A record level of gloom among hedge funds over arabica coffee prices among hedge funds could be setting up futures for a near-term bounce, despite poor supply and demand fundamentals.

Managed money, a proxy for speculators, extended its net short position in New York arabica coffee futures and options to 35,939 contracts as of November 13, data from the US regulator, the Commodity Futures Trading Commission said.

The increase took the net short – the advantage of short positions which profit when prices fall over long holdings which benefit values gain – to the highest on records going back to 2007, indicating a high level of bearish sentiment over coffee prices.

Values have been undermined by expectations for a return to a world production surplus in 2012-13, and for a strong Brazilian crop in 2013-14 in what is an off year in the country's two-year cycle of higher and lower producing seasons.

"Traders are talking of a record off-cycle crop which could comfortably be above 50m bags," London broker Marex Spectron said, in comments which follow bearish forecasts too from the likes of Macquarie and Standard Chartered.

Portfolio weighting

However, despite the bearish fundamentals, the extent of the net short position could have primed futures for a short-term recovery, given the prospect of a large amount of buying ahead from index funds, which offer investors returns linked to commodity indices.

Index funds are poised in July to undertake a reweighting exercise in which they rebalance their portfolios back to the make-up of the index they track.

This means the purchase of commodities which have performed badly – such as coffee, down by one-third so far this year - and now account for smaller proportion of the fund portfolio than the relevant index would suggest.

Index funds vs hedge funds

"The index funds will reweight, leading to the buying of just over 10,000 contracts," on current estimates, Marex said.

"Hence we look for a short-term low in the coming one-to-two weeks," the broker said.

"Short-term, between now and mid-January, we favour a rally."

'More manageable levels'

The CFTC data also showed speculators raising their net short position in cotton above 19,000 contracts over the week, near to historic highs, while cutting their net long in raw sugar below 13,000 lots to the lowest in nearly five years.

However, the extent of the cut in managed money's net long position in soybeans – down more than 38,000 contracts to the lowest since February - raised hopes that speculators may be close to neutralising the negative impact on prices which stemmed from a record large net long earlier in the year.

"Selling over the past several days may finally be bringing these long positions to more manageable levels with funds seen adding to shorts," Kim Rugel at broker Benson Quinn Commodities said.