How Speculative Selling Could Provide Opportunities for Coffee Buyers
PublishedFeb 9 2024
Raw material prices in the food and beverage sector have caused consistent challenges for companies over the past few years. In 2021 and 2022, grain markets hit record highs on the disruption to global supply chains caused by adverse weather, pandemic-induced production backlogs and, most notably, Russia’s invasion of Ukraine. However, wheat and corn prices have calmed over the last year and the soft commodity complex has since taken up the mantle of headline-worthy price rallies. As companies seek to mitigate the impact of record prices and protect their bottom line, this week’s article looks at how the behaviour of commodity speculators can provide a leading indicator as to when an opportunity could arise for buyers.
The Role of Speculators
Commodity market speculators often hold a negative reputation, particularly during periods of extreme price volatility as they can be portrayed as profiteering at the expense of producers or consumers. However, they provide a vital role in commodity markets through providing liquidity, aiding price discovery and reducing the risk of market manipulation by dominant producers. As noted by Andrew Hecht in an evaluation of their impact on commodity markets, most speculators “constantly monitor and analyze the fundamental and technical factors affecting the markets in which they trade”.
For manufacturers, the fundamental supply and demand of their required raw materials will always be the most important factor to monitor so as to keep their production line moving. However, the remit of a procurement or risk management professional within an enterprise company is more varied than that of a commodity trader, and as such they cannot afford to spend the same amount of time monitoring every factor which may impact their supply chain costs nor do they typically have access to the kind of state of the art AI driven market assessment tools and information as their counterparts on commodities trading desks. As such, the behaviour of speculators can signal information about future supply and demand conditions, as well as directly affecting the price, meaning they can provide a useful resource with which to anticipate future market movements.
Windows of Opportunity
Cocoa prices have experienced a relentless rally over the past 18 months, with only a handful brief periods of downward movement before the upward momentum resumed. Indeed, prices for ICE New York cocoa futures recently eclipsed the all time record high, set in the late 1970s, while the London cocoa market has been consistently breaking and resetting its own record level. In the context of a once-in-a-generation rally, every period of declining prices provides a crucial opportunity to secure coverage for cocoa buyers.
In late February 2023, the International Cocoa Organization (ICCO) published its latest Quarterly Bulletin of Cocoa Statistics which predicted that the cocoa supply deficit in the upcoming season would be reduced from the previous season. In the following week, money managers reduced their net-long position on New York cocoa futures by over 60% as prices came down by 7% in the first half of March, exemplifying the intertwined nature of speculative money and fundamental narratives. By the week ending March 28th, however, a similarly dramatic reversal had occurred as the market narrative became increasingly bullish again and prices have barely looked back down since.
A similar effect occurred in the sugar futures market in late November 2023, as shown in the graph above. By the final quarter of last year, sugar had climbed to 12-year highs on expectations of a significant supply deficit. However, rainfall brought relief to key production regions in Brazil and crop estimates were subsequently raised, leading to a rapid price fall. Between the COT reports of November 28th and December 5th money managers reduced total long positions from 205,669 to 159,566, a decline of approximately 22%. During the same time period, the price of sugar fell by 7.5%, however it would go on to fall by more than 15% in the subsequent three weeks. As such, the rapid sell-off by sugar speculators in the first week of December provided a leading indicator of further price falls to come.
One market to watch for a similar effect in the near future is robusta coffee futures. Robusta beans face supply shortages owing to the impact of dry weather in key production regions, such as Vietnam and India, caused by the El Nino weather phenomenon. As a result, robusta futures posted an all-time high in January 2024 and the market is closely watching for any reports of changes to the supply outlook. The graph below shows that speculators currently hold a significant net-long position on robusta futures. A reduction in this net-long position could provide pricing relief to coffee buyers at enterprise companies, and this situation is one to watch this quarter.