Brazilian Dry Spell Stirs Coffee Prices

By Leslie Josephs and Alexandra Wexler
Wall Street Journal February 4, 2014
Coffee futures staged their biggest rally in eight years Monday amid worries that abnormally dry weather in Brazil would hurt the country’s crop.

The dry spell in Brazil, the world’s biggest producer of coffee, has forced manytraders to rethink their coffee forecasts. In November, many analysts had forecastthe Brazilian crop would be a record for the third consecutive year.

Since hitting a seven-year low of $1.0150 a pound in November, coffee prices in the $7 billion futures market have shot up 34%. Prices rose 8.6% Monday to $1.3595 on the ICE Futures U.S. exchange, the highest settlement since May. The contract posted the biggest one-day percentage gain since September 2005.

Dry weather—rainfall in Minas Gerais, the top coffee-producing state, was 60% below normal in January—comes at a bad time. Fruit on coffee trees, which surrounds the beans, still are just maturing.

The price jump underscores Brazil’s importance as a commodities producer. Huge harvests drove down prices for commodities ranging from sugar to coffee to oranges in the last two years. Now, those markets have bounced off recent lows, as less than ideal weather conditions dented supply forecasts.

“There are really two things that move coffee—a drought and a freeze; those are the two big wild cards,” said Fain Shaffer, president of Infinity Trading Corp., an Indianapolis brokerage. “I wouldn’t be surprised to see some really wild swings.”

He said prices could reach $1.50 a pound and has placed options bets that would benefit from rising prices.

The arabica-coffee market has seen a particularly sharp turnaround this year. Prices dropped 23% last year after investors bet on oversupply. Since Jan. 28, prices have gained more than 19%, the largest five-day percentage gain since October 2002.

Higher coffee-futures prices can take months to drip down to consumers’ cappuccinos. Roasters often buy coffee long before the beans are harvested, so many will be working through cheaper supplies for months. Plus, beans are only part of the cost that coffee drinkers pay. At Starbucks stores, for example, coffee represents just 8% to 10% of a café’s operating expenses, the company has said.

Money managers have held a net-short position in arabica coffee since July 2012 as supplies of the beans outstripped demand amid back-to-back bumper harvests in Brazil. During the week ended Jan. 28, they had placed 7,023 more bets that prices would fall than rise, the most since the week ended Dec. 31.

The dry weather is encouraging some investors to cover those bets and then buy even more futures, Mr. Shaffer said.

Since the year began, investors added $25.23 million to the iPath Dow Jones-UBS Coffee Total Return ETN, an exchange-traded note that tracks coffee prices, said ETF.com, a research and analysis firm. The product was up more than 7% Monday.

Some investors took profits from the move higher. Seamans Capital Management LLC, which has about $150 million under management, bought shares in the iPath ETN between August and November. The fund liquidated its entire position Monday.

“We like the fundamentals of coffee, but when it jumps like this, we’re happy to take our profits and reset,” said Richard Seamans, the firm’s chief investment officer. Mr. Seamans plans to buy the coffee ETN again if futures fall below $1.10 a pound.

It was the hottest January on record for parts of southern and southeastern Brazil, Somar Meteorologia in São Paulo said. Rain isn’t likely to fall in Minas Gerais state, which produced about 72% of Brazil’s coffee last year, until mid-February, said Patricia Vieira, a meteorological technician at Somar Meteorologia. The arabica-coffee harvest will begin in late April or early May.

Conab, the government crop agency, expects this year’s coffee crop to range between 46.5 million and 50.2 million bags, based on estimates released in early January. Others have given different estimates, and some analysts say it is too soon to known by how much the lack of rain will reduce the size of the crop.

Some forecasters had predicted Brazil’s harvest would be as high as 60 million bags. Bags are the standard measure of volume and on average weigh about 60 kilograms each. One bag of coffee yields 7,500 shots of espresso. “This changes the bag-count idea,” said Sterling Smith, a futures specialist at Citigroup in Chicago. “If the dryness persists, the 60 [million-bag estimate] is obviously off the table.”
—Jeffrey Lewis contributed to this article.