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Coffee look better placed than sugar for price recovery

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Coffee looks a better bet than sugar to recover from its price tumble.

Futures in both have been poor performers, with New York-traded arabica coffee tumbling 20% so far in 2015, on a front contract basis, and raw sugar dropping 10%, hitting their lowest on Wednesday since 2010.

And they are being depressed largely for the same reasons, centring on Brazil, the biggest producer and exporter of both agricultural commodities.

The weakness of the real cuts the value, in dollar terms, of assets in which Brazil is so important. And recent rains in central Brazil - the major producing region for both cane and coffee, where dryness has been a big concern - have improved output prospects for both crops.

But extent of the drop in prices looks easier to justify for sugar than coffee.

Weaker supply outlook

Indeed, the extent of the tumble in coffee futures to the same level as January last year, when concerns over Brazil's drought were in their infancy, looks difficult to justify.

World coffee supply prospects, a major determinant of prices, look worse now than they did then, a factor which would justify higher prices - offset with some allowance for the weaker real.

For 2014-15, Volcafe, for instance, estimates the world coffee production deficit at 8.9m bags, bigger than the shortfall of 5m bags it was forecasting in January last year.

The trading house sees a further deficit of 1.4m bags in 2015-16. And that forecast is based on estimate for Brazilian coffee production of 49.5m bags this year, more than many other commentators are factoring in.

Brazil question

Indeed, in cutting coffee prices so far, investors appear to be factoring in a decent recovery in Brazilian output which looks a bit of a premature assumption for now.

The production of coffee beans is a complex process, starting with the production of vegetation which will carry the cherries the next year, the flowering and grain-filling processes, all of which require decent conditions.

No matter how much rain falls between now and harvest, yields will not exceed levels determined by, say, flower setting late the previous calendar year.

Message not getting through

For sugar cane, however, rains will have a more direct impact in improving yields.

Indeed, it is more difficult to see any sign of a supply squeeze sufficient to give traction to sugar rally.

For most markets, the cure for low prices is low prices, in discouraging production and so limiting supplies.

But for sugar, this message to curb output is not getting through to growers thanks to the plethora of government support programmes for an agricultural commodity which is particularly prone to state interference in pricing or trade tariffs.

The reluctance to allow market forces to take their course is condemning sugar prices to extended weakness.

Hedge fund watch

One factor that sugar futures have had in their favour, in terms of potential for a rally, has been the large extent of the net short held by hedge funds, raising doubts as to the appetite for more selling.

In arabica coffee futures and options, they still retain a net long position, if the weakest one for more than a year.

For hedge funds to shift too far into net short territory in arabica coffee would likely create the ammunition for a hefty, short covering-fuelled bounce in prices.


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