Volatile prices make the coffee market an attractive arena for trading. However, downside risks currently dominate, experts warn.
Investing in coffee is currently paying off: the Bloomberg Coffee Index has risen 44 percent this year through early December and is trading at a record level. According to Darwei Kung, head of commodities at DWS, the rally began several years ago after exceptionally dry periods, particularly in Brazil, Vietnam, and Indonesia. These countries rank among the world’s most important coffee producers, increasing concerns about future supply. ‘In addition, US trade tariffs on Brazilian coffee, the largest producer of Arabica, have pushed prices even higher,’ Kung said.
This is now the fifth consecutive year in which the market has faced shortages, and never before have those deficits affected both Arabica and Robusta. The high prices reflect this tight market, but Kung expects coffee prices to decline over time. ‘Traders will want to take advantage of current price levels and sell inventories built up earlier. Moreover, the drought in Brazil has ended, and there are signs that harvests could recover strongly in a few years.’
Even so, several good harvest seasons will be needed before the market returns to balance, he warned. The coffee sector remains highly dependent on weather conditions, making the outlook uncertain. ‘Climate change has structurally affected the coffee market, but the precise consequences are still difficult to assess,’ Kung said.
Over the longer term, the commodities expert does expect greater stability due to broader diversification in production. ‘Output in Costa Rica, Colombia, and several Asian countries appears to be increasing, which could offset disappointing harvests in Brazil and Vietnam.’
Hog cycle
Consumption growth in recent years has come mainly from Asia, but demand there is now declining due to high prices. In other regions, consumption remains fairly stable. Kung does observe that consumers are increasingly substituting more expensive Arabica with the cheaper Robusta segment. According to him, this shift is likely to persist for the time being, partly because the price gap between the two bean varieties has widened to 1.30 dollar due to the weak Brazilian harvest, almost double the historical average of around 70 dollar cents.
Kung views the coffee market primarily as a domain for active traders and currently maintains a neutral position. ‘We expect better harvests to eventually make the market more ample and put pressure on prices. We also think the price gap between Arabica and Robusta will gradually return to normal levels.’
According to Paul Jackson, a strategist at Invesco, coffee is a niche market for specialized traders. ‘Because the real coffee price has shown no clear trend for decades, it is a market suited to short-term trading. In addition, some investors deliberately avoid agricultural commodities, partly for ethical reasons. They fear that their participation could drive prices even higher, a sentiment that is particularly prevalent among European investors.’
Current high price levels make him cautious. Agricultural markets typically follow a classic hog cycle, he explains. Higher prices stimulate additional production, while demand tends to fall. This ultimately results in a surplus and lower prices, after which the cycle begins again. ‘Given the current situation, it seems likely that supply will increase and coffee prices will weaken again later on,’ Jackson said.
He points to the real price of Arabica, adjusted for US inflation, which based on data since 1985 stands about 67 percent above the long-term average. ‘Although coffee has occasionally been even more expensive in the past, that rarely happens. This leads me to suspect that the price is excessively high,’ Jackson said.
Disruptions
Looking further ahead, Jackson sees several structural factors that could either strengthen or restrain the coffee market. Climate change tops the list. ‘As weather becomes more extreme and unpredictable, droughts like those in Brazil are likely to occur more frequently, leading to temporary supply shocks and greater price volatility.’
In addition, global warming could significantly alter the geographic distribution of coffee production. ‘Which regions will ultimately gain or lose production capacity is difficult to predict, but shifting production zones could lead to temporary supply disruptions, especially when traditional producing areas face declining yields,’ Jackson said.
Demographic trends and the continued spread of coffee drinking could also support demand and thereby provide a tailwind for prices. Still, he tempered that effect. ‘Global population growth is slowing and is increasingly concentrated in Africa, where coffee consumption has traditionally been low. As a result, this impulse is likely to be smaller than in previous decades.’