It’s déjà vu all over again. Coffee futures are flirting with the upper end of a long term range in the $1.50 area, cash price differentials are nearing extremes, and fundamental news is exceedingly bullish. Anybody recall May of last year? At that time however, there was no fighting the monster down seasonal that grips the coffee market every year. But this time we find ourselves in a very bullish time frame, conveniently nestled between major harvests and sipping away at stocks until the next.

Columbian coffee cash differentials are approximately 70 cents above the March futures price. This means that those in need of Columbian arabicas are paying $2.00 for a coffee that can be substituted with similar, cheaper product. Historically this situation plays out by dragging futures prices higher as tighter coffees are substituted with cheaper alternatives abroad. This setup is a form of backwardation, though it hasn’t directly manifested in futures prices yet.

Contango, an upward sloping yield curve, is the normal state of a commodity. Storage and shipping adds costs to the current spot price, and causes distant futures prices to exceed near futures prices. This implies a state of ample short term supply. Backwardation, or a downward sloping yield curve, implies the opposite. Backwardation occurs when the nearest futures prices are higher than distant futures prices. For example, if March coffee futures prices exceeded July coffee futures prices, the coffee market would be in backwardation.

Backwardation suggests extreme tightness, and reflects the fact that buyers are willing to pay higher prices to secure immediate product rather than hedge or wait for less expensive contracts. Backwardation is perhaps the most bullish of market signals. Prices are directly telling you there is a supply deficit. That is essentially what we have occurring with Columbian spot price differentials, despite the fact that this tightness has not resulted in futures price backwardation yet. It might soon.

Furthermore, ICE certified coffee stocks are at their lowest since 2003, evidencing consumption has not dwindled through hard times. Taking into account this stocks situation, the Columbian spot differentials, a strong bullish seasonal tendency, and uncertainty over the coming harvest while consumption is on the rise, the situation looks particularly bullish. Coffee futures are clearly in a short, intermediate, and long term bull trend, and prices are a stones throw away from $1.50. If we can see prices exceed and hold above that price, we could see a very fast climb to the previous 2008 high in the $1.75 range.

The one caveat here is that production estimates for the coming Brazil harvest are all over the place and direction of the dollar is questionable. CONAB released an unusually high production estimate, but it doesn’t take into account probable quality issues that may have occurred due to poor weather and a lack of maintenance throughout the financial crisis. And even if they are accurate, we have to wait 4 months before ‘ample’ product starts rolling in. In sum, this market at the very least is being supported by actual supply tightness, and at most is gearing up for a move north.