Coffee ETFs Face Bearishness In The Months Ahead

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October 16, 2013 2:19pm NYSE:DBA NYSE:JO

coffeeAfter being revived for a while thanks to some dollar weakness, natural resources again slipped into trouble. This is especially true for soft commodities which couldn’t even stay afloat when other products from metal and mining sectors

were surging on the latest round of concerns.

A demand-supply imbalance was mainly held responsible for such a downturn in agricultural commodities. Among various others, coffee has been massively beaten down over the last two years and no hope is seen for a return to strength anytime soon.

In fact, the Dow Jones-UBS Coffee ETN (NYSEARCA:JO) – which provides exposure to futures contracts on coffee, is down more than 40.0% in the past one year, underperforming the broad agricultural fund PowerShares DB Agriculture Fund (NYSEARCA:DBA) which was down by around 11.9% and SPDR SP 500 ETF (NYSEARCA:SPY) which actually gained more than 15.7% in the said period.

Growing production

Global coffee supplies will likely surpass demand for the second consecutive year in the 2013-14 season because of plenty of Arabica availability, according to Volcafe Ltd. Coffee production will be 3.8 million bags higher than consumption in 2013-14, said another Switzerland-based firm.

About one-third of the coffee supplies come from Brazil, the biggest producer and exporter on earth. The record crop in Brazil so far in 2013 lowered the price of Robusta and Arabica coffee beans, further adding to coffee’s woes.

Although the year 2013 was an off-year of its biennial production cycle in Brazil, the lack of frost in the year reversed the biennial crop trend. Also, a good quality productive tissue in the main coffee growing areas the country for a bumper 2014-2015 production year.

Not only Brazil, but also Vietnam — the world’s top producer of the Robusta variety– will likely produce a record 30 million bags in 2013-14, up 15.4% year over year. Harvest in Colombia, the second-biggest Arabica producer after Brazil, will see an increase of one million bags to 9.5 million bags in that period to add to oversupply conditions.

Moderate Consumption

In Europe, total consumption softened with a less than 1% increase in 2012. Germany and France, in fact, witnessed a decline in consumption. In U.S. — the biggest single coffee consuming country — consumption grew just 1% in 2012.

Modest uptick in consumption was insufficient to contain the surge in supplies. Hence, coffee inventories — which are now hovering near their three-year highs are restricting prices from rising. The monthly average of the ICO composite indicator price fell by 2.1% in August 2013 to a level of 116.45 U.S. cents/lb. – The lowest level since September 2009.

Weak Currencies of Exporting Countries 

The depreciation of the currency – especially the Brazilian Real which impacted coffee prices the most, and partly the fall in the Indian rupee, dampened coffee prices. A weaker currency allows exporting countries to sell higher amounts which in turn increases availability in the market but at the same time pressurizes prices.

Goldman Sachs cautioned investors against hopes of a recovery in Arabica prices. Huge production in the off-year of its biennial production cycle is keeping a lid on increases in the short to medium term (Read: Play Goldman’s Views with These Commodity ETFs).

Bottom Line

Given this languishing trend, we caution investors who still are long on coffee instead of shorting the product. As such, JO currently carries a Zacks ETF Rank of 4 or ‘Sell’, indicating that the fund might face significant bearishness in the months ahead.

Presently, the fund is hovering just over its 52-week low price of $15.42 per share suggesting that the product has way to go for recovery.

On an overall basis, soft commodity ETF investing has been pretty rocky this year mostly on easing supply concerns. Products covering sugar, wheat, soybean, and corn all have Zacks ETF Ranks of #5 (strong sell) affirming the fact this is certainly the space to be avoided in the near term barring some exceptions like cocoa (NYSEARCA:NIB) which carries a Zacks ETFRank #3 (Hold).

This article is brought to you courtesy of Eric Dutram.

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