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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

While the logistical situation is certainly bad, we have already seen prices start to decline. In the quotes that I receive from shippers I noticed a steep decline in prices out of Asia, and we can see this in the Baltic Dry Index as well.


Moreover, the busiest portion of the year usually takes place in the buildup until Christmas. This should have already peaked by now, or at worst is just about to peak, so we should expect that the shipping should only improve going forward into Q1 of 2022.


Strong Dollar

It is by now considered a fact that the Federal Reserve will be tapering and raising rates, most likely in November, but very shortly. If this is the case, then the only stopping a strong dollar will be when the Fed decides to stop raising rates. However, since we haven't even started raising interest rates it stands to reason that we are still a long way off from the top. Especially if we need to curb inflation not seen in a generation.


A strong dollar is inherently bearish for commodities in general ("stuff" becomes cheaper to buy in dollar terms). Add to that the economy-cooling effects of tapering, plus the close of Christmas season demand and the end of fiscal stimulus triggers and we may very well see a decline in commodity prices.


In fact, it is a cooling down of prices that the tapering and interest rates is directly attempting to target.


Bi-annual Cycle

Lastly, we come back to Brazil's biannual crop. While the 22/23 crop has undoubtedly been compromised by the drought and Frost, it is still supposed to be a bumper crop and the global market anticipated to be in surplus.


It is possible that with all of the damage to the crop from weather, that there will be such a poor 22/23 crop that the world will be in deficit again. If that happens...$3 or $4/lb is not out of the question. It would be VERY bullish.


However, in my experience Brazil tends to surprise with more coffee rather than less. With the improvements in weather we could most definitely see the 22 crop surprise with more coffee than anyone had anticipated. We will see the first clues to this in December.


On top of this, we have to consider that $2 coffee is a boon to farmers the world over. These high prices will stimulate as much coffee as can be squeezed from existing farms in Brazil and other origins.



One rule in coffee that I live by is this. The Brazil farmer is smart.


Right now, the Brazil farmer is very bullish and is holding back their coffee, but take a look at the above chart. The Brazilian farmer has literally never seen prices this good before in BRL terms. Not in 2010 when coffee was at $3, not in 2014 when it was at $2.25.


They will hold off on selling to squeeze as much out of this market as they can (and why shouldn't they? They need to make a living). However, the other origins will not hold back, and the October crops are coming online now.


Moreover, there is a time limit to how long the Brazilian farmer can hold back. That time limit is the 22/23 crop.


We are still a ways away from that crop, but if the farmer detects that they will have a good crop in 22/23, perhaps better than they had thought, then it will becomes a game of musical chairs. No farmer wants to be the last one to sell their crop when the prices start coming down.






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