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The Trade is Bullish (the Roaster is Not)

Like yin and yang, the Law of #Supply and the of Law of #Demand are complementary economic truths: When prices are high, supply increases. When prices are low, demand increases.


This is normally reflected in the #COT. When prices rise we see the commercial short position rise and the commercial long position fall. Yet today things don't look quite that way: despite terminal prices of nearly 200 cents/lb, the Commercial short position is barely above average.


Let's look at the data.


The #coffeefutures "C" Market is at the highest price in the last 7 years, so we would expect the commercial short position to be at a similar high. Yet despite rising prices the Commercial short as a percent of OI has actually declined since January from over 50% to the current level of 43% (vs 41% avg of last 5 years). This suggests to me that the #Trade is in fact #bullish.


The #Roaster, by contrast, is at the lowest point of coverage for this period since the 2016 rally (24% vs 30% 5 year avg). The implication is that the roaster is #bearish, but I don't think that is exactly true.


I'll come back to this point but first let's take a little detour to look at the trade.


When analyzing the COT we often consider the commercials (Roasters and Trade) to be "smart money" and that is for good reason. Commercials, specifically the trade, have the best connections and understanding to origin markets. They also have an incentive to sell high as their short positions are proxies for #farmer #hedging.


When we do not see the commercial position rise with the market, there could be multiple reasons why, but using Occam's razor we can cut to the the simplest one: the commercials are expecting higher prices.


This expectation for higher prices would incentivize the trade to hold off on selling not only because of the opportunity to sell at better levels, but also for a more defensive reason: #margin calls. With the risk-off credit crunch in #commoditymarkets, commercials may be especially hesitant to add on short hedges if there is the possibility of large price increases.


Another reason would be that there is simply less coffee. It is no secret that this was an off year for #Brazil, and with a 10 mm bag deficit there is less #coffee to hedge. If the prices were high enough we would see forward selling of next year's crop. However, weather issues of #frost and #drought have made the size and price of next year's crop in doubt.


Meteorologist David Streit Discusses the Dry Weather in Brazil


The other thing to consider here, is the Swap position. The #Swap position is absolutely massive for the shorts. Since 2020 the swap short position has ballooned to a high of 13% earlier this year (currently at 11% vs 3% 5 year avg). However, even if we add this 11% to the Commercial short position, we are still well below 2020 coverage.


Trade and Swap Positions


Moreover, the Swap position brings up an interesting point about vulnerabilities.

The #OTC positions favored by origin #producers often include double-ups and knock outs that essentially cause short positions to snow-ball into bigger short positions when the price is against them. It is fair to surmise that a large portion of this large short swap position is due to positions that were put on at much lower levels and have since gained in size.


This suggests that the trade may not be bullish, so much as in a poor position. Those #exporters with large swap position may be stuck with a situation where they get shorter as the market rallies. That is actually more of a bearish trade, then a bullish one. But it is a bearish trade that could have been put on a while ago.


This also brings us to the roaster vulnerability. I said in the opening that the Roaster is bearish, but I don't think that's exactly correct. I have many roaster friends, and the roasters are also "smart money". Like the trade, the roasters have excellent access to information and many of them are actually quite bullish.


However, if you are a roaster you are between a rock and a hard place. These are high prices to go long, so if you are a roaster the best strategy may be a defensive one. Allow coverage to run down and purchase hand in mouth coverage on dips. This strategy accounts for the drop in the COT.


The problem is, much like the short swap position, this strategy tends to snowball when it goes against you. If you allow coverage to drop as the price rallies, then the risk is that the price doesn't correct lower. If prices continue to rise, then you have more to buy at higher prices. That is the risk here for the roaster.


If the weather in Brazil improves during the wet season, we may see the spec sell off a bit and the roaster may get their chance to add coverage. If the dryness persists, it could be a perilous situation for both the trade and the roaster.



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