Coffee Demand Not Slowing Down [Starbucks Corporation, Dunkin Brands Group Inc, Keurig Green Mountain Inc]

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October 21, 2014 1:11pm NYSE:JO

coffeeChris Orr: Coffee: I love the stuff. No matter the price, I’ll come up with the money to pay for it every morning, although the thought of a price increase does concern me. And today, a price increase is exactly what we’re seeing.

This year’s coffee crop was shriveled up by the El Niño-induced drought that settled in across Brazil last year. Early this year we saw the price of the commodity rise quickly, though it leveled off as suppliers worked through a vast inventory of Arabica and Robusta beans.

Now, that inventory is shrinking and this year’s crop is coming in at the lowest level in two years. Given these factors, prices are expected to climb significantly higher.

And while El Niño and growing consumer demand are conspiring together to drive the price of your next cup of java higher, we’ve got a great way for you to rake in profits on the price’s rally.

El Niño Shrinks Coffee Harvest

The ocean phenomenon called El Niño, an area of ocean temperatures between Peru and Indonesia that is warmer than normal when the cycle is active, is having a negative impact on the prime coffee regions of the world.

El Niño brought drier-than-normal weather to Brazil, Vietnam and Indonesia — three of the top four coffee-producing countries in the world — for most of this year. El Niño weakened a little this summer, and while the return of rain and the blooming flowers on coffee bushes raised hopes for a good crop, those hopes were diminished by late summer.

Coffee flourishes within a narrow area near the equator, and typically comes in one of two varieties. Arabica coffee, which makes up 70% of the coffee picked, grows at higher, cooler elevations of Latin America. Robusta coffee, on the other hand, comes from trees that are hardy and disease resistant, preferring warmer climates at the lower elevations of Vietnam, Indonesia and Africa. These robusta beans are considered to be lower quality and are used for instant coffee, blends and espresso.

The ideal growing conditions for these crops include a combination of frequent rain — about 60 inches a year — and spells of sunny weather.

Unfortunately, these conditions were not met late this summer when rainfall was below normal across Vietnam, Indonesia and equatorial Africa. That means the supply of both Robusta and Arabica coffee will grow tighter.

To make matters worse, El Niño strengthened again in late August and the drought returned, leaving the plants in rough shape, producing small beans. All things considered, we’re looking at a much smaller harvest.

Coffee Pinching Your Wallet

Looking back at coffee prices from the 1990s to last year, I discovered that prices always go up during El Niño and go down during La Niña, El Niño’s cooler cousin.

The retail price lags behind the commodities market by nine months, so if the price of the commodity keeps going up, you’ll see similar increases at the grocery and specialty shops well into next year.

This summer, Folgers, a J.M. Smucker brand, and Dunkin Brands both raised retail prices at grocery stores. Starbucks raised their prices, too, even though they are heavily hedged with nearly a third of next year’s bean price locked in.

Inventory will be squeezed more next year because Brazil has a two-year crop cycle and next year is the “off” year. Coffee grown in Africa might have problems, too, because equatorial Africa usually has a drought the year after El Niño forms.

Even though next year will be rainier across Indonesia, it will likely take one growing season for the plants to recover from this year’s drought. Vietnam will remain dry next year, further delaying those plants’ recovery.

Coffee Demand Not Slowing Down

At the same time, global demand for coffee is growing. Consumption in China is increasing at 12.8% per year, while Japan has become the No. 3 importer of coffee in the world due to rising popularity of the beverage. As economies around the globe improve, coffee is seeing an uptick in demand as consumers with rising disposable income treat themselves to that extra cup of Joe in the morning.

To put the price into perspective, in December 2013, it hit a low of $1.05 per pound, then rose sharply to $2 in May. This month, the price roared to $2.20 a pound.

The iPath DJ-UBS Coffee Subindex Total Return Exchange-Traded Note (JO) closely mirrors the price of coffee because it is based on one commodities futures contract.

JO is a simple yet effective way to capture any coffee price gains. And although prices have already moved higher, we still think we can brew additional gains, given the combination of weak harvests from some of the world’s leading producers and the growing global demand for everyone’s favorite caffeine fix.

There’s a silver lining in every cloud.

This article is brought to you courtesy of Chad Shoop.

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