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Why Coffee Certs are Different Now, and NOT Bearish

One of the most important data points to follow in the #coffeemarket is the certified stocks. Every day, I send out my #Coffee #CertifiedStock reports to my subscribers (available for free here) and the reason that I do so is because this report is one of the most useful ways to estimate #fairvalue of #coffeefutures that we have.


However, this relationship has changed dramatically in the last year and I want to show how we need to adjust our thinking on this report.


Over the next few paragraphs, I'm going to discuss what the historical relationship is with this data, and how we need to adjust our thinking, and what it potentially means now.


The Key Relationship Between Stocks and Price:

It is one of the foundational principles in #economics that price is a method of regulating scarcity. If #supply are plentiful and #demand is low then price is low. If stocks (supply) are scarce and demand is high then price is high. Since coffee has fairly stable demand (#inelastic as we say in economic-speak), then the supply is the key variable in determining price.



Certified Arabica Stocks vs Price


This is why "supply shocks" are what move #markets in #commodities (see #Brazil #Frost).


You can see in the above graphic how the inverse relationship between futures price and supply of coffee certs holds true.


The Certified stocks were particularly useful in this regard for two reasons:

1) Certs are accurate, well accounted for and reported daily. This ensures that the entire market knows what the stocks are and the confidence in their fidelity means that the market is willing and able to adjust to the data.

2) Certs are the ACTUAL supply of the futures market. Since only "certified" stock can be exchanged for futures this was literally the very definition of supply.


How Things Changed

There was a problem with the certified stocks an indication of supply, and that has to do with replacements.


Until just a couple of years ago, certified stock excluded the largest producer of #Arabica--#Brazil. While only certified stocks can be tendered for futures, to a consumer the certified stocks are fungible with numerous other types of arabica, including Brazilian #naturals. Because of this there could be a large disconnect between the price of futures and the inventory of certified stocks.


This all changed when the #semiwashed Brazils were added to the "C" market contract. Once Brazils were allowed to be tendered we saw a massive increase in certified inventory from last year's crop, while at the same time we saw an increase in the futures price. This is the exact opposite of what we would expect given the increase in supply.



How We Should Change Our Thinking

All this new development seems contrary to what we would expect at first, but it actually does make sense.


To understand why, we need to look at the global supply of Arabica. Brazil is roughly 50% of the total supply of the world's Arabica. As of this morning and as of this morning, Brazil represents 52% of the world's supply of certified Arabica inventory. This means that the certified stocks actually better represent the global supply of coffee now then they ever have.


The challenge is that there was a ramp up period where the certified stocks had to grade and pass an entire crop of Brazil coffees to include them in the inventory. During this period, the Arabica market had to essentially ignore the increase in certified inventory as an indication of global scarcity.


Cert Stocks vs GCA Stocks


Data from the GCA stocks for example (which shows non-certified inventory) shows very clearly that USA stocks actually went down during this period. This accounts for the ensuing price rise.


Going forward, I think it is fair to think of the #CertifiedStocks as having "reset" at this point. Now that the certified stocks more accurately represent the global coffee supply they have the potential to be an even stronger indication of price.



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