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The Bear Case for Coffee

The #Robusta spec position hit an all time high of 43% of OI and #Brazilian #farmers are reportedly holding back sales, referring to $2/lb as "low prices". I recognize the #bullish #fundamentals as much as anyone, however, I think the conversation has become a bit one-sided and so I think it is fair to consider the #bear's angle.


Now with any good debate, you should start by acknowledging the strength of the opposing position. In this article, I will start with the bullish position, and then present the #bearish case, and why I think it is not being taken seriously enough.


Why the Market is above $2.


Supplies are tight.


If you are a #fundamentalist then price comes down to 1 thing: #stocks.


You can expand that to include the future expectation of stocks. But at the end of the day, for a #commodity with inelastic #demand, price will be determined by the amount of #supply available.


#GCA stocks and #JCA stocks are at the lowest points over the last 5 years, and we are at the peak of stocks for the season. Stocks are only expected to decline at this point in any year, but even more so in a #deficit year.



Biannual Cycle


Brazil's biannual cycle combined with #drought meant that the 21/22 crop year was destined to be a steep deficit of something like 10 mm bags. However, the biannual nature of the #Brazil crop was the saving grace, the 20/21 crop was huge, and so the forecasted 22/23 crop was also expected to be quite large.


This meant that there was ample stocks, largely in #Europe, to be able to withstand the draw down from the deficit. Moreover, we would only have to experience a year of drawdown until 22/23 crop replenished stocks once again.


Bad Weather.


Mother nature however, had other ideas.


The drought that impacted the 21/22 crop and contributed to the deficit, also impacted the 22/23 crop, inhibiting branch growth and potential. Of course July brought with it the dramatic #frost that further impacted the expected 22/23 bumper crop.



Over the next 2 months, Brazil was hot and dry which only worsened the damage to the 22/23 crop.


To add fuel to the fire, while Brazil was too dry, Colombia was too wet. Excessive rains in Colombia have caused quality and quantity problems to the crop there and the production potential may have been hit by as much as 1/2 million bags.


Logistics

Covid has caused disruptions that have completely upended the global supply chain. Freight rates from Asia have doubled and tripled as availability decreased.


This has forced destination markets to seek replacements for some coffees and to draw down local supplies when they would have preferred to get fresh crop from origin.


The logistical problems connecting to Brazil are some of the worst in the world right now, with exporters advising that new business should not expect to ship until December at the earliest. Additionally, there are numerous delays at destination to unload and extra taxes and fees levied on shipping worldwide.


All of this is adding to the cost of coffee.


Inflation

Last but not least we have inflation. #Logistical problems, #QuantitativeEasing, #FiscalStimulus and weaker #currencies have all contributed to a massive increase in prices across commodities since the start of #Covid back in Mar of 2020.


During this time, coffee has largely tracked with the commodity indexes in a massive bull market.




Why the Market is Overvalued at $2.

In a nutshell, we could say that the market is overvalued here because all of these factors are priced in to the market at present, but the market is forward looking. At $2, the market is overvalued for present value and doesn't take into account any improvements in the fundamentals.


Weather

The market priced in the extent of damage from the Frost within a few days. In the weeks and months that followed, the market coalesced around figures outlining the extent of damage from the frost and the drought as surveys were done. On top of the damage priced in from the drought, the market was also pricing in the possibility of a dry wet season.


This risk at least was averted.



Over the last month, the rains have been fantastic and we have seen strong flowerings throughout the Brazil coffee regions.


It is still unclear how many of these flowerings will set and develop into cherries. After a period of dry stress, the tree will often have abundant flowerings that have higher abortion rates. However, since the rain has returned to Brazil, we couldn't ask for a stronger scenario for a crop recovery.


Logistics