Coffee prices could be ready to recover as the market negotiates a production deficit – but the gains may struggle to last long, according to Sucden Financial.
The commodities broker pegged global coffee production for the current 2017-18 crop year at 154.4m bags, down from 156.3m bags last year, while consumption is expected to increase to 158m bags.
The resulting deficit of 3.6m bags could lend support to coffee prices, which have been under consistent downward pressure for the last 12 months.
Meanwhile, the net short in New York-traded arabica coffee futures and options is approaching record highs, which could leave the market vulnerable to a rapid spike, Sucden said, flagging the potential for a weakening dollar to support price gains too.
Greenback weakness against the likes of the real boosts the value in dollar terms of assets in which, in this case, Brazil is a major player.
However, Sucden caution against expecting any longer term price improvements, anticipating "the dark cloud of a large Brazil crop to cap prices on the upside".
Bigger Brazilian crop
Output in the world’s largest producer, Brazil, is slightly lower in 2017-18 on 50.6m bags, due to the biennial cycle of Brazilian production.
But the upcoming 2018-19 crop is forecast considerably higher, reaching 60 - 62m bags despite the delayed onset of rains.
"A crop of this magnitude would enable some re-stocking of Brazilian warehouses which have been depleted after years of deficit".
In Vietnam, the second-largest coffee producer, heavy rains might not have affected the quantity of production, which is pegged at 28.1m bags, but could result in quality issues.
Again, low stock levels would need to be replenished, indicating that "shipments will be low for the remainder of 2017", Sucden said.
La Nina factor
This supply scenario could be complicated by the onset of La Nina, which is underway according to official US meteorologists, who give it a 65-75% chance of continuing through the winter.
Although the link between La Nina and coffee is less strong than other commodities, Sucden warn that "a devastating storm in Vietnam could decimate robusta coffee production for that year and following years".
La Nina weather patterns are often associated with generous precipitation in South East Asian countries, and so are closely followed by investors in agricultural markets such as palm oil.
Rapid demand growth in China
Amid this uncertainty over supply, rapid demand growth is expected in new and emerging markets, particularly China, where demand has increased by 45% over the last three years.
"As a result, we believe the Robusta market will experience fundamental tightness. This is because Chinese consumption is in favour of the lower quality Robusta bean", Sucden said.
In the saturated markets like the US and EU, demand growth is more modest, slowing overall consumption growth to 1.3% in 2017-18.
‘Grist to the mill of the bears’
Sucden concluded that a 3.6m-bag world coffee production shortfall in 2017-18 could spur a brief price rally, although analysts at Commerzbank sounded a more sceptical note.
"While Sucden’s prediction of 3.6m bags is in the upper range of the deficit estimates, it is unlikely to unsettle the market,” the bank said.
It added that this would be "grist to the mill of the bears on the coffee market".