Seasonality in my opinion is one of the most overlooked and important factors in commodity trading in general, and coffee futures trading in particular. Seasonality is the tendency for a commodity to rise or fall at a certain time of year, every year. In many commodities like cotton, wheat, cocoa, and cattle, this manifests in rising prices after the peak in harvest, and falling prices in anticipation of harvest. In other words, seasonality in most agricultural commodities is supply driven.

In other commodities like crude oil and gold, where supply tends to be relatively steady, barring any natural disasters, seasonality is demand driven. Crude oil futures rise from March through May in anticipation of the summer driving season, and again from July through September in anticipation of the winter heating season. If a trader is familiar with these seasonal tendencies alone, and has an intelligent money management system for reducing risk and maximizing gains, I believe trading on seasonality alone is enough make a fortune in commodity trading.

How does this apply to our best investment pick for 2009; coffee futures? Coffee futures prices are heavily influenced by seasonality. There are a few major coffee producers and those few make up the great majority of coffee supply. Naturally, coffee futures prices are very sensitive to the production cycles of these producing nations. Brazil, the largest producer, harvests coffee in the summer months, starting in May or June and lasting through August. In anticipation of the massive contribution to the supply chain, prices drop sharply nearly every June. This is one of the strongest seasonal tendencies in all commodity trading.

There have been only a few exceptions in the last thirty years. So if you’re long coffee futures in May tighten your stops and reduce your position. Coffee prices may also experience declines in September or October before the Vietnamese harvest begins. A great many of my losses could have been avoided if I had taken heed of seasonality, rather than focusing on the fundamentals and technicals of a market alone. So if coffee prices tend to fall under the burden of heavy supply two times a year, when do they tend to rise?

If you’re planning to go long coffee futures and want the support of seasonality, you’ll want to enter in October and look to tighten stop losses in December, and again enter in February looking to tighten stops sometime between March and the end of May. To add weight to seasonality, every major Bull Run in coffee futures prices in the last 30 years occurred between October and May of the following year. Every major Bull Run! During years of large crop production which transitioned to years of much smaller supply, like the year we are currently in, prices had a hard time breaking north before February due to the weight of copious supply from the previous on-year harvest.

When the brunt of this supply began to thin, as it already has already this year, and there is no fresh supply until June, then coffee futures prices can respond with unfathomable strength. In sum, seasonality in conjunction with extremely tight fundamentals and dirt cheap prices is suggesting that coffee futures prices are due to pop. It is mid February, supplies are tight, prices are cheap, and no more coffee is coming online prior to June, when an inadequate and cyclically smaller crop will be harvested in Brazil. Seasonality is one of the many factors supporting my view that coffee futures are the ‘best investment in commodity trading for 2009′.

Coffee futures trading can be very intimidating at first.  Coffee futures have a reputation for being extremely volatile, and its one of those commodities that has no daily limit for price movement.  Meaning there’s no limit to how much you could make or loose in a single day.  But for those beginners out there, lets break down this daunting world of coffee futures trading.

Coffee is now electronically traded on ICE.  One coffee contract accounts for 37,500 pounds of coffee.  So whenever coffee moves a cent, you arrive at the profit and loss figure by multiplying that cent by 37,500, realizing a profit or loss of $375.  If you are long coffee futures and prices rise 10 cents, you make $3,750.  Not too complicated. 

Where coffee futures trading gets exciting is the tremendous amount of leverage a futures contract has.  Most of us could not afford to buy a coffee contract outright.  At today’s futures prices ($1.20 per pound) an entire contract is worth $45,000.  Too rich for my blood.  Fortunately for those of us who want to join in the game, we can buy this contract on margin for a fraction of the value of the entire contract.  At current prices and volatility levels, you can control a coffee futures contract, accounting for 37,500 pounds of coffee, for about $3,000 on margin.  What does this mean?

If you own a single coffee futures contract, and the price of coffee rises only 10 cents, you have more than doubled your initial investment.  If on the other hand coffee prices fall 10 cents, you have lost more than 100 percent of your initial investment, unless you’ve placed a tight stop loss or hedged your position with a put option.  10 cents is a hiccup for coffee.  Coffee futures prices can move faster and farther than imaginable should the right news pop up, or should a series of stop losses get triggered.  This makes for a very risky and potentially very lucrative trading experience. 

At current coffee futures prices, and at current margin requirements, it would be unwise to trade a single futures contract in this market with less than $20,000 starting capital, or a good deal of experience with technical analysis and stop losses.  Coffee is a very difficult market to step into for the long haul without allowing for a good deal of price fluxuation.  Having a stop loss less than 10 cents below your entry point will create a high probability of getting stopped out on a small decline, which will shake you out of your position, and having a stop loss of greater than 10 cents gives a pretty poor risk to reward ratio.  So if you want to attempt coffee futures trading start by paper trading or taking small positions with strict adherence to your trading system.

Before I get into the many reasons Coffee Futures are the single Best Investment in Commodity Trading for 2009, let me begin by saying that futures trading is not easy.  Below I give you the why, not the how, to own coffee in the coming year.  In follow up posts I’ll talk to more specific strategies, including coffee futures trading, coffee options investing, and commodity etfs that a novice can use to invest without risking the farm…or in this case, the plantation.  On to the Glory.

I am not a waffler or your typical investment news reporter.  You know the type with their half hearted price projections and potentialities.  These jokers flood the news with crap like “Coffee futures could rise 15% in 2009 due to supply problems” or “The best investment for 2009 may very well turn out to be coffee.”  If you’re anything like me than you hate this garbage.  It elicits an immediate emotional response…hope, greed, without containing any real substance.  Well let’s discuss the matter like courageous adults or confident gamblers shall we and put your money where my mouth is.  Coffee futures are going to record highs before December 2010, and people will look back on January 2009 prices as being dirt cheap.  Mark the time of this posting, the end of January 09, with futures prices around $1.20, as the beginning of the largest bull market coffee has ever seen.

Coffee has a unique story to tell.  While virtually every other commodity is experiencing a moderate to sharp cutback in demand due to the global financial and now economic crisis, coffee has been one of the few beneficiaries of gloom.  Fortunately for coffee producers, and even more fortunate for coffee futures traders, coffee consumption rises when the world is stressed out, depressed, and nervous.  Coffee consumers cutback on their Starbucks frapolates and start buying Maxwell House for a morning cup of joe at home.  This is bad for Starbucks, but good for coffee futures prices. 

I don’t know about you, but when I make coffee in the morning I make a mess.  And judging by historic at home use patterns, more coffee is consumed, wasted, and dumped down the drain due to the inefficiencies of at home brewing.  But is this enough to make coffee futures the single best investment in commodity trading this year?  Not by itself, no.  Coffee demand has been on a constant rise every year for nearly two decades.  And so has supply for that matter.  The caveat here, however, is that coffee production has not kept pace with consumption, and we’re facing at present a perfect storm for coffee futures prices.

Before we tackle the reasons for coffee’s imminent rise, let’s quickly look at some of the long term factors contributing to this coffee crisis.  Coffee, like every other commodity since 2001, is experiencing rising demand due to the rapid growth of China and India.  I currently live in Shanghai and I can tell you first hand the rate at which the Chinese are embracing coffee culture in what has traditionally been a nation of tea drinkers is astounding.  Even in every second and third tier city in China you’ll have no trouble finding a decent cup of joe.  On top of that, consumption in producing nations like Brazil, Vietnam, and Columbia, the three largest producers of the commodity, have made great progress in augmenting local demand.

On the production side we have a few key factors converging.  Coffee is a cyclical crop.  Every other year leading producers turn out massive crops which have set world records consistently for many years now.  And every other year coffee trees produce smaller crops while they rejuvenate, having exhausted themselves the previous season.  We are currently at the half way point between the larger production cycle of 2008-2009 and are entering the cyclically smaller harvest cycle of the 2009-2010 season, which kicks off in Brazil around June, give or take. 

Normally the smaller of these production cycles would force producers to draw from stocks (reserves) created during the larger seasons to meet demand, in full knowledge the following season would replace, if not add to, present stock levels.  But the rate of change in demand has exceeded the rate of growth for supply for many years now, and producers have been selling from reserves into gradually rising prices to both meet world demand and to bank a little extra coin. 

What makes this situation dire is the degree to which stocks have dwindled, and more importantly, dwindled in respect to world consumption.  Let’s look at a few numbers here from the International Coffee Organization borrowed from Daily Futures .com:

What should be clear from the above is that for the last 7 years coffee stocks in both on and off years have been at lower levels than their prior biennial ending stock number despite the fact that production numbers have risen significantly.  Furthermore, the stocks to usage ratio, currently at 13% for 2009, is sure to be much lower in 2010, as soon as what at present looks to be an impending shortage to the tune of 10 million bags for the coming season is factored in.  Even without this impending 10 million bag deficit, a stocks (in producing countries) to usage ratio of 13% is the second lowest on record.  What will a loss of 10 million bags do to that ratio?

Now add to this tight fundamental situation the impact of the global financial crisis.  In November coffee futures fell with the herd, the proverbial throwing the baby out with the bathwater if you will.  In a better year the coming shortage of coffee would have begun the pricing in process already.  But money was pulled from everything, stocks, commodities, real estate, in an all out panic.  This pulled coffee from its comfortable range in the $1.40’s down to a low of $1.02. 

The impact this is having on farmers is an inability to secure loans to carry stock forward.  They sold into the declines and pushed prices further along with all the hedge fund managers who were crapping themselves.  In conjunction with this fire sale in coffee, and everything else, fertilizer costs are and have been through the roof, and crop care in producing countries has slipped considerably.  The combination of a lack of funding to hold back product, and a lack of funding to take care of crops is turning out to be the straw that broke the camel’s back.  This market is ready to pop.  Why now you ask?  Perhaps the economic situation is more poignant than I’m willing to admit?  I’m glad you asked.

As I mentioned earlier, in a normal year, a production deficit would be priced in in advance of the smaller harvest.  Coffee futures prices are seasonally driven, typically rising from October through May, crashing in June, and bottoming in July or August.  We saw this phenomenon clearly in 2004 when prices rose from around 70 cents in October to around $1.40 by March of 2005.  And again last year we saw prices bottom in July of 2007, rise gradually through the end of the year, and explode in February to a high of around $1.70.  We are finally through the worst of the financial crisis. 

Coffee is starting to behave more independently.  And we are through the peak of the Vietnamese and Columbian harvests.  But due to a smaller crop out of Vietnam, and a much smaller out of Columbia, the coffee pipeline is beginning to show extreme tightness and delays are occurring in Central and Aouth America.  And as the indelible law of supply and demand dictates, when you have more demand than exists supply, prices must rise until a new supply and demand equilibrium is found.  How high is that you ask?

Jim Rogers, that infamous commodities investor has said that during a commodities bull run, every commodity reaches a new all time high.  We have seen that already in gold, crude oil, soybeans, corn, wheat, copper, platinum, lead, and several others.  Crude, Corn, and Wheat, having had some of the tightest supply and demand fundamentals did not merely reach new highs; they destroyed previous records to the tune of 100 to 300%. 

Coffee has a very similar fundamental setup to that of Corn from 2005 before it quadrupled in price.  Look for Coffee to climb well above its historic high in the $3.50 range into uncharted territory.  And look for it to do so before December of 2010.  That’s a 300% rise.  And that’s a ton of profits for anyone in the futures or options game.  Good trading to you and let’s bank this one together.  Stay tuned for updates and trading strategies for coffee futures, the single best investment in commodity trading!