Outlook Still Gloomy For The Coffee ETF

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August 29, 2013 3:09pm NYSE:DBA NYSE:DBC

coffeeBroad commodities have made an impressive comeback after a steep fall earlier this year, and have caught enough investor interest of late. While the commodities in the precious and industrial space have rebounded from their lows or are even

moving higher, soft commodities, in particular coffee, are still plunging.

In fact, the iPath Dow Jones-UBS Coffee Subindex Total Return ETN (JO) has been down more than 8% in the past one month, underperforming the broad PowerShares DB Agriculture Fund (DBA) and PowerShares DB Commodity Index Tracking Fund (DBC) by wide margins.

This is especially true amid falling emerging market currencies that are encouraging higher exports as well as increased concerns over the Fed’s intention to slow down the asset purchase program. Further, the supply glut across the globe has resulted in a steep fall in the price of coffee.

According to the U.S. Department of Agriculture, global coffee production will exceed demand again for the fourth consecutive season by 4.46 million bags for the 2013–2014 season. As such, inventories would reach its 5-year high of 30.5 million bags at June 2014, up from 30.2 million bags a year ago.

Brazil: The Real Trouble

About one-third of the coffee supplies come from Brazil, the world’s biggest producer and exporter. Over more than four years, the Brazilian economy has been struggling from slower growth and heightened inflation that has been taking a toll on its currency (Brazilian real) against the greenback (read: Forget Brazil ETFs, Focus on This Top Ranked Fund Instead).

The Brazilian real has depreciated more than 5% over the past two months and 15% so far this year. The weak currency is making imports expensive and exports cheap, posing a major threat to coffee prices.

Additionally, dry weather in Brazil has boosted production, leading to robust coffee supplies. This, along with tepid demand suggests bearish fundamentals for coffee.

ETF Impact

Given the weak emerging currencies against the dollar and demand/supply imbalances, global coffee price and the related ETF is expected to move in the negative territory at least in the near term (read: 3 Currency ETFs Crushed in Emerging Market Rout).

JO in Focus

The ETN tracks the Dow Jones-UBS Coffee Subindex Total Return. The index delivers returns through an unleveraged investment in the futures contracts on coffee and currently consists of one futures contract on the commodity (see more in the Zacks ETF Center).

The product is a bit expensive as it charges 75 bps in fees per year. It trades in moderate volumes of nearly 85,000 shares on average daily basis that increases the trading cost in the form of a somewhat wide bid/ask spread. The fund is also unpopular and has attracted $92.5 million in assets this year. The fund lost nearly 26% of its value so far in 2013.

JO currently has a Zacks ETF Rank of 4 or ‘Sell’ rating implying that there is significant bearishness facing the ETN in the months ahead (read all the agricultural ETFs here). Even though the central bank has taken a number of steps recently to stop the currency slide, the outlook for the currency remains very weak. Further, the Government has announced some measures to boost coffee prices, which may bring some relief to coffee growers but overall supply-demand fundamentals remain quite weak.

Bottom Line

Given the current bearish fundamentals, we advise investors still long on coffee to get out of this weak space or go for shorting the product. On the other hand, for a positive play on commodities, investors could instead consider the metals markets that have shown strength in the recent weeks (read: 3 Metal ETFs to Buy on the Commodity Upswing

Fortunately, there are several options in this market allowing investors to play individually or the combination of all the metals. While these are by no means immune to global trends, we think that any of them could be better positioned than coffee in the near term.

This article is brought to you courtesy of Eric Dutram.

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