Fundamental analysis, in contrast to technical chart analysis, is the method of analysing a market via supply and demand figures as well as associated external influences and rates of change of those figures.  How much coffee is produced this year?  How much do we consume?  If consumption outpaces production, then place your bet on rising prices.  Basic economics, the indelible law of supply and demand. 

The problem with this method, and I speak from experience here, is that fundamentals are completely irrelavent in the short term.  Markets are complex machines made up of whimsical decisions made by both educated and very uneducated speculators.  This can push prices any which way in the near term, even contrary to what long term fundamental factors would suggest.  So while a fundamental analyst may know the coming long term direction of a market, he may even have a strong idea as to the magnitude of a move, he is almost always wrong in the short term.

This coming bull run in coffee could have been predicted as early as 5 years ago, and was in fact by Jim Rogers in ‘Hot Commodities’.  Coffee has made decent gains, up 100% from prices at that time, and still holding up much better than nearly any other commodity.  But it has not as of yet done the dirty deed I’m holding out for.  Coffee, according to the extreme fundamental setup we find it in, has no option but to rise dramatically to find a place where demand curtails to align with output numbers.  We are a long way off from that, and coffee prices are still cheap. 

Today Bloomberg released yet another article on the tightening fundamentals of coffee.  A short excerpt:

“The premium for cash-market supplies of arabica coffee from Colombia surged to 38 cents a pound above New York futures from 5 cents to 8 cents, said Hernando de la Roche, a director at Hencorp Futures. Coffee inventories stored at the five warehouses monitored by ICE Futures U.S. have declined 12 percent since reaching a four-year high on Oct. 24, exchange data shows.”

 Let me recap that number…38 cents.  That means while we are paying around $1.10 per pound of coffee at the exchanges, those out there who actually need massive sums of coffee to maintain business operations are paying nearly 40 cents more to have it today.  This is indeed a severe problem and one that is only going to be exacerbated with time.  Who in their right mind would bring their coffee to sell it at the exchanges when they can get 40 cents more per pound selling it directly?  The answer is nobody, nobody in their right mind.  Which explains why certified stocks as well as stocks pending grading are dropping precipitously.

Even given the very precarious economic times, coffee is on the verge of a supply crisis, and one that will result in a massive bull move in coffee futures.  I fully expect coffee futures to be at previous all time highs, somewhere in the $3.50 range by the end of 2010, if not later this year.  And I fully expect before this bull run comes to fruition that prices will far surpass those prices, possibly by 100-200%.  And if spot prices continue to hover so high above exchange prices, this could happen sooner rather than later, as tightness could begin to manifest as contract defaults and an all out scramble for coffee supply. 

So while you and I are cursed through fundamental analysis now, we will be blessed when speculators and coffee futures finally take notice.  And I feel that time is not far off now.  Keep the faith.

Well, Tuesday’s move in coffee futures was puzzling.  As a general rule, markets ought to react to bullish news by moving higher, and react to bearish news by going lower.  If a market reacts to bullish news with a move lower, it’s typically a sign of severe weakness, and possibly unkown fundamental factors overriding known factors.  With todays clearly bullish coffee report from the ICO, coffee futures mockingly closed $0.35 lower on the day.  Why?  Your guess is as good as mine.

The International Coffee Organization revised its estimate for global coffee output downward from 133.4 to 127. 8 million bags, due to smaller crops out of Columbia, Vietnam, and india.  This is big news, and in light of the coming deficit season, futures prices should have had no trouble holding ground Tuesday.  Is this cause for short term concern?  Definately.  If you’re long this market, as I am, place your stop losses or hedge with puts.  This market is fundamentally primed for a bull move that will blow the top off of previous historical bull runs, but in the short term people are crapping their financial pants.

There is still that lurking concern of consumption curtailing along with every other commodity out there.  But as of yet, the contrary seems to be true.  Fear and stress tends to augment coffee consumption, not reduce it.  And it really has achieved diet staple status, where people don’t perceive it as a luxury so much as a daily essential.  And the transition from coffee house use to in home consumption should prove to increase over all consumption, as in home brewing is not nearly as efficient as commercial coffee brewing, allowing larger portions of coffee to flow down the drain.  Conclusion is still that this market is gripped by fear, but as soon as fundamental factors manifest in actual arabica shortages coffee futures prices should respond swiftly and dramatically to the upside.