Speculative Overreaction Last Year Augurs Well For 2015 Coffee Pricing

For this first issue of 2015, I thought we would take a look back at 2014 and especially at Arabica coffee futures, which had a crazy run-up based almost exclusively on speculation that, with a severe drought affecting Brazil for much of the year, supplies might run short, making coffee more scarce, and therefore more valuable. This assumption, which was eroded by decent rainfall in the late fall (late springtime in Brazil), and origin selling in November and December, never came to pass.

According to a Bloomberg report, coffee was the best-performing commodity of 2014, but the year closed in a bear market that shows few signs of ending. Prices that had doubled by October then fell 13% in the past two months, as rains aided parched trees in Brazil, the world's top grower. November was the wettest month of the year, after the worst dry spell in eight decades.

Based on my 35 years' experience of watching the coffee market, there is one takeaway that I find fascinating when considering years such as 2014: the outsized difference between future speculation on what might happen, which rocks futures markets, and what actually does happen, which usually brings the market back down to earth.

Even in the late 1970s, which saw the biggest actual damage to the coffee harvest caused by a Brazilian "black frost" in 1975 which affected production for the 1975 (and more so, the 1976) Brazilian crop, there was no running out of coffee completely, no turning to fillers such as chicory, as had been the case during the American Civil War when New Orleans found itself blockaded and it was very difficult for the Confederacy to import coffee. Chicory was added to our favorite beverage to stretch out coffee supplies -- a fun fact that has led to the use of chicory for tradition's sake at outlets such as the über-popular Café Du Monde).

Parsnips, acorns and beets have also been used as coffee stretchers, but I've heard very little regarding the use of these, nor the need to even consider any of them, during any panicked markets during my tenure in the business. The concerns and estimates that turn the market upward always prove to be overdone, even if they must be considered and dealt with as they affect the current reality through future speculation about pricing.

All of the upswings start with an initial bump in the market which leaves many, including yours truly, wondering what exactly the issue is. By the time word trickles down from the big trading houses, the market has already "snowballed" into an unstoppable force upward, overshooting the reality of the situation into pricing that represents, at best, the worst-case scenario for future supply. That the worst case scenario never seems to come to pass does not stop those overshoots to the upside from happening time and time again.

As much as I am tempted to short the market during these events, I recall my dad's words of wisdom that remind and restrain me from such action: "We are coffee buyers, and gambling should be left to Vegas!"

Shorting the market even at $2.20 would be folly if the market were to continue its ride up to the $3 range, which is not out of the realm of possibility in any uptrend.

Emotionally, as a coffee buyer, I feel more biased to buy the market when it hits $2.20 than to sell it, which is exactly why these events have the momentum they do, and why it takes longer than one would expect for them to subside.

I do feel that the worst is over for this run, and we should see a tighter range with bias to the downside taking hold in the first half of 2015.

Going forward, low oil prices will force commodity index funds to rebalance positions, and with coffee being higher than it was on January 1st of 2014, this should mean net selling of coffee by the "big boys," leading to downward pressure.

It is as difficult to pick where the bottom might be as to predict the top, since the market tends to overshoot to the downside as often as it does the up. Average costs per pound for producing countries on green coffee range between $1.10 and $1.40, but that doesn't mean we might not see prices below that this year. Getting below $1.00 would be very difficult, however, so it is reasonable to assume we will see a range that settles between $1.60 and $1.10 for the year ahead.

I wish all of you a wonderful and fulfilling 2015. If there is a subject involving coffee or our industry that you would like me to cover, feel free to email me at Nivekrst@gmail.com.

May your cup be full, and the brew exquisite!