Coffee trading is one of those markets that many people instinctively avoid. The thinking seems to be that this is one for the professionals, for those who have been doing it for years, for people with an instinctive understanding of the beans that get many millions of people going in the morning.
Why is this?
In part, it is a sub-section of a general aversion to trading in natural resources. You may well have heard the old saying that anyone thinking of dealing in commodities ought to lie down until the feeling passes.
Prices very volatile
This is especially true of “soft”, or agricultural, commodities, which are often seen as fickle and volatile. Wheat, for example, is prone to influences, such as bad weather or boll weevils, that leave the likes of copper and tin largely unaffected.
In the specific case of coffee, the “tropical factor” kicks in, the unspoken feeling that, while the likes of corn and pork bellies are produced in stable North America, coffee comes from countries prone to coups and uprisings.
None of this ought to deter a novice trader from trying their hand at coffee trading. But it should be borne in mind that there is something in these negative factors, and would-be traders need to be aware of them.
In particular, coffee prices are notoriously volatile. Currently, Arabica is changing hands at about $2.73 a kilogram. In October and November last year, it traded at above $3 a kilo and in November 2016 Arabica changed hands at more than $4.
Something to trade on
Go back five years, to April 2014, and the price was a shade below $5 a kilo. In April 2011, the price was about $6.6, but in April 2009 it was broadly the same as it is now, at about $2.97 a kilo.
In other words, coffee prices have spent ten years going around in a circle. Doubtless, that is very annoying for growers, food manufacturers and – assuming price changes are passed on – consumers.
But for the trader, a 69% price swing is very good news indeed, because the first rule of trading is that you need something to trade on.
Arabica is one of two main types of coffee, the other being Robusta. Arabica is more expensive because it is thought to have the smoother flavour, while Robusta may appeal to hard-bitten coffee addicts, having a higher caffeine content.
Another difference is location, with Arabica grown in Brazil and other parts of Latin America and the Caribbean, and Robusta mainly produced in Africa and the Far East.
And a third factor that separates Arabica from Robusta is the price, with the latter currently trading at $1.69 a kilo, about a dollar less than Arabica.
But there is one thing that unites the two branches of the coffee family – price volatility. Robusta was trading at over $2 a kilo towards the end of 2017, having come close to $2.7 in May 2011.
As with Arabica, its price ten years ago was close to that of today, at $1.66 in April 2009. That’s a near-60% price range over the period.
The price difference between the two reflects the general view that Arabica is the better bean, although many coffees involve a blend of the two.
So, entering the coffee market means trading on the price volatility. This, in turn, requires you to have an understanding of the factors driving that volatility.
The first, and probably most important, is the weather. A great deal of coffee is grown in the tropics, and harvested between October and March. Cold weather can hit output, lifting prices, as can drought including that caused by the El Nino weather system.
By contrast, good weather, such as that experienced by Tanzania in 2018, is likely to raise output, putting downward pressure on prices. Traders need not be daunted by the logistics of keeping an eye on the climate, given the resources available on the internet.
For example, tapping in “long range weather forecast Brazil” takes you to a 25-day forecast from AccuWeather. Elsewhere, publications such as The Economist and the Financial Times, aware of the critical importance of weather to commodity prices, will report any expected relevant meteorological events.
After the weather comes a mixture of different influences on coffee prices. One is the state of play in terms of world trade, with recent suggestions of a US-led tariff war being particularly important.
A simple alternative
Another relates to the linked issues of transport costs and the strength or otherwise of the American dollar. They are linked because both oil, a key expense for the transport industry, and coffee itself are priced in the US currency. A stronger dollar will make both oil and coffee cheaper for American consumers and more expensive for those buying in other currencies, but it helps producers, as the price of their coffee (or oil) is higher when translated into their own currency.
It may be thought that the effects of a strong dollar for the coffee industry would cancel themselves out, with higher local-currency prices for coffee being balanced by higher local-currency costs for transport and distribution. But economics rarely works out so neatly.
Then there is the unavoidable issue of political risk. In descending order, the largest five producers are Brazil, Vietnam, Colombia, Indonesia and Ethiopia. In other words, a military dictatorship until 1985, a Communist state, a country long-plagued by drug-related armed conflict, a dictatorship until 1998 and a one-party state.
No-one trading coffee can afford to ignore political developments involving the major producers.
Finally, there is the danger that consumers will drift away from coffee, either because of changing tastes, or health concerns – or both. Admittedly, there is little sign of this so far, given about 2.25 billion cups are drunk every day.
And should you want to bet either on coffee’s continued popularity or its fall from favour, but still do not fancy trading it as a commodity, there is a simple way to do so – trade Starbucks.