Here at the close of March 9, 2009, we find coffee futures at the edge of a precipice yet again.  For a coffee bull, this setup has fooled us twice already within the last 5 months.  It occurred before the all out collapse in futures prices in October, and it occurred again at the market lows in December.  And here we are again. 

For those new to the mind numbing art of technical analysis, this chart may not look like anything useful to you, and alas, you might be right.  Time will tell.  But it does show us my two favorite technical indicators for the coffee futures market.  The indicator on top, which is accompanying the daily price bars is called the Relative Strength Index, or RSI.  The one on the bottom is called the MACD Histogram.  For those interested in knowing how these are calculated, or what exactly they indicate, I highly recommend buying, reading, and rereading A. Elder’s Book ‘Trading for a Living’, or simply drop me a question.

Both of these technical indicators scream the same thing as of today, that the market has hit an intermediate to a longer term bottom.  This comes at a time when the previous market low of $1.05 was tested, broken, and eventually held by day end.  And it comes at a time when commercial interest is heavily supporting the market, as can be seen in the COT chart from my previous coffee futures post.  From a technical perspective, it is hard to find a better, low risk opportunity to enter a market.  All indicators are flashing go, and you can enter with a tight stop loss, risking less than $1,000 dollars to test the entry, as the stop loss can be place just under today’s low at $1.0425. 

Again, these indicators over the last 5 years have been over 80 percent accurate when used together…until the end of 2008, when all indicators became worthless and fear plagued the markets.  Can we trust them again, or are coffee futures still under external market pressures?  I’m keeping my fingers crossed and entering here with a small position, long one may coffee future, and hedging with one may $1.05 coffee put option.  For those puzzled over my addiction to coffee futures, you can read why they are the best investment for 2009 and 1010.

The Commitment of Traders Report, for those who don’t know, is a report released weekly by the Commodity Futures Trading Commission that details the positions (commitments) of various groups of traders. Who are these groups and why should we care? More importantly, what do they have to do with our beloved coffee futures?

These groups are comprised of commercial traders, large traders or hedge funds, and small or independent traders. In general, the public is the last to jump on a genuinely bullish or bearish market, and so trading away from them tends to reap the most rewards. Large traders with big institutional money tend to be ‘trend followers’. They tend to miss market bottoms and tops but catch large moves either up or down. When a market has established a trend, making sure the large trader position is consistent with the trend will add credence to it. And finally, the gem of these various groups, the commercial traders. Commercial traders are producers or users of the actual commodity. In terms of coffee these are the Brazilian or Vietnamese plantation owners, Maxwell House, and Starbucks. These companies not only have the big bucks and power to have eyes and ears around the globe physically monitoring crop conditions, their survival depends on it. As such, they are not speculators. In fact, they are not legally allowed to speculate. They are scale traders, and it is in this nature of their trading that gives us the most important piece of information.

Scale trading is to buy as the price is falling, and sell as the price is rising. This theory seems common sense but it is actually the opposite of how the vast majority of traders trade. Commercial traders therefore are short the market during the largest price rallies, and long the market during the largest bear markets. This would be a horrible loss for them if they weren’t dealing in actual physical product, which allows them to maintain their livelihood despite massive paper losses. So how does this look in the real world? Coffee futures have fallen along with everything else over the past 5 months. And as they fell, commercial positions have become heavily long the market. What does this mean? It means that those groups who have a vested interest in the physical commodity, in coffee itself, and have the most knowledge about it, are telling us that these prices are cheap. Producers are not concerned with hedging, or being short the market to protect their equity. And Maxwell House is buying up its future needs, recognizing that these prices are temporary and sure to be short lived. But can we really trust these commercial traders, especially at a time of such economic turmoil? I believe so.

In the last 8 years, the Commitment of Traders Report and the commercial trader position described therein, has accurately picked and/or created each and every long term and intermediate term bottom in coffee futures. Each and every one. This report pretty much blows every other market timing indicator out of the water, and is well worth heading. The difficulty with it lies in the precise timing, as market tops and bottoms may take weeks or months to establish themselves. That said, for the last 8 yrs, every time commercial traders have gone long coffee futures, coffee futures prices have been within 10 cents of a long term bottom (within 10 % of the bottom) and moved 40 to 80 cents higher within the following 6 months. This has been the case during a gradual tightening of global supplies. What kind of move should we expect in our current fundamental setup, where for the first time in 12 years, an actual shortage of supply will be felt in the market? Your guess is as good as mine as to how the financial crisis will continue to weigh on the markets, but if history tells us anything, the big boys who use coffee are telling us that coffee is cheap, and that these prices ain’t gonna last. You can see a long term commitment of traders coffee futures chart at commitmentoftraders.org. It’s lone advocate Steve Briese deserves many thanks for his hard work in keeping the COT report alive.

The red line on the bottom signifies the commercial trader position.  You can see that it has an inverse relationship with coffee futures prices, and that it has been net long, causing the last rally to the mid $1.20’s, and is now flirting with the net long marker for the second time.  This is a phenomenon that signifies long term bottoms in coffee futures prices and a strong long term entry point for those involved in coffee futures trading.