While the ongoing rise in the price of gold has captured all the headlines in recent months, there is no end to the skyrocketing prices across the commodities markets.
For example, while coffee started the decade trading as low of 41.50 US cents per pound, it closed out last year trading at 244.50 cents per pound.
The future outlook remains positive as well. The three countries that dominate the coffee market, Brazil, Vietnam and Colombia, produce more than 6o% of the world’s supply, and have all suffered from poor weather in recent months. At the same time, US coffee reserves are at their lowest level in 10 years. Additionally, there is increasing fears that Brazil and Vietnam are hording supplies to push up prices.
Coffee isn’t just some small part of the globe’s trading. In 2006, studies concluded that coffee was the second-most traded commodity in the world. While this claim was the subject of much debate, the fact stands that it remains one of the most active parts of the commodity market.
A short (black) history of coffee
Coffee futures first traded in New York in 1882 on the Coffee Exchange of New York. While metals trading had been always been dominated out of London, coffee development was guided from New York, with other international exchanges taking their lead from New York.
There are two different coffee contracts. The most actively traded contract is the Arabica contract. This is the benchmark “C” contract. Arabica, the more difficult plant to cultivate, is grown at higher altitudes, produces a milder, more aromatic and more complex coffee than the alternative, Robusta.
The Robusta coffee is made from the hardier Robusta tree and has higher caffeine levels and a stronger, more bitter taste. Robusta has traditionally been traded out of London.
Soft commodities differ from energy and metals. They are generally grown and include cocoa, sugar and coffee. Soft commodities can also include other products such as grains, cotton and orange juice, although these can also be characterised as agricultural commodities.
Traders and analysts view these types of commodities as a specific sector. While each are unique, they also share a number of qualities.
After the acquisition of the New York Board of Trade in 2007, the centre of coffee trading became the ICE (Intercontinental Exchange).
The contract trades from 8:30am to 7pm GMT. So we can easily watch the opening of the day, with it starting in the Australian evening.
The main contract traded is the Arabica contract out of New York. Coffee is priced in US cents. One pound of Arabica coffee started the year trading at 244.50 cents.
The tick value, or the amount it can move each trade, is 0.05 of a cent, and each move is equivalent to US$18.75 per contact. Therefore, each full cent is US$375.
The coffee contract can easily move five or ten cents in a session and that equates to days on which you could be up or down as much as $3750. As you can imagine, it’s not for the faint-hearted.
CFD providers offer a number of smaller contracts, for example IG Markets offers mini contracts that are half the standard size.
Orb Investment Management managing director Akhilesh Kamkolkar said the best way to understand prices is through fundamentals. This is because one of the major drivers in the market is supply.
“The amount of coffee people drink doesn’t really change. If demand doesn’t change much, then supply becomes the major driver of price,” he said.
“Rainfall is all important. If you see a large amount of rain in Vietnam for example, which produces a large amount of Arabica, then a good crop could really cause prices to fall.”
Seasonal factors also play a part. Some market analysts believe different forces throughout the year particularly influence the agricultural commodities. June and July are often seen as periods of weakness for coffee futures.
As well as being one of the most-traded commodities, coffee is also one of the most volatile.
One of the major reasons for coffee’s volatility is the high probability of supply disruptions. This is because virtually all production is outside of the OECD group of countries. In less stable countries, such as some in Latin America and sub-Saharan Africa, political strife can cause supply disturbances.
Also, throughout the 1990s and 2000s, governments such as Vietnam pushed prices higher by buying supplies as they attempted to increase market share.
Kamkolkar said the nature of the coffee market means that trade is generally fairly thin.
“Coffee contracts trade in London in the hundreds, so if there is a sudden rush of funds into the market, we can see price rise higher very rapidly,” he said.
So is there a place for coffee in a trader’s universe?
The trader with limited funds or the technical trader might consider giving this market a miss.
Kamkolkar said he find technicals give only part of the story in a market that is often driven by unpredictable events such as freak weather conditions or political unrest.
Also, the large position sizes can cause a trader with a small account to be wiped out pretty quickly.
But traders that are driven by fundamentals, with larger accounts, or a weather fetish, might start investigating further.