Coffee - better fundamental factors, weak BRL

 

We saw a big improvement in the coffee markets last Wednesday. The prices of both Arabica and Robusta have reached multi-month highs. On the other hand, we saw a continuation of the weakness of the Brazilian real, which started at the end of July and intensified in the middle of last week.

 

 

In the case of fundamental factors, however, we have definitely better news. The ICO changes its forecasts and expects a large deficit on the market this season. The 2019/2020 season (October-September) will bring a decrease in coffee production to 168.006 million bags (-2.9% y / y). In turn, consumption will increase by 0.3% YoY to the record level of 168.492 million bags. Therefore, the deficit is expected to be almost half a million bags! This is a huge change, taking into account last year's surplus of 5.136 million bags and the June projection when the ICO expected a surplus of 1.85 million bags. Of course, these are still projections, but in real terms, we observe the surplus of demand over supply through the decline in inventories on the stock exchanges. Inventories monitored by ICE dropped to 1.5 million bags for Arabica (3-year low), while Robusta stocks dropped to a 1.5-year low.

 

 

What about other factors? It turns out that the weather factors are not very favorable in the two most important coffee producing countries in the world - Brazil and Vietnam. Vietnam recorded a double-digit decline in exports (more importantly, Vietnam is the producer of Robusta, coffee which is mainly used in homes in the form of instant coffee, i.e. the one for which demand has not suffered during the pandemic, but has also benefited). In contrast, in Brazil, in the Minas Gerait area, current rainfall has fallen to 2% of its historical value.

 

 

Of course, not all factors support a further rebound in coffee prices. Before we move on to the most important one, it is worth mentioning two others. The weather in Colombia is currently very good, leading to an increase in coffee production prospects. Exports are growing on an annual basis in this country. Importantly, this country mainly produces Arabica, i.e. coffee used primarily in the restaurant sector. The second thing is coronavirus. The continued spread of the pandemic is not very good for the demand outlook, mainly for the restaurant sector. It turns out that demand did not suffer much during the pandemic, mainly due to the change of place of consumption from cafes / restaurants to homes, although it is worth mentioning that in this case such a change is primarily good for Robusta. Interestingly, Fitch believes that the increase in consumer spending on coffee this year will amount to 5.8% y / y with the 5-year average of 1%.

 

Real is currently the biggest threat to the coffee price rally. The weakening of the real makes exporters willing to sell off coffee - the price in dollars (relatively) does not change, and the transaction is settled in this currency. There are opinions that with the real appreciation against the dollar this year, there is a chance that the price will exceed $ 2 per pound! This forecast, however, seems somewhat cut off from reality. Fundamental factors do not support such a monstrous price rebound. Such a forecast would require a significant reduction in supply in the form of an enormous drought or disease (such cases have happened in previous years) or a huge increase in the value of the real. A price of $ 2 per pound would require USDBRL around the 3.00 level.

One can see a huge divergence in the short term between the coffee and the reversed USDBRL pair. Moreover, the weekly chart shows a clear supply signal in the form of a long wick of the candle from the previous week. It is currently visible that coffee may be under pressure in the short term, but in the longer term there are potential prospects for further strengthening. Source: xStation5