How High is High?

The coffee market had accelerated to the upside and punched through $3.00 per pound for the first time since May 1997 but has since backed off the recent highs. As much as the fundamentals hold promise to become even tighter in 2011-12, the off year for the Brazilian crop, at some point it becomes time to recognize that all the bullish fundamentals are already reflected in the price and look beyond to what will happen next. Bull markets generally die fast and usually sooner than many care to recognize. One need only look at the other soft commodities (sugar, cotton, and cocoa) to see how quickly markets can turn and go from raging bull to bearish in a flash.
There are some seasonal factors that suggest the bull’s life expectancy is running short as well as some other telltale signals. The trouble is that that the Brazilian winter is just ahead, where there is always a risk that the world’s largest supplier may have a cold front push north from Argentina and cause frost damage to the more southerly coffee regions of Brazil. The last severe frost was in 1994. The earliest recorded frost was on May 30th, back in 1979. The likelihood of a frost is rather slim. Much of the traditional cold pockets in Parana State no longer even grow coffee. Immediately following the Brazilian winter is when the market will watch for timely rains that will promote the blossoming of the 2012-13 crop. While the upcoming harvest is the off year and will not be sufficient to meet domestic needs as well as international demand for Brazilian coffee, the following crop could be a “monster” and the market will be faced with the potential threat of turning from one of shortage to surplus.  This could take some of the steam out of the bull market.
As the market has risen it has become more difficult for producers to actually sell their coffee because the trade is reluctant to take on new commitments with the possibility of explosive action and the burden this would place on their finances to meet margin calls on the short hedged position. Roasters are reluctant to add coverage at these higher levels and that is making trading conditions thinner and potentially more volatile. In most bull markets, a signal that the end is near, is when the open interest or the number of outstanding positions starts to drop but prices rise on short covering, usually panic type buying. Most explosive bull markets have very little to do with speculators running amuck and creating the wild trading behavior that drives prices sharply higher.
There are other signals to watch as well for signs the bull move may be ending. Certified stocks had been fiercely dropping when supplies were tight and roasters were forced to turn to the coffee that has been graded for delivery against the New York “C” contract, but of late, there has been a steady influx of coffee being graded and certified.  It shows that for right now, the spot market demand is being satisfied and the Board is perhaps becoming an attractive buyer of coffee once again, because it is becoming difficult to place the coffee elsewhere. The tightness could easily reassert itself though if the Brazilian harvest is disappointing or Colombia continues to have weather related difficulties.
USA Coffee Stocks Starting to Creep Up Again