There’s an old saying that goes something like, “when its easy to own something, you probably don’t want to.”  Well, anyone in coffee futures right now is probably feeling as uneasy as I do.  Cocoa and Sugar futures have had a phenomenal year on arguably weaker fundamentals.  But they did have a story and perhaps their time was due.  Coffee futures meanwhile have had a hell of a time making it to and maintaining our current trading range in the $1.35 to $1.50 area.  This, needless to say, is discouraging.  However…

I want you to take a look at the coffee price chart from 2008 before coffee futures ran to the highest prices in 10 years.  Comparing our current setup at our current time of year in 2010 to that in 2008, we’re looking at a nearly identical technical setup.  Prices were range bound for almost 2 months into the end of January.  You’ll notice futures prices bottomed around the 25th of January and from there climbed steadily for 30 days.  What’s more important is that that run up was preceded by bearish divergence on the MACD histogram, which, as I mentioned before, has a strong track record for fortelling major turns in this market.  It was wrong then, which is indicative of exceedingly strong fundamental factors. 

In mid December of 2009 the MACD Histogram flashed bearish divergence and prices corrected down to around $1.35.  If we can see coffee prices hold and/or correct at these current levels in the upper $1.30’s, both the MACD histogram (plotted on bottom) and the Relative Strength Index (plotted with prices on top) will give a strong buy signal, that is, this valley will be shallower than the last for both indicators.  All commodities were adorned in red today thanks to our paradoxically strong dollar, but should that fail to maintain its strength, then coffee futures have a great many bullish influences.

To recap from the previous post, we are in the most bullish time frame of the year for coffee futures.  We are at the longest period of time between major harvests contributed by Brazil and Vietnam, and what would normally provide some alleviation to tightness, Columbia, is experiencing severe losses this year due to weather.  Ice certified stocks are the lowest in 7 years, and the stocks relative to global consumption are the lowest in 30 years.  And…technicals could be turning very bullish here before week end.  It’s time to be long this market, and at these levels one can enter with strong fundamental and technical support.  And if you’re not long, you don’t want to be short.

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.

It’s been too long now since I’ve posted on coffee futures. Coffee news is exceedingly bullish, but this is quite typical for this time of year. That said, there may very well be something different this time around. We’re going into next season with the lowest stocks to usage ration on record, and all major producers are reporting smaller 2010 harvests.

Coffee futures have been range bound to drifting lower since mid October, but have gained over 15 cents in the last two weeks to challenge the highs set in October. Coffee has a lot going for it fundamentally speaking, but what’s more important is coffee’s seasonal tendency to rise in December, and to maintain an upward bias until March. If coffee is going to make a run this year, we are in that perfect time frame for it.

The decline from October into mid to late November is also consistent with coffee seasonality, and although this may have seemed like weakness in the market, it was probably more of a constructive shake out of weak longs and the last major buying opportunity for commercials. From a longer term perspective, it should be obvious that coffee futures are making higher highs and higher lows, the very definition of a bull trend. This should, until prices prove otherwise, leave the long term investor with a ‘buy the dips’ mentality.

At today’s prices, which are nearing the highs of the year, the short term investor should watch very carefully for further advances. Breaching previous highs at this time of year will leave the 2008 highs in the 170s as the only ceiling for prices in the last 10 years. The best way to trade this market after today’s jump in prices is to set buy stops above 150 which stop you into a long position should coffee futures advance. Because prices have been range bound, a breakout should lead to a new consolidation zone at higher prices which leave the current range safely behind, while providing a low risk entry point.

Sugar and Cocoa futures have both had their fun this year, and now I believe its coffee’s turn. Not to mention that cocoa and sugar are at levels that may be tough to sustain from a fundamental perspective, and when investors start to pull out their cash and take profits, it should drift into the only other soft commodity with bullish fundamentals, coffee. If those two commodities could rally as they did this year with a more subtle bullish case, then coffee should be primed to experience a mark up that parallels them both, doubling prices and taking them into the $2.50 to $3.00 range, for starters.

Timing this market is, has been, and always will be a bitch. But someone with deep pockets and a bit of patience is going to get paid within the next year from this market. If one doesn’t have experience trading, I’d highly recommend buying coffee ETF’s. ETF’s lack the leverage of futures, which both reduces profit potential and reduces risk, but they do allow one to stay the course and see this market do what its been preparing to do for the last 10 years.

For those looking to time this market, you have a window of safety in to March. Option sellers will have a field day selling puts into this market. And coffee futures traders should be able to trade the trend, and stay long the market with stops below the 20 day moving average. Should this market really run away, stops should be raised to follow prices a little more closely, for when coffee shits, its shits like an elephant.

Well, your perennial coffee futures bull is a tad lost for direction. It’s been a while since the last post, and for good reason. I haven’t seen anything worth commenting on. Coffee futures seem to have put in a solid bottom, and are looking now for confirmation. But the fundamental picture is not what it was a couple months ago.

The size of the Brazilian harvest was more than ample, and considering this is an off-year it certainly is cause for concern over the potential size of next year’s on-year crop. The spark which lit the fire under coffee futures prices back in April has fizzled, as Columbian premiums are dropping and the wait for new supply is rapidly decreasing, alleviating concern for deficit.

I usually post with a purpose, to elucidate trading principles in the context of coffee futures trading, or to update fundamental or technical developments. This post is different, but perhaps it can stand as a lesson of its own. The lesson is this; when things which were previous clear to you become blurred, its time to stand aside.

It’s a difficult thing to believe in an impending bull run in coffee futures and to find yourself temporarily in uncertainty, but it happens sometimes. My natural inclination is to persist, and continue to try to work my initial plan as at one time it made perfect sense. My natural inclination is rarely correct. This is why it is of the utmost importance to define your signals, signals which you understand and which show a base of reliability, and only trade on the basis of those signals.

The downside is you are going to miss important events because markets don’t always conform to market indicators. Coffee futures couldn’t care less how I intend to analyze them, nor do the thousands of players involved in making a single trade at a single price. This never seems to change the fact that we all have that ‘lucky’ feeling that tells us the market cares about us, and that it intends to pay us out this month.

Coffee futures and fundamentals are sending mixed messages at present. This is the ideal time for a seasonal low, and that low no doubt was set in July. Seasonality dictates that we ought to see oscillating prices with an upward trend into December. The strength of the upward trend is contingent on crop outlook, dollar value, and investor demand. We aren’t due for another massive Arabica crop for 9 months or so and that generally underpins prices this time of year. This is generally bullish.

Futher bullish signals include COT funds increasing longs, which portends a longer term upward trend, global economic news is improving, global coffee consumption is increasing, and investment demand should return in droves to commodities. Before long inflationary pressures should grip commodities again, at least those which have supportive fundamental conditions, and push them to all time highs. That’s what we’re presently observing in Sugar futures, which are at their highest prices in 30 years despite the fact that fundamentals are fuzzy.

On the negative side, the weight of this year’s Arabica harvest may weigh heavily on coffee futures, as next years harvest is predicted to be massive. If these two crops have the potential to increase global stocks then coffee futures have little hope of rallying significantly. This is very discouraging to someone who just put up a website on the inevitable coffee Bull Run, but we have to adapt. Price may still rally on the basis of seasonality alone, but I’m not finding a clear technical or fundamental picture with which to trade. I’ll stand aside for a short time.

Ways in which to profit from this uncertainty may be to sell out of the money coffee call or put options. Selling these is in essence, selling hope to someone that believes coffee futures prices are going to move sharply up or down. This seems unlikely in the short term, and selling calls or puts may be a promising strategy. I’d be more inclined to sell puts at present, as the coffee futures generally don’t surpass the July lows. We’re not far from the previous lows here, so this lends some safety to the equation. But before selling coffee futures options, make sure you do your own homework. Coffee futures are extremely volatile, and selling hope means you’re also accountable for potential losses.