By Mark Shore, Founder www.shorecapmgmt.com
We drink it every day; we love the flavor in various foods and beverages, we use it to wake up in the morning and we “grab” a cup for meetings. Coffee also known as Coffea, is one of the largest commodity markets in the world, but what do we really know about it?
It is believed coffee plants originated in the Ethiopian province of Kaffa. By the 15th century, via the port of Mocha, coffee was cultivated in Yemen. By the late 1600’s coffee was discovered by consumers around the world with the Dutch often given credit for introducing the product to various countries. By the 1830’s Brazil became the largest producer of coffee. By the early 1900’s Colombia became a global producer. The opening of the Panama Canal was influential to Colombia’s exporting.
According to the Commodity Research Bureau Yearbook, Puerto Rico and Hawaii are the only two areas of the U.S. for sizeable coffee production. It is a slow production cycle as the coffee plant will not produce the first full coffee bean crop until it is five-years old. After 15 or 20 years the plant loses productivity. In an average year, a coffee plant produces enough beans to make an estimated 1 ½ pounds of roasted coffee. Interesting to note, wine was the first known drink made from coffee cherries, honey and water.
In some less developed countries, coffee exports may account for more than 50% of the country’s foreign exchange earnings. In some coffee producing countries, the product is considered second in value only to crude oil as a source for foreign exchange. A few historical notes; the Boston Tea Party was planned in a coffeehouse, the NYSE, the Bank of New York and London Stock Exchange began in coffeehouses.
In 1882 coffee futures began trading on the New York Cocoa Exchange. Later part of the New York Board of Trade and acquired by the Intercontinental Exchange (ICE) in 2007. Arabica coffee futures are traded in NY and at the Brazilian BM&F Bovespa. Robusta contracts are traded at the NYSE-LIFFE London exchange. Spreading strategies of the contracts are common between these exchanges.
Chart 1: NY Coffee (KC) monthly nearest futures contract basis May 2014 from February 1989 to February 2014.
Chart 1, contains the monthly nearest futures prices over the last 25 years of New York Arabica coffee. As noted, the volume and open interest continues to increase, especially since 2002. Coffee, similar to other commodity markets is a mean-reverting market. It tends to rally to quick spikes of high prices and then gradually falls back to an average or equilibrium price. 2014 started the year with a rally. As of February 13, 2014 Coffee is up 26.2% in 2014.
According to the International Coffee Organization, Coffee is part of the Rubiaceae botanical family. Arabica coffee (about 60% of world production) and Robusta coffee, economically are the two most important of at least 25 known species of coffee. Lesser known and grown on a smaller scale are Libercia coffee and Excelsa coffee. Coffee plants cover the spectrum from small shrubs to large trees. The leaves tend to be dark green, yellowish, bronze or with some purple.
Table 1: Lists the top 10 countries of coffee production 2010—2011 crop year, ranked by thousands of bags. One bag weighs 60 kilograms (132 pounds).
Source: Bloomberg News http://www.bloomberg.com/news/2011-08-19/world-s-top-10-coffee-producing-countries-in-2010-2011-table-.html and USDA
After viewing Table 1, you may ask yourself, I hear the terms Arabica and Robusta all the time, and drink it often, but what is the difference? Arabica and Robusta were first described about 1753 and 1895 respectively. Robusta plants tend to be more resistant to disease than Arabica.
The Arabica coffee plant tends to be a large-sized bush with dark green oval leaves and oval fruit. The flat seeds inside the fruit are the coffee beans. The plants are commonly grown in Latin America, Central and East Africa, India and to a lesser degree in Indonesia. The Robusta plant may be either a shrub or a small tree. The fruits are rounded and the seeds are oval. Robusta is commonly grown in West and Central Africa, South-East Asia and to a lesser degree in Brazil.
Table 2: Lists the differences between Arabica coffee and Robusta coffee
Table 3: Top 7 countries and regions of coffee consumption and import in the 2012/13 crop year
Source: USDA http://apps.fas.usda.gov/psdonline/psdHome.aspx
As noted in Table 3, the largest consumers of coffee tend to be the largest importers. They will import about as much as they consume each year. Any negative supply shocks will likely influence an upward price movement. Many commercial distributors of coffee, such as retail stores tend to hedge in the futures or forward markets to reduce commodity price risk.
Chart 2: Coffee production and exports from 1979/80 to 2012/13 crop year per thousands of bags
Chart 2 demonstrates both coffee production and exporting is growing over the last three decades, especially in the last 10 to 15 years. As long as consuming countries are importing similar numbers as they are consuming, it causes constant pressure for exports to be maintained and for commercial end-users or distributors to hedge their commodity price risk.
The next time you sit down for a cup of coffee, or “java” or “joe” with some friends, you can discuss how this simple drink is such a meaningful commodity both in history and to several producing countries.
Copyright ©2014 Mark Shore. Contact the author for permission for republication at email@example.com Mark Shore has more than 25 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. His research is found at www.shorecapmgmt.com
Mr. Shore is also an Adjunct Professor at DePaul University's Kellstadt Graduate School of Business where he teaches a graduate level managed futures/ global macro course. He is a board member of DePaul University’s Arditti Center for Risk Management and a frequent speaker at alternative investment events. He is a contributing writer for the Eurex Exchange, CBOE Futures Exchange, Reuters HedgeWorld, Yahoo.com, Examiner.com and Micro-Cap Review.
Prior to founding Shore Capital, Mr. Shore was Head of Risk for Octane Research Inc ($1.1 billion AUM) in NYC, where he was responsible for quantitative risk management analysis and due diligence of Fund of Funds. He chaired the Risk Management Committee and was a voting member of the Investment Committee.
Prior to joining Octane, he was the Chief Operating Officer of VK Capital Inc, a wholly owned Commodity Trading Advisor unit ($250 million AUM) of Morgan Stanley. Mr. Shore provided research and risk management expertise on portfolio construction, product development and business strategy. Mr. Shore graduated from DePaul University with a degree in Finance. He received his MBA from the University of Chicago.
Past performance is not necessarily indicative of future results. There is risk of loss when investing in futures and options. Futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone. The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.
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