Marex Spectron signalled optimism over a recovery in arabica coffee futures, saying that current values "underprice" a looming output deficit, amid a rash of selling by momentum funds also evident in the cotton market.
The London-based commodities house said that price signals from cash markets for arabica coffee were "finally turning", flagging relatively strong values of Colombian and Brazilian supplies compared with New York futures.
The reversal was happening at a time when the arabica coffee market was moving from a "material surplus" in 2016-17 "into material deficit" for 2017-18.
"The 2017-18 arabica deficit is beginning now to be felt in the cash market."
While Marex did not split out its individual supply and demand estimates for arabica coffee, including robusta too, it forecast a world production shortfall of 4.4m bags for 2017-18, compared with a surplus of 900,000 bags in 2016-17.
Indeed, while the tumble in arabica futures - which for September delivery touched 115.50 cents a pound in New York last week, the lowest for a nearest-but-one contract in 15 months – looked reasonable if considering only 2016-17 only, it was not supported by future prospects.
"Today's futures price is a fair reflection of today's 2016-17 arabica surplus, but underprices the 2017-18 overall deficit," Marex said.
The price also "contains no weather premium for 2018-19", for which weather concerns will begin to become particularly acute around September and October, with the flowering period for Brazilian plantations.
"Three out of the last five Brazil crops have been weather impacted, and another weather problem in Brazil in 2018-19 doesn't bear thinking about."
Marex, which acknowledged that an assessment in April that prices were "closing in a major low" had proved wide of the mark, flagged "extraordinary" selling by funds in fuelling the decline.
"The commodity bear market since 2012 has led to a huge reallocation of assets from managed (human) funds to systemic (computer) funds," the group said.
"We can point to $25bn in assets that has been withdrawn from managed funds that historically traded coffee."
This "huge reallocation from value investors to momentum investors" means that short-term price moves last longer and "can significantly overextend".
"This is particularly true in agricultural crops when one crop year has very different fundamentals to the next," as appears to be occurring in arabica coffee, with the turn from world output surplus to deficit, and has already played out in a tumble in prices of cotton, facing looser supplies.
To bet on arabica coffee futures continuing to decline would require foreseeing that Brazilian producers will not exploit their increased bargaining power, gained by the prospect of a 5.5m-bag drop in the country's overall output to 50m bags in 2017-18.
"One needs to believe that the Brazilians will capitulate and sell the market lower to make the momentum funds right."
In fact, a "lower arabica crop and lower carry-in stocks should give the producer strong pricing power and we would expect to see producer resistance to current prices," a factor "confirmed" by cash market moves.
Arabica coffee futures for September closed on Tuesday up 0.6% at 125.30 cents a pound.
By Mike Verdin