Too Much Caffeine for Coffee Traders?
Fundamentals
The Coffee futures markets in both New York and London have certainly been downing "double espressos" the past couple of weeks, as prices continue to surge higher. Lead month September Coffee has rallied over 30 cents per pound, sending prices to highs not seen in over 12 years. Analysts attribute the rally to tightening supplies of high quality Arabica coffee, especially that of deliverable grades against the ICE futures contract. Before the price spike, coffee prices were contained in a relatively narrow price range, as traders focused on the potential for a huge harvest out of Brazil, the world's largest Coffee producer. However, Brazilian Coffee is not deliverable against the New York Arabica contract, which is negating its influence on futures prices. Poor harvests in Columbia the past two seasons have curtailed supplies in the cash market and have sent domestic cash prices to a large premium vs. September futures. If that was not enough, Robusta Coffee futures, which trade in London, have also seen a sharp price rise, as producers continue to stockpile supplies awaiting even higher prices. This lack of origin selling -- especially out of Vietnam -- has caused exchange warehouse stockpiles to decline, triggering concerns of a possible short squeeze in the July futures. Trend following speculative accounts have certainly jumped upon the bullish Coffee bandwagon. The most recent Commitment of Traders report shows large non-commercial traders added an additional 20,391 new net-long positions for the week ending June 15th. This huge surge in speculative long positions triggered buy stops as prices moved higher. Origin selling has started to come into the futures market, but commodity fund buying has willingly taken the commercial offers, keeping the bullish momentum going. With prices now having moved "parabolic", traders fortunate enough to be holding long positions should be on the lookout for a potentially sharp price correction should speculative buying start to decline. There is an old trading adage that "It takes a whole lot of fresh buying to move prices higher, but only a lack of buying to have prices collapse". These are words that every trader should take to heart!
Trading Ideas
A market that starts to move in a "parabolic" fashion can be difficult for even those fortunate to be holding a winning futures position in the market. At this point, the potential for an even more violent price move increases as both "fear" and "greed" enter traders' psyches. Some traders holding a long position in Coffee futures who would like some down side protection in case prices reverse may wish to explore initiating a "collar" position using Coffee futures options. Using the September futures, which are currently trading at 168.55 as an example, a trader holding a long September Coffee futures position could purchase a September 155 put, and at the same time sell a September Coffee 195 call. The purchase of the put acts as floor on his futures position, and the sale of the call helps to pay for the premium paid for the protection of the put. However, the sale of the call also caps the potential upside gain on the trade should the coffee price continue higher than the strike price of the call sold.
Technicals
Looking at the daily chart for September Coffee, we notice the extent of the violent up-move once prices broke above the multi-month consolidation pattern. If we look at the 14-day RSI during the consolidation, we do note that the RSI was making higher lows even as prices were testing the recent lows near the 131.00 area. The strong rally on June 10th sent prices above both the 20 and 100-day moving averages on a closing basis, which may have triggered fresh momentum buying. The large increase in volume added validity to the price rally, although some of the increase was due to the "roll" from July into the September contract. The 14-day RSI is well into "overbought" territory, with a current reading of 82.15. The lows of the recent consolidation near the 155.00 level look to be near-term support, with Thursday's spike highs of 176.50 acting as near-term resistance.
Mike Zarembski Senior Commodity Analyst
