Let Coffee Give Your Portfolio a Mid-Year Kick

by Tony D'Altorio

Let Coffee Give Your Portfolio a Mid-Year Kick

by Tony D'Altorio, Investment U Research

Thursday, June 17, 2010

Most people don't think about it as they pour themselves a good morning cup of joe, but coffee can be a major moneymaker.

Akin to oxygen for some, the steamy, black beverage is practically recession proof. Just ask anybody in North America and Europe. People consume a third as much coffee as they do water on both continents.

Naturally, that makes for one very important global business. Worldwide, some 25 million small producers rely on coffee for a living.

Unfortunately, many of those 25 million small producers don't have it very easy right now. Their troubles are pushing up coffee prices, even while other commodities continue to struggle this year.

So far, the bean has hit its highest price in over a year...

Coffee 101

Caffeine connoisseurs have a vast array of flavors to choose from. But there are only two types of coffee beans globally traded on the futures market.

  • The first kind, the lower quality robusta coffee bean, mainly ends up as instant coffee. It trades on the London International Financial Futures and Options Exchange (LIFFE).
  • And then there's arabica, which makes up over 60% of global coffee production. Investors can find it on the New York Board of Trade, or NYBOT.

As for its places of origin, nearly 50% of all coffee production comes from Brazil and Vietnam. While the former has long been the world's leading java source, Vietnam has become an increasingly important player in recent years. Today, it grows the largest amount of robusta beans.

But both countries are experiencing supply problems. And that has sent the price of coffee soaring on the futures markets.

Oh Coffee, Where Art Thou?

Last week saw coffee behaving more like jumping beans. The July contract on robusta rose as much as 18.2% for the week, while arabica futures gained 11%.

That gave traders in the traditionally sleepy, niche commodity a real jolt. The Financial Times even quoted one trader as noting "a sense of panic around."

The thing is, that panic could have been avoidable. But the commodities market is notorious for its misplaced optimism. So it comes as no surprise that the coffee outlook doesn't look as appetizing as first predicted.

According to the International Coffee Organization (ICO), global coffee output came in at 128.1 million (32lbs) bags last year. This year, it estimates the final figure will amount to only 120.6 million.

  • In part, that's because Brazil experienced far too much rain during its flowering season. That overabundance in October didn't go over well with the new coffee crop.
  • Columbia, a big producer of arabica, experienced its own damp weather, which will probably put a damper on its coffee production as well.
  • Uganda, the largest regional coffee exporter, has had to deal with a drought and ongoing issues from a disease that destroyed crops back in 1996-97. It expects to decrease shipments by as much as 17% this month.
  • And over in Vietnam, exports are 20.5% lower than last season so far. While crop yields are a bit down, farmers there can't get credit easily, to everybody's detriment. Jose Sette, the head of the ICO, says, "The market now realized that the Vietnamese crop is smaller than previously thought."

Meanwhile, coffee lovers aren't expected to slow down. If anything, they'll probably drink 134 million bags worth, up from about 131 million last season.

Percolating Nicely...

Global coffee inventories are already falling.

The amount of robusta at LIFEE-registered warehouses has sunk to 230,000 tons. This time last year, there was nearly 400,000. And since September alone, it has decreased 40%.

Mr. Sette believes: "Stock is very low in historical terms. If we have any weather problems in any producing country, there will be no reserve or stockpile to handle this." Yet even if there isn't, coffee lovers should expect to dig a little deeper to feed their habit.

Investors, on the other hand, can enjoy the current situation with a particularly rich ETN. The iPath Dow Jones-UBS Coffee Subindex Total Return (NYSE: JO) is set up to reflect the performance of one arabica coffee futures contract.

In addition to providing a solid return, JO also offers a good level of diversification. It has a correlation with the S&P 500 Index of just 0.19 and a correlation of only 0.14 with the Barclays Capital US Aggregate Bond Index.

Now that smells good.

Good investing,

Tony Daltorio

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