Supply Shock May Caffeinate Coffee ETFs

As the demand for coffee continues to remain insatiable, an imbalance in supply and demand is likely to bolster the price of the soft commodity.

Over the past two decades, the cumulative net deficit for coffee have been satisfied by Brazil’s buffer supply, however, as this supply depletes, there just may not be enough coffee around the world to satisfy demand.  Additionally, reserves held by private roasters are starting to dwindle down as well, as that they are near record lows in terms of historical stock to usage ratios.   In fact, according to the ICE, inventories of coffee have fallen to an 8-year low.

To further add to the supply woes faced by the soft commodity, weather conditions have taken their toll on production.  In Colombia, humid and damp weather is expected to result in curtailed production in the world’s third largest supplier of java.  Severe weather conditions are also effecting production in Africa, as Uganda, the biggest exporter of coffee in the continent, is witnessing a drought which is destroying coffee crop.   

In a nutshell, the rate of change of worldwide consumption of coffee has exceeded the rate of change of production, resulting in a supply and demand imbalance and paving the road to positive price support for the soft commodity.

Some ways to play the coffee market include:

  • iPath Dow Jones-AIG Coffee ETN (JO), an exchange-traded note linked to the Dow Jones-UBS Coffee Subindex Total Return.  JO closed at $46.50 on Monday.
  • PowerShares DB Agriculture (DBA), which allocates nearly 13.9% of its assets to coffee futures contracts.  DBA closed at $25.85 on Monday.

Although supply and demand imbalances indicate that positive price support for coffee is prevalant, it is equally important to consider the risks involved with investing in such a commodity.  To mitigate the downside risk, the use of an exit strategy which identifies specific price points at which an upward trend is coming to an end is important.

According to the latest data at www.SmartStops.net, these price points are as follows: JO at $45.07 and DBA at $24.00.  These price points change on a daily basis and are reflective of market conditions.

Disclosure: No Positions

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