Trade of the Week: Wake up and trade the coffee

Coffee prices in New York and London slumped to a five-week low on Wednesday, as higher supplies met with reduced demand from recession-hit European coffee drinkers.

   The price of high-grade Arabica beans on the InterContinental Exchange in New York dipped below $1.60 per pound on Wednesday October 17, down 14% from $1.86 per pound on October 3, while the cost of cheaper Robusta coffee on NYSE Liffe in London stood at $2,010 per tonne, down 10% from $2,200 at the start of October.

   A trader holding a put option on Ice’s Arabica contracts struck at the October 3 price and exercising it at Wednesday’s low of $1.60 would have made a notional gain of $9,750 per contract, before fees. One contract on Ice Futures US is equivalent to 37,500lbs of coffee.

   Put options give the holder the right to sell a contract at a future date for a pre-agreed price. Since they are a risky investment for the bank or broker selling the option, who can incur steep losses if prices fall rapidly in a short space of time, they often come with a high fee.

   The prices of Robusta and Arabica beans usually track one another closely. The slight disparity suggests coffee vendors, particularly in Mediterranean Europe, might have cut back on the more expensive Arabica beans, stocking cheaper Robusta beans instead, according to analysts. Robusta futures on Liffe are priced in $ per tonne, while Arabica is priced in $ per lb on Ice.

   Analysts at Barclays blamed the price slump on “fears about the global economic outlook amid the ongoing European debt crisis weighing on soft commodities,” as well as better-than-expected harvests in big Latin American producers such as Brazil and Colombia. Production in the latter rose 13% year on year in September, the bank’s commodity analysts said.

   Prices had moved to a cyclical high on fears of a reduced harvest in Brazil, analysts said. But as those fears were assuaged by improved crop reports from Brazil, the world's largest producer, prices began to fall heavily.

   The trend of falling prices has been in evidence for a while, however. In its monthly market report for September, statistics from London-based trade body the International Coffee Organisation suggested that long-term demand in traditional key coffee drinking countries such as Italy and Spain had declined by 3.4% and 9.7% respectively in the three years to 2012. Reports have anecdotally pinned the decline on recession-hit Italians and Spaniards cutting back on their erstwhile cafe culture.
Even before October, coffee has been one of the worst performing soft commodities globally in 2012, analysts at Deutsche Bank said, with prices down 24% year-to-date.

   Coffee is not alone in suffering from the slowdown in global demand, however, Barclays said. The trade in other soft commodities such as cocoa and sugar, have also been hit. That is in stark contrast to other commodity crops such as grains, which were hard hit by the prolonged drought in the US Midwest this summer, driving up prices.