“Cold” Coffee A Treat For Bulls

Coffee traders received another morning jolt, as frost fears have surfaced in the southern Brazilian growing region. This comes on top of other potentially bullish fundamentals, such as a smaller than expected crop in Columbia, a weak U.S. Dollar vs. the Brazilian Real, and lower estimates for the 2009-10 Coffee harvest in Brazil. These factors have contributed to Coffee futures reaching highs not seen since September of last year. Traders and analysts were expecting a poor crop out of Columbia, a major coffee exporter, but the extent of the drop has surprised the trade, with April 2009 production falling to a mere 345,000 bags. This has caused cash premiums to rise, as current inventories remain very tight. In Brazil, the rising Real vs. the U.S. Dollar has kept origin selling light, as producers are holding inventories looking for higher prices in the coming months.

Brazil is the largest producer of Arabica Coffee, and market and growing conditions there are widely watched by traders looking for the direction of the Coffee futures market. Brazilian Coffee production for the 2009-10 marketing year is forecast at 43.5 million bags, down 15% from last year, as the Coffee trees are in the downside of their biennial cycle. This lower production estimate has heightened any concerns about weather conditions, so it should come as no surprise that traders responded bullishly to the recent potential frost threat. Coffee has historically been a very volatile market, and any potentially serious weather concerns could move prices sharply. One just has to look back at historical charts to see large price spikes higher, with prices moving over the $3 per pound level at the extremes. Though it is way too early to predict whether Coffee prices could hit anywhere near these extreme levels this year, it should give one a reason to pause before trading on the short side going into the South American winter.

Trading Ideas

Given the potentially volatile nature of the Coffee market, some traders may want to look at the Coffee futures options market for potential trading ideas. Since Coffee options are relatively expensive, a trader with a bullish slant may possibly wish to explore Coffee bull call spreads. An example of such a trade would be buying a September Coffee 160 call and selling a September 200 Call. With September Coffee trading at 143.70, the spread could be bought for about 5.50, or $2062.50 per contract, plus commissions. This would be the maximum risk on the trade, with potential profit of $15,000, minus the premium paid if September Coffee is trading above 200.00 at the option expiration in August. A more aggressive trader may potentially wish to sell a put below the major support area around the 115.00 level. This will increase the downside risk to the trade, but the premium received will help to offset the cost of the bull call spread.

Technicals

Looking at the daily chart for September Coffee, we notice prices moving sharply higher at the start of May and accelerating to the upside once we had a weekly close above the widely-watched 20-day moving average. Volume has also increased lately, but some of the increase is due to traders rolling their positions over from the July contract. The most recent Commitment of Traders report shows large speculators added an additional 4,560 net long contracts, to stand at 30,474 contracts as of May 26th. However, this position is still well below record levels seen last year and still provides some room for additional long positions to be added without the market becoming too overbought. The 14-day RSI is well into overbought territory, with a current reading of over 80. This may signal that a price correction is overdue, especially if weak longs exit the market on any minor pullback. 150.00 is the next psychological resistance point for September Coffee, with major support seen near the 115.00 area.