Decaffeinated
Fundamentals
Newton once said what goes up must come down. Coffee traders seem to be heeding this advice, sending prices higher at break-neck speed, only to have the market collapse onto itself in recent weeks. The initial supply fears were seen as severely overblown, leading to the massive exodus. Funds decreased their net long position by over 44 percent last week, followed by small speculators who shed over 77 percent of their position. In the cash market, producers rushed to sell, contributing to the tumble in futures prices by shrinking the cash to futures basis. While this can be seen as negative in the short-term, it does not change the fact that supplies are still very tight. The October to May production season saw the lowest harvest in more than twenty years at 6.53 million bags. The tight supply picture would suggest a positive fundamental bias, but the upside potential may be limited due to concerns that the main crop may be rather large in size and roasters may be tempted to substitute with other varieties of Coffee beans. The USD will likely play a part in the movement of Coffee. Given the fact that the Fed has not given any indication as to when it will reign-in its aggressive policies, while other central banks have at least hinted at the idea, this may be seen as Dollar bearish and bullish for Coffee.
Trading Ideas
Given the positive fundamentals, some traders may possibly want to enter into a bullish strategy. The somewhat limited upside potential and conflicting technical outlook may convince other traders to opt for a more conservative strategy. An example of one such strategy would be a bull call spread, buying the Sep 120 call (KCU9120C) and selling the Sep 125 call (KCU9125C) for a debit of 1.75, or $656.25. The trader risks the initial investment for a potential profit of $1,218.75. To minimize losses, traders may look to exit the spread on a solid close below 115.00 in the underlying Sep Coffee contract.
Technicals
Turning to the chart, it appears as though the September Coffee contract is attempting to build a base, with support near the 118.00 level. It remains to be seen whether the pattern holds up as a rounded bottom or if the market is in the process of consolidating before facing further declines. The crossover of the 20 and 50-day moving averages can be seen as negative in the short to mid-term. Like the chart, the oscillators have failed to give a clear picture. The slow stochastic crossover and oversold conditions on the RSI suggest a positive bias, but the momentum indicator is showing bearish divergence.
Rob Kurzatkowski, Senior Commodity Analyst
