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(March 21, 2002) COFFEE: The coffee market has lived up to its volatile reputation recently as prices exploded to the upside last week only to give a sizeable portion of it back early this week, and then turn higher once again. Fundamentally, analysts have been hard pressed to come up with any justification for the market's breakout to six-month highs, nor its abrupt downward correction and subsequent rebound. Some participants have hinted that the market may be trying to build a weather premium into the market ahead of the Brazilian frost season, but normally this doesn't occur until mid April. Instead, the volatile gyrations appear to be more technically inspired. Typically such volatility is normally seen when coffee is in its most price sensitive period during the Brazilian frost season and this is still months away.

The most recent commitments of traders report confirmed this technical flavor when it showed the large speculators (a.k.a., the funds) flip-flopped their net position from net short to net long in dramatic fashion. The funds are trend followers whose managers pay practically no attention to the fundamentals. The report indicated the funds went from net short 6,973 lots to net long 7,560 lots as of March 12, coinciding with the breakout and easily one of the largest one week shifts in the fund net position in the past several years. The funds have been consistently net short the market for months. The combined position of the funds and small speculators, or locals, swelled to net long 15,556 lots, the largest net long position since December 14, 1999, which coincides with the period that the coffee market began its unrelenting price slide. The market responded to the report on Monday with a torrent of selling from the speculative community with daily losses around 400 points. The market absorbed these losses very well and its ability to hold at key support levels provided a springboard for the speculators who started to buy back positions they had dumped on Monday.

The market's apparent upward bias has us leery because most of the buying was coming from the speculative community. End-users, or roasters, have mostly held to the sidelines. This goes back to one of the key fundamentally bearish factors overhanging the market, namely the exceedingly large amount of coffee held in warehouses of consuming countries. With roasters amply covered, and no real reason to be worried that supplies are in jeopardy, end-users have been in no rush to buy. Industry buying is also more subdued amid expectations that Brazil will be harvesting a monster coffee crop later this summer. The Brazilian government has pegged the 2002/03 crop at 39.6 million 60-kg bags, a significant increase from last season's crop, but private estimates are even higher, looking for the upcoming crop to come in around 45 million bags.

With no apparent change in the bearish fundamental situation and much of this volatile price action coming at the hands of the speculative community, we prefer the sidelines.

 

Andrew Buderus

www.agedwards.com

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