Coffee: new landfill or stabilizing?

Coffee: New landfill or stabilizing? After what might best be described as a freefall for prices during the early part of the summer, the worst may be over for the coffee market.

In early June, coffee futures prices touched $1.30 per lb. But, when the International Coffee Organization

A Shearson Lehman Hutton analyst, Sandra Kaul, says the sticking point in the ICA discussions was quotas. The United States wanted the organization to increase the quotas of those countries producing higher-quality arabica coffees. The Caribbean countries, especially Colombia, are among the biggest producers of the higher grade of beans.

Brazil produces lower-grade robustas and refused to listen to any proposal that would lower its quotas. The ICA couldn't survive the intransigence of the United States and Brazil. In the absence of the agreement's price support, prices nosedived.

At the beginning of June, before the talks, the market anticipated trouble. Traders looking at June 2 prices (see table) noticed a slightly inverted market -- that is, nearby contracts were higher than deferreds. The market therefore saying, in effect, "The future doesn't look good so don't store coffee. There's no reward for storage." But, by late July, the market was anticipating better days ahead. Prices for July 27 indicated a carry market -- that is, prices for deferred contract months were higher than nearbys. Through the carry spreads, the market was saying, "Store coffee."

The market is not saying prices will top 90^ per lb. by March. It is saying traders are willing to hold coffee in the belief prices will improve. In summary, through the last few months, the market has been doing just what traders "pay" markets to do.

Fundamentally, Kaul says, the coffee market has to rebound to some extent. In the absence of an agreement, she adds, "Producing countries like Colombia, Mexico, Brazil and Indonesia are selling aggressively to build market share."

But she says the market can take a lot of selling because blenders (heeding market signals and news) reduced stocks in anticipation of trouble. Now they must go back to the market.

Coffee growers enjoy little in the way of government subsidies, so even with a competitive situation like the present one, growers can't afford to sell below their cost of production. Consequently, the market can't really go into a complete freefall.

"Long term," Kaul says, "this is probably a necessary step. It will ultimately force some growers out of the market."

The result will be a better supply-demand balance and a stronger market -- which is the message of the spreads. Or, to put it another way, it doesn't really look like coffee will become the new landfill.