Brazil is the largest coffee producer in the world. No other country comes close, and Brazil has held this position for 150 years. There are roughly 10,000 square miles worth of coffee plantations in Brazil’s southeastern regions.
A rise in global coffee production means Brazil’s share of the world coffee market has declined from peak levels in the 1950’s. Even still, Brazil supplies about a third of the world’s coffee, and coffee remains one of Brazil’s top ten exports.
Coffee prices have been depressed by Brazilian crop expectations. The outlook is good, meaning Brazilian plantations are expected to have robust output. (Robust, get it?) Favorable outlooks for Vietnamese and Central American crops are also contributing to forecasts of a global coffee glut over the next year or two.
You can see the gloom in the price action of JO, the Bloomberg Coffee Sub-index ETN. But here is the thing about market expectations… When expectations are fully “priced in” to a market, a small adjustment to the outlook can move prices significantly in the other direction.
In the case of coffee, those who are bearish mostly have already sold or gone short. A downgrade of expectations for the global coffee crop (which would reduce anticipated supply) could thus push coffee prices higher.
The chart below shows bullish positioning for commercial hedgers in the coffee market. The commercials generally have the best information, and they are now aggressively net long coffee futures relative to historical levels.
The chart above also shows historically high levels of open interest in coffee futures contracts. This is another bullish sign.
The commercials are “strong hands,” meaning it is hard to shake them out of their positions, whereas speculators are “weak hands,” meaning it is easier to make them cover their positions or otherwise get out.
Because “weak hands” speculators are positioned short versus the now heavily net long “strong hands” commercials, a shift in expectations could force the speculators to cover their shorts. That could fuel a big upside move.
The time cycle forecast for coffee also paints a bullish picture. The time cycles outlook for coffee is bullish through the rest of 2018.
The opportunity here is a contrarian bullish trade in JO, the Bloomberg Coffee ETN (or possibly coffee futures contracts if you are a commodities trader).
On a related note, while coffee is no longer the main driver of Brazil’s economic outlook, it’s notable that Brazil is doing well these days.
Roughly nine months ago, we made a long recommendation in EWZ, the MSCI Brazil ETF, when EWZ dropped 16 percent on a burst of political fears. EWZ has risen roughly 40% from that point and continues to look strong.
The time cycle forecast for EWZ is also bullish with EWZ still 60% away from its all-time high.
Coffee is no longer Brazil’s most important export, but it is still an important one.
If there is a contrarian bullish recovery in coffee prices, that could improve Brazil’s outlook too, and drive EWZ toward further gains.
Richard Smith, PhD
CEO & Founder, TradeStops