Is Coffee The Next Soft Commodity To Move Big Time?

Commodity prices moved lower in 2015, across the board. That is with the exception of soft commodities. In this sector of agricultural luxury commodities, the prices of sugar, cocoa, cotton and frozen concentrated orange juice futures all posted year-on-year gains in 2015. The only commodity in this sector that moved lower on the year was coffee. Coffee began the year around the $1.65 per pound level but by the end of 2015, it was trading around $1.20.

At the beginning of 2016, the prices of all commodities including the softs have moved lower.

The price of Arabica coffee futures plummeted over the course of 2015 as rain in Brazil was a positive factor for production of java beans. This has lowered costs for individual consumers as well as for companies like Starbucks and J.M. Smucker Company, the maker of Folgers brand coffee. A combination of positive developments for weather in growing countries coupled with a higher dollar and declining local currencies has encouraged coffee producing nations to export and sell as they receive appreciating dollars in return for their crops. While the U.S. Department of Agriculture expects supplies to rise, they also believe that output and exports will be ample to meet worldwide demand for a sixth straight year in 2016.

In Brazil, a drought curtailed production in 2014 but last year rains were plentiful enough to reverse damage to coffee trees.

According to Rabobank, the harvest this year will rise to 58 million bags from 48.4 million in 2014. However, the crop could rise as high as 60 million bags from Brazil, the world's largest and most influential producer of coffee beans.

Production is also rising in other producing nations. Columbian output could reach 14 million bags in 2015 compared to 12.1 million in 2014.

Columbia has said that their crop could rise to 18 million bags by 2018. Honduras, the largest coffee producer in Central America, appears set to reap a record crop in 2015. This is why the price of coffee dropped by over 23% in 2015. So far in 2016, the price of active month ICE March coffee futures have dropped to under $1.12 per pound as of January 20. However, all of the bearish news is already in the price of coffee and any surprises could change this price trend very quickly.

Coffee is a popular and ubiquitous drink worldwide. Increasing global population and wealth, demographics, means that demand for coffee rises each year. There are simply more coffee-consumers in the world each day. Global population now stands at around 7.3 billion, an amazing level considering that in the year I was born, 1959, there were fewer than 3 billion inhabitants of planet earth. The steady increase in demand for coffee beans makes the fundamental equation for the commodity very sensitive to any changes or surprises.

The 2014 drought in Brazil sent coffee futures prices traded on the Intercontinental Exchange (ICE) from just over $1 per pound to over $2 in just a few short weeks. The El Nino of 2015 will extend into 2016.

This could trim output in Columbia, Brazil and other producing nations causing output to decline below levels that the market currently expects. Forecasts for a bumper crop depend on positive weather developments.

When it comes to coffee, the size of the crop is as important as the quality of the beans. Coffee drinkers are quality sensitive consumers. It is simply a case of quality over quantity. Weather can be as volatile as the price of coffee. Moreover, coffee is always susceptible to a crop disease, leaf rust, which can decimate a crop.

Therefore, as we are now in 2016, the prospects maybe for supplies to satisfy demand but there are still a lot of unknowns when it comes to the weather and this is likely to create volatility in the coffee futures market. With coffee around $1.11 per pound on January 20, 2016, only eleven cents above the lowest price seen over the past decade, the downside in this important commodity appears to be limited.

Coffee traded to highs of $3.0625 per pound in 2011, it was above $2 in 2014. Based on the price action in coffee over the past ten years, the risk-reward at $1.11 per pound favors the upside.

Considering that all other soft commodities appreciated in 2015, despite the secular bear market in commodities, coffee could be a candidate for a surprise in 2016. Keep your eyes on coffee, if Mother Nature provides any surprises in growing countries, the price could start percolating on the upside once again very quickly.