06 September 2016 at 9:30 GMT
- Rounded-bottom formation in coffee indicates upside swing
- Robusta coffee has led move but Arabica could be set to follow
- Arabica could potentially move to 182 cents/lb
- Likely shortfall in 2017 supply underpins case for stronger coffee market
Who isn't partial to a cuppa as a mid-morning pick-me-up? Photo: iStock
By Ole Hansen
After having consolidated for the past 18 months, Arabica coffee is beginning to show signs of life once again. The monthly chart below shows how Arabica has been forming a rounding bottom during this period.
Rounding bottoms are found at the end of extended downward trends and signify a reversal in long-term price movements. The creation of a rounded bottom often takes several months and once a breakout occurs it tends to translate into a new upward trend. Is coffee's rounded bottom pointing towards an upside break?
Source: Saxo Bank
Robusta coffee has been the main engine behind the recovery in coffee during the past couple of months. Adverse weather in Vietnam, the world's largest grower, and Brazil has seen the price recover strongly. While the US market was closed Monday, the most active traded Robusta coffee contract traded hit a fresh 18-month high in London.
While the recovery in Arabica coffee has taken much longer, the chart below shows how Robusta went straight from a bear into a bull market earlier this year. Since the low in February it has rallied by 44% and in the process retraced more than 61.8% of the 2014 to early 2016 selloff. During the week ending August 30, hedge funds increased bullish bets by 11% to 26,665 lots, the highest since October 2014.
Robusta coffee has been the star performer of the two major coffee varieties
Source: Saxo Bank
Arabica coffee looks set to challenge 154.75 cents/lb which represents the 38.2% retracement of the above mentioned coffee selloff.
A break above 154.75 cents/lb could trigger the completion of the rounding bottom mentioned earlier. This would likely trigger an upward reaction initially to 168.25 cents/lb but potentially to 181.75 cents/lb and beyond.
Arabica ready to challenge 154.75 cents/lb
Source: Saxo Bank
Hedge funds are currently holding a net-long position of 32,000 lots, just shy of the recent peak of 36,000 seen during the week of July 19. When the priced peaked back in 2014, the net-long stood some 36% higher at 50,000 lots.
The latest jump in prices was triggered by data showing a slump in world exports which helped increase the focus on the potential for tightening supply. In Brazil there has been growing talk that frost conditions may have damaged trees. This has raised concerns that the 2017 harvest could be weaker than expected.
The International Coffee Organization last week released data that showed world coffee exports tumbled by 22% in July. With the drop explained by weaker supplies rather than a slowdown in demand, the market will increasingly be asking where supplies are going to come from over the coming months.
This leads us to the interesting observation that coffee producer and merchants currently hold a net-short position of 76,000 lots. The last time such an extended short was held was back in 2014 when the price of Arabica was trading north of 200 cents/lb. Data also shows that the number of coffee bags held at warehouses certified by the ICE futures exchange has fallen to the lowest since 1999.
— Edited by Martin O'RourkeOle Hansen is Saxo Bank's head of commodities strategy