Coffee: Buy The Dip Before The $3 Record High

Unseasonable chill has descended on the coffee patch in Brazil—a country renowned for its searing heat and humidity—creating a supply scare for premium coffee chains such as Starbucks (NASDAQ:SBUX) and Tim Hortons.

New York-traded arabica, the coffee bean of choice for these retailers, has already gained more than 30% over the past week to above $2.15 per lb, and Bloomberg quotes veteran industry consultant Judy Ganes as saying record high prices of above $3 are inevitable with more crop freeze headed Brazil’s way.

But technical charts tracked by Investing.com indicate a correction first before the market runs further upward, suggesting a buy-on-the-dip opportunity for those willing to wait.

Arabica Weekly

All charts courtesy of S.K. Dixit Charting

As Sunil Kumar Dixit, chief technician at SK Dixit Charting in Kolkata, India, puts it: 

“The galloping pace of coffee certainly leaves some gaps to be filled which could pull the prices down.”

Dixit’s reading shows that after Monday’s near 7-year high of just above $2.15 per lb, front-month arabica on ICE Futures US has a better chance of traveling down to the five-year Exponential Moving Average of $1.89 and the static horizontal support of $1.69.

Drilling down the potential daily trend in arabica, the overbought Stochastic RSI read of 95/97 call for caution against pull back and consolidation, Dixit said. 

“Thus, on an immediate basis, coffee is more likely to undergo a natural price correction before hitting through $2.25, the level reached in 2014,” he added.

But charts also indicate a breakout to the higher side after that.

“On the upper channel, coffee can certainly extend to the record high of $3.06 reached in May 2011,” Dixit said.

Arabica Monthly

Arabica’s seven-year highs came as coffee trees in Brazil were weakened by a drought and then pummeled by two frosts in less than a month. Freezing temperatures last week especially hurt young trees, which will need to be trimmed or replanted. 

Jack Scoville, chief crop analyst at Chicago broker Price Futures Group, in a post seen by Investing.com said:

“Freezing temperatures were reported in much of Minas Gerais and Parana and also in Sao Paulo.”

“It is not yet known how extensive the damage was but ideas are that a significant part of the cop got hurt. It is flowering time for the next crop and the flowers were frozen and will drop off the trees.” 

Such a development could affect output for years to come, including slashing next year’s harvest by as much as 5.2 million bags, according to an Ecom Research report seen by Bloomberg. A bag weighs 60 kilograms, or 132 pounds.

Any hit on Brazilian coffee production cannot be taken easily because it accounts for 40% of world output, Ganes, the veteran industry consultant, said. In her own words, she asks: “Where is the coffee going to come from?”  

The rally in arabica was also supported by the ICE exchange’s almost doubling of the margin requirements for trading coffee futures, encouraging traders to cover their short bets.

Other major growers are going to reap less coffee than expected this year, including Indonesia, which is also seeing a light crop.

Forecasters expect more low temperatures in Brazil in the coming days, with an increased chance of frost in Sao Paulo and south of Minas Gerais during a cold spell expected July 29, Somar Meteorologia said in a report.

“Cool temperatures will continue early in the 6-10 day period as well, so there will be additional frost threats in the same areas over the next weekend,” Maxar meteorologist Donald Keeney was quoted as saying by Bloomberg.

Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold a position in the commodities and securities he writes about.