalued. The spec by contrast, is long as all-get-out and they only have a finite amount of risk appetite.


When they (Specs) hit the highs of their positioning, we tend to think of that as a soft "max" (see post on how to read COT). So from this point of view we could view the positioning as bearish Robusta.




However, the flip side of this is that sometimes the smart money gets it wrong.

When prices get very high, the consumers will let coverage go so as not exacerbate a bull market. However, in an extended bull market the roasters will eventually need to cover and they will buy. This is called #Capitulation. If the roasters #capitulate, then we will see a final extension of the market before it eventually comes off.


Freight and Certs

#Certs are a key driver for spread prices in robusta because if someone wants to take delivery of #certifiedstocks then the spread must rally until it finds a deliverer.


The rapidly rising #freight rates are incentivizing the cert draw on two fronts. On the one hand it is getting harder and more expensive to ship coffee from origin to destination to tender, and on the other hand it is making spot coffees at destination a lot more attractive (no shipping costs).


I mentioned in my #inversion article the freight costs for Ningbo to Los Angeles rallying from $4500 to $13300 from April to Jun, and since then they have rallied another $5000.


This freight rate rally has been driven by container shortages in exporting countries. Will that get better or worse? Well, the Christmas season hasn't even started yet. Not to mention, energy (shipping fuel) is in a roaring bull market. So it looks like high freight costs will be around for a little while.


Energy in a roaring bull market


Conclusion

I've outlined the biggest factors that I see that will contribute to robusta prices over the coming months. That said, when I was actively price modelling Robusta coffee, I concluded that the single biggest input into the price of Robusta was...


[drum roll]


...the price of Arabica.


So without a doubt, a big driver in the high robusta prices is the Arabica prices. That can go both ways. However, I think the case is quite strong that Arabica has bullish fundamentals and robusta too has some pretty strong support at the moment.


Their are bearish risks too. A strong #dollar could crush coffee prices. A lot will depend on how aggressively the Vietnamese farmers decide to sell their crop. A covid variant and new lockdowns could potentially hurt demand, that's a risk. Maybe even high prices won't be enough to convince coffee companies to switch to cheaper blends, that risk is there too.


However, I think the issues above point to strength continuing into the Christmas season at least. In theory, that should be when container problems peak and shortly after that we may see the Vietnamese farmer start to sell for Tet.


That's my view, feel free to share your view in the comments!

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