Coffee has seen a resurgence in market interest as a storm of factors has driven up the price of the favourite brew of millions of people around the world. The commodity might not be traded in the same volumes as other commodities such as oil or gold, but with coffee prices hitting multi-year highs, investors are finding tidy profits.
It is certainly worth a closer look at the potential for a further upswing because the coffee market may not have seen the end of its bullish run.
Coffee as a financial instrument
Coffee can be bought and sold on a futures exchange, with traders buying them when they think prices will rise and selling them when a price fall is forecast. Businesses such as food and drink companies will hedge their coffee needs by securing a purchase price for a set amount of the commodity.
A coffee contract that is traded on the Chicago Mercantile Exchange (CME) Group represents 37,500lbs (17,000kg), and the contracts are priced per pound.
Coffee: key fundamental drivers
Robusta and Arabica are the main types of coffee beans produced and consumed, with Arabica – which is mostly cultivated in Brazil – accounting for 75% of production. Robusta, which is mostly produced in Vietnam, accounts for the remaining 45%. Robusta is used primarily in instant and espresso coffee.
The “Big Four” companies – Nestle, Proctor & Gamble, Sara Lee, and Kraft – buy almost 50% of all coffee produced worldwide, mostly Robusta. Meanwhile, Arabica is likely to be in a Starbucks cup of coffee.
Coffee trees are at the mercy of the weather. Frost, as seen in Brazil this year, is one of the biggest threats to coffee production, while too much or too little rainfall prevents the trees from flowering and yielding a successful crop.
Five countries account for about 75% of the global supply of coffee beans. Brazil is in the lead position; it produces around 40%, followed by Vietnam, Columbia, Indonesia, and Ethiopia. Political unrest and conflict, together with poor weather conditions, can lead to lower coffee production and higher prices.
Coffee price forecast depends on Brazilian weather
While there is less coffee price news and analysis in the media and there are fewer financial analysts covering coffee compared with other commodities such as oil and gold, prices for all commodities have moved higher in the past year.
Oil and gold markets can be easier for new investors to follow because they often track eye-catching developments. For example, the latest turmoil in the Middle East often correlates with higher oil prices, or a rise in inflation might boost gold prices.
The coffee price has recently hit general and market news headlines in the same way oil or gold often does because of several concerns – notably, weather shocks in Brazil. Drought and freak frosts have been followed by worries there will not be enough rainfall by late September to safeguard Brazil’s harvest next year.
Crop losses in Brazil were already expected next year because of the frost, which would be compounded by insufficient rainfall, said Stephen Hurst, managing director and founder of coffee importer Mercanta.
Back in June, world coffee production for 2021/2022 was already forecast to suffer a shortfall of 11 million to 164.8 million bags because of bad weather, the US Department of Agriculture said in a report.
Adding to coffee producer woes, the strict COVID-19 lockdowns have been affecting freight and logistics in the coffee-producing areas of Vietnam, the world’s leading exporter of Robusta. Crops have also been set back by cloudy weather in Colombia, the second-biggest exporter of Arabica.
All of this comes on top of worldwide transportation disruption, with supply chains hit by container issues because of the pandemic.
Such a coalescence of events is leading investors to consider that bullish coffee price predictions can continue their momentum and justify a high Arabica coffee price forecast.
Evaluating key levels
Arabica futures peaked at a near seven-year high of $2.15 in July, but then dropped to around $1.80 in the same month. Since this correction, in August prices reached a high of $1.90s because of worries about Brazil.
Making an Arabica coffee price forecast more than a couple of years into the future is difficult given its dependency on weather, which is becoming more erratic. But shorter-term trends are a little easier to discern. The lows seen in May and early July were unlikely to be seen again in the near future.
Psychological milestones in the past decade occurred in 2011 when the coffee price traded above $3 per pound, while in 2020 it traded below $1 per pound.
However, the relative strength index (RSI) reached overbought territory to stand at 74 on 31 August, triggering a pullback but still staying at bullish levels while traders and investors await further crop news out of Brazil.
Coffee price prediction: where next?
The case for shorting coffee appears weak, given that analysts believe the coffee price outlook appears bullish. Arabica coffee passed a $2 psychological milestone when it hit $2.15 on 26 July.
Many analysts expect prices to hover just below $2, with some price swings until there is further coffee production news. This is supported by the fact that analysts have started to downgrade the profit forecasts of some food and drink companies whose coffee hedging contracts may only cover them against price rises until the end of this year.
“Hedging has deferred the pressure, but some companies will have to go back into the market at higher prices in the first half of 2020,” said Martin Deboo, equity research analyst at Jefferies International.
Arabica prices were forecast to end the year at almost $2 per pound, according to a Reuters poll of 11 traders and analysts conducted in early August, before it was known exactly how much the weather would affect Brazil’s coffee crop.
Based on the median forecast of survey participants, the Intercontinental Exchange (ICE) Arabica KCc1 coffee future would reach $1.9850 per pound by the end of this year, up 55% from the end of last year
The price of the Robusta LRCc2 future was seen ending the year at $1,983 a tonne, 43.1% higher than the market close at the end of last year.
The Robusta coffee price forecast has seen a strengthening, given the hit to Vietnamese exports, but Brazil’s Robusta crop may meet some of the shortfall. Analysts expect Robusta to trade in a more sideways range compared with Arabica’s sharper upswing.
Coffee prices have been rising since July 2020. Arabica peaked at nearly a seven-year high of $2.15 in July, and August saw prices in the high $1.90s because of worries about Brazil.
Consider making your own Robusta and Arabica coffee price forecasts to spot the best levels for potentially profitable trades. Never forget that markets can go against you.
Weather is one of the biggest factors affecting the price of coffee, particularly in Brazil, one of the world’s biggest producers. The COVID-19 pandemic is also contributing to higher prices, such as the strict lockdown since September 2021 in Vietnam, the world’s leading exporter of Robusta.
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.