I recently returned from a thoroughly enjoyable trip to the USA. Despite media hysteria, I found the country actively engaged in business, regardless of what the stock market may indicate. The primary purpose of my trip was attending the National Coffee Association (NCA) conference in Houston, TX. As often happens with such events, the conference itself was less engaging compared to the valuable meetings held alongside it. I had the opportunity to reconnect with old friends in the coffee industry and forge new relationships.
The conference highlighted significant stress in the market due to elevated prices and persistent backwardation of the futures curve.
Conversations with traders revealed a notable reduction in trading volumes by 25-30%, which aligns with expectations given that prices have doubled over the past year. Working capital limits are under considerable pressure. The industry's main concern centers around the roasting sector and their capacity to pass higher prices through the supply chain. Apart from major household names, many second-tier roasters face challenges in managing procurement strategies amidst high market volatility.
A consistent theme among roasters is their reluctance to commit to higher prices. This exemplifies the principle: "Show me the incentive, and I'll show you the outcome." Typically, coffee buyers are tasked either with purchasing at prices lower than their competition (or internal budget) or, at worst, matching competitor prices. In a declining market, buyers exercise discretion by locking in advantageous prices, often being rewarded for doing so. However, in a rising market, there's minimal incentive to hedge prices proactively due to career risk.
Consider the following scenario:
You hedge your price risk at $3.80 per pound after prices recently hit $4.40—historically high but still 60 cents below recent peaks. You face three outcomes:
1) Prices return to recent highs: You appear smart but gain no bonus increase due to tight operating margins. You're likely seen as lucky, and management believes you should have hedged even lower (CFOs and farmers are renowned for perfect hindsight!).
2) Prices drop to $3 or below: You appear foolish, risking your career.
3) Prices remain unchanged: You've added no benefit to the company.
Given these incentives, buyers often defer pricing decisions until closer to First Notice Day (FND). Framed this way, what would you do?
KC Arabica - March 2025 contract
Could similar volatility emerge in the May and July contracts ahead of Brazil's upcoming harvest? Possibly. The commercial net short position is currently 20,000 lots lower than early February but remains historically significant.
Net Commercial Short Position - last 5 years
Looking back over the past 8 years, the short is still large on a relative basis.
CFTC COT - Commercials Net Position (lots)
Looking ahead, monitoring spread movements, changes in absolute and relative basis level, and capital flow is crucial. Recent trends in cocoa markets suggest a secondary spike is plausible for Arabica and Robusta.
The two main takeaways for me from the conference was that less well capitalised participants need assistance in two critical areas:
1) Consumers require improved understanding of hedging alternatives and the establishment of robust risk management frameworks that extend beyond process and procedure and extend to align with practical incentives.
2) Traders and consumers both face capital scarcity, highlighting the need for access to flexible and strategic capital amid volatile price movements experienced in recent years.
The remainder of my US trip focused on meetings with alternative capital sources and establishing partnerships to enable tailored solutions for the industry that are flexible and fast moving. These productive meetings promise exciting announcements in the upcoming months.
Meanwhile, the senior advisory team at GSX brings six decades of combined expertise in risk management, hedging, and capital solutions. If our services could benefit your operations, please reach out.
