Coffee: What’s driving volatility in 2019?

Market Analysis /
30 Jul 2019

Most of us probably enjoy a cup of coffee or two a day, but as well as dropping into your neighbourhood artisan café or multinational coffee chain, it’s also possible to trade the underlying asset itself. Although production may be undertaken across a wider geographic spread than something like cocoa where farms are concentrated in West Africa, the product remains susceptible to basic factors such as the climate and supply disruption.

 

Pricing

There are a host of different coffee contracts traded in the underlying market, but one of the most common products is Arabica coffee, predominantly grown in Brazil and Colombia. That’s the underlying contract on offer from AxiTrader, with the price being quoted in US cents per pound (lb). The other popular coffee type is Robusta, grown more commonly in West Africa and Vietnam and although it may be a little more complex to get exposure to that asset, the two are to a degree interchangeable, with price correlation to match.

 

Long term performance

The below chart shows the performance of coffee prices over the last twenty years. There’s certainly little correlation with equity markets – coffee prices have fallen over the last decade as stocks have been rising, and the asset showed little reaction through the credit crisis either – but there’s a series of key influences present which should be considered.

Source: Bloomberg

That sharp jump in early 2014 was a consequence of drought in Brazil – said to be the worst in half a century - which at one point saw coffee prices rise by 20% in a week. Between 2015 and 2018, the International Coffee Organisation notes that production grew by around 10% with the surplus supply being in part responsible for the recent decline in prices. However, with coffee now so cheap, many farmers are struggling to make a return on the product and instead are seeking out other crops. Back in 2017, droughts in Brazil saw local production fall by as much as 10 %, promoting concerns that some farmers were switching to growing pepper instead, although the shortfall in production from the world’s largest producer proved to be only a brief interruption.

 

Recent price action

Most interestingly however is the move through the second quarter of 2019. Having traded down to a 15 year low of just 87 cents in mid-April, prices jumped by as much as 30% in the following three months. Although there has been a modest retreat from those highs, the question that is being asked now is whether there’s a fundamental change in the supply of coffee emerging. Two years of bumper harvests from Brazil – following that drought in 2017 – are seen as having been instrumental in driving prices lower at the start of 2019. However, farmers are seen as needing to sell coffee for at least $1 per pound if they are to just break even and this unsustainable economic model is now starting to bite. Some growers are reported to have joined the migrant caravan making its way through central America in a bid to get to the USA and as prices start to rise, there’s mounting speculation that production is set to be constrained.

Add to that the fact that Brazilian coffee production – the country produces about 40% of global output – will this year face something of a lull. The harvest is said to follow a biennial production cycle, so the 4.25 million bag surplus seen in 2018 will be reversed into a 1 million bag deficit for 2019.

 

What to watch for

Where will the price go from here? This Reuters article from February predicted prices would rise by 20% by the end of the year. Most of that has already been achieved, but will there be another run higher, and what can traders look for?

  1. Weather. Extremes; be those drought, flooding, high winds or unexpected temperatures in any major growing region, such as Vietnam, Brazil, Columbia, Ethiopia, Indonesia or West Africa, will have the potential to impact an already constrained supply. A full list of producing states and their recent output levels can be found here.  

  2. Political unrest. Again, anything that has the potential to damage crops or disrupt distribution routes should be closely followed in those key producing areas.

  3. Lack of supply. Any reported change in crops being planted by farmers may have an impact on price, although the switch into pepper by many in Brazil seemingly had little overall effect.

  4. Lack of human capital. As noted above, when prices are below $1, it’s reportedly not worth the farmer producing the crop anymore. Their time and effort will be better spent elsewhere, be that working in another industry, or becoming an economic migrant in search of prosperity
     

Don’t worry however if this consideration of rising coffee prices has you thinking that you’re suddenly going to see prices spiking when you order that next grande mocha Frappuccino. Fortunately for you, but perhaps less fortunately for growers, the actual cost of the coffee in your drink is only 5%-10% of the overall price. The remainder – the milk, cup, staff, store overheads and shareholder profits – account for the vast majority of what you pay.


The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

More on this topic

See More News

Open your account. Apply in minutes.

Start your trading journey with a trusted, regulated, multi-award winning broker.

Open Account Try a Free Demo