Coffee's Rally Grinds to a Halt
Fundamentals
The surprising bull market in Coffee futures might be starting to cool, as the anticipation of large new-crop supplies and fears of weakening world economic conditions have nervous Coffee bulls stampeding to the exits. Just this past Monday, lead month December Coffee nearly reached 13-year highs, as current tight supplies of Arabica Coffee spurred further commodity fund buying, as trend-following traders added to their net-long positions when new contract highs were made. However, the rally was short-lived as commercial selling began to emerge, which capped the rally attempt. Weak longs then started to exit positions once prices moved below the day's lows, which some technical traders interpreted as a "reversal" signal. Selling really accelerated yesterday and commodity positions in general were liquidated in a bout of "flight to quality" buying, as traders feared continued economic weakness would hurt world demand for commodities in general. Although high quality Coffee stocks remain tight, it appears that Coffee production out of Columbia is expected to rebound later this year, which if true, should help to alleviate the current supply situation. A quick look at the most recent Commitment of Traders report shows both large and small speculators are holding net-long positions in Coffee futures totaling a combined 49,910 contracts as of August 17th. This relatively large net-long position may trigger additional weakness in Coffee prices as protective sell-stops are triggered should prices move toward key support points.
Trading Ideas
The old trading adage "never buy a market in liquidation mode" may ring true in Coffee futures in the near-term, as long liquidation selling pressures prices. Some traders expecting a correction in Coffee prices but who wish to limit the potential risk should the market rebound may wish to explore the purchase of a bear put spread in Coffee futures options. An example of this trade would be buying the October Coffee 170 puts and selling the October Coffee 160 puts. With December Coffee trading at 173.35 as of this writing, the October 170/160 put spread could be purchased for about 3.50 points, or $1,312.50 per spread, not including commissions. The premium paid would be the maximum potential risk on the trade, with a potential profit of $3,750 minus the premium paid which would be realized if December Coffee is trading below 160.00 at option expiration in September.
Technicals
Looking at the daily chart for December Coffee, we notice the sharp correction that occurred yesterday after prices collapsed from new highs. The steep sell-off moved prices through the 20-day moving average, triggering sell signals for many short-term momentum trading systems. The move to contract highs on Monday occurred on below average volume, leading some analysts to question whether it was fresh buying or more likely short-covering that sent prices to contract highs before falling later in the session. The next support level for December Coffee is seen around the 164.00 level. Resistance is found at Monday's high of 188.65.
Mike Zarembski, Senior Commodity Analyst
