Coffee's Downtrend Starting to Get Cold?
Fundamentals
Since reaching 14-month highs back in mid December of last year, Coffee futures have turned cold, having fallen over 20-cents per pound on expectations of large supplies this season out of Brazil, the world's largest Arabica Coffee producer. Also setting a negative tone for the Coffee market as well as other commodities has been the resurgence of the U.S. Dollar, with the Dollar index futures hovering near 9-month highs. It appears that traders are ignoring current tight world coffee stocks, caused by disappointing production totals out of Central American and Columbia this past season, and are looking towards potentially huge supplies expected out of Brazil once the harvest begins in May. The current supply situation has been given less weight by traders now that spring weather is moving into the Northern Hemisphere, putting an end to the peak Coffee consuming season. Supplies of Robusta Coffee, however, look to remain tight next season, as Vietnam, the world's largest Robusta Coffee grower, is expecting its Coffee production to fall by 15% this season, to total only 14.2 million bags. Large speculative accounts continue to liquidate their net-long positions in Coffee futures, with the most recent Commitment of Traders report showing large non-commercial traders (commodity and hedge funds) were holding a net-long position of 11,372 contracts as of February 23rd. This was down nearly 3,000 contracts for the week and could signal that the recent down-move has been due to liquidation of positions, not the initiation of new shorts entering the market. With prices having rebounded since multi-month lows were made last week, the Coffee market might be due for a period of consolidation, at least until we start to see how large the Brazilian harvest may actually be.
Trading Ideas
If coffee prices remain range-bound ahead of the start of the Brazilian harvest, some traders may wish to investigate trading opportunities that will benefit from a sideways market. One such trading strategy would be selling out of the money strangles in Coffee futures options. Since mid-December, May Coffee futures have traded within a price range bounded by 149.20 on the high side and 126.60 on the low side. A trader could sell a May Coffee 155 call, and at the same time sell a May Coffee 120 put. With May Coffee trading at 132.05 as of this writing, this strangle could be sold for about 0.85 points, or $318.75 per strangle, not including commissions. The premium received would be the maximum potential gain on the trade. Given the potential loss on selling naked options, traders should have an exit strategy in place in case the position moves against them. Some traders may possibly wish to consider exiting the trade early if the premium on the strangle moves to 3 times the amount received, or if May Coffee closes above resistance at 149.20, or below support at 126.60 before the options expire in April.
Technicals
Looking at the daily chart for May Coffee, we notice prices holding below both the 20 and 100-day moving averages, which confirms its current bearish bias. However, we do notice a bullish divergence forming in the 14-day RSI, as the February 25th lows of 126.60 failed to produce a new low in the RSI. This lends some confirmation to the belief that the downtrend is beginning to look tired, and we are likely to see prices move sideways for awhile. Also notice how volume has fallen the last few sessions, right after the roll from the March contract was completed. We did not see any increase in volume as prices moved lower, which could signal that little fresh selling has taken place other then the liquidation of existing long positions. Near-term support remains at 126.60, with near-term resistance found at 137.35.
Mike Zarembski, Senior Commodity Analyst
