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El Niño And Chinese Demand Could Give Coffee A Wake-Up Call


The stimulating power of coffee has made it the 2nd most traded commodity on the planet after crude oil. The allure of a tasty pick-me-up is universal. Europe is the biggest consumer, accounting for the bulk of global bean demand. The U.S. is second. Coffee-loving Millennials comprise a grand-sized 44% of U.S. demand, propelling the thirst for coffee beans worldwide to a record in 2016. U.S. demand – mainly from Millennials – is up 1.5% and forecast to rise 2% per year until 2020.

But the biggest jolt in demand could come from population-heavy China. The Chinese are just discovering coffee and coffeehouse culture. Plans by coffeehouse giant Starbucks (NASDAQ:SBUX) to expand in China, combined with the growing sophistication of the Chinese consumer, have the potential to quickly boost demand.

Global exports increased 6.7% in just the first 5 months of the 2016/2017 growing year. Some forecasters believe global coffee demand could increase by as much as 25% over the next five years should interest from China and the rest of Asia continue to accelerate.

Supply Still Threatened By WeatherThere are two types of coffee beans: Robusta and Arabica. The Robusta plant is generally hardier than its Arabica cousin. Robusta beans have a higher caffeine content and tend to be bitter compared to Arabica beans. Roughly 30% of global production is Robusta, with Vietnam the biggest producer. Europe drinks a lot of Robusta coffee. No surprise, the “Nescafe” brand, ubiquitous outside the U.S., is a Robusta blend.

Arabica coffee tends to be milder and subtler. Nearly all coffeehouse roasts start with Arabica beans. Flavor is often determined by the roasting process. Brazil is the world’s largest Arabica producer as well as the biggest overall coffee producer. Vietnam is the second biggest overall coffee producer followed by Colombia.

Coffee is a tropical commodity. This makes it more susceptible to tropical weather events like El Niño. El Niño is associated with drier-than-normal weather in the South Pacific and wetter-than-normal weather in South America. Drought brought on by the 2015 El Niño devastated Vietnam’s Robusta crop. It has still not fully recovered. With El Niño expected to make another appearance this year, 2015’s damage could be compounded. At the same time, excessively wet weather could disrupt the Brazilian harvest.

Weather is unpredictable and global climate change has made it even more so. Coffee is facing its third consecutive year of supply shortage. Total coffee output (Robusta and Arabica) is estimated to be 151.6 million bags while global consumption is expected to climb to 155.1 million bags.

Potential Buying OpportunityThe bears have been in control of the coffee market since the beginning of the year, driving prices into long-term support between $1.31 and $1.11 per pound. Coffee is notoriously volatile, turning on a dime at any time. Let’s see if we can use further weakness as an opportunity to pick up a longer-term bullish position on the cheap. We’re looking for a weather and demand-inspired bounce before the end of the year. Our target is the 2016 high of approximately $1.75 per pound.

Consider placing an order to buy December $1.60 / $1.75 bull call spreads for $750 or less. These spreads settled yesterday at $866.25 each, which means we need prices to drop further into our support zone to get filled on our order. If filled, our maximum possible loss is $750 plus transaction costs. This spread has the potential to be worth as much as $5,625 if coffee rallies back to its 2016 high prior to option expiration on November 10, 2017.

Disclaimer: The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results. Trading advice is based on information taken from trades and statistical services and other sources that R.J. O’Brien believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades.

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