Is a Near-term Top Brewing in Coffee Futures?
Fundamentals
Coffee futures have been running hot lately, with the front month December futures attempting to test the $2 handle for the first time since 1997. Coffee bulls cite tight supplies of high quality Coffee as the catalyst for the steep run-up in prices, as the market has not yet fully recovered from the two consecutive years of below average production from Columbia, who is a leading supplier of high grade Arabica Coffee. However, Columbia's production is expected to increase this season, with its August production up over 50% from last season. Other major Coffee producers such as Costa Rica and El Salvador are also expected to see production increases, so supplies of quality Coffee should increase this season. So if supplies are expected to increase, why are Coffee futures reaching 13-year highs? One reason might be renewed interest by commodity funds in not only Coffee, but also other "softs" such as Cotton and Sugar. In fact, it appears that funds are also in a buying mood for other so called "commodity staples", such as the grains, and for livestock futures as well. This speculative buying may be the real reason behind Coffee's move higher, but until we see commercial selling emerge to take advantage of these "high" prices, there appears to be few willing sellers waiting to try to pick a top in this bull market.
Trading Ideas
The Coffee futures market's moves could become more volatile now that speculators are attempting to move prices through resistance at 200.00. Some traders who are anticipating a big move in Coffee prices and an increase in volatility may wish to consider investigating the purchase of a strangle in Coffee options. An example of such a trade would be buying the December Coffee 215 calls as well as buying the December Coffee 175 puts. With December Coffee futures trading at 193.30 as of this writing, this strangle could be purchased for about 11.50 points, or $4,312.50 per spread, not including commissions. The premium paid would be the maximum potential risk on the trade, with the trade profitable at option expiration in November should December Coffee be trading above 226.50 or below 163.50.
Technicals
Looking at the daily chart for December Coffee, we notice the recent leg of the rally has occurred on lower volume. In addition, the 14-day RSI has formed a major bearish divergence! Wednesday's attempt to test the 200.00 level was met with selling pressure, with some commercial selling noted at new contract highs. This possible "reversal" signal could spark additional selling from not only commercial hedgers, but also from weak longs as well. 200.00 remains strong resistance in the December futures, with support seen at the 20-day moving average, currently near the 181.00 area.
Mike Zarembski. Senior Commodity Analyst
