Marcelo Fraga Moreira
original - http://archerconsulting.com.br/artigos/artigo9776/
Right on Monday, after the Set-21 traded near the highs of the year (@ 143.20 cents/lb) the market couldn't take it and fell during every trading session of the week!
The Sept-21 oscillated between the high and low @ 143.20 and 131.95 cents/lb, ending Friday @ 132.65 cents/lb. A drop of 1,055 points! Or approximately -90 R$/bag!
One of the reasons alleged for the drop in quotations in US$ in New York was the devaluation of the Real against the US currency. The R$ devalued and appreciated +/- 3.00% in a single day! In the week it oscillated between 5.61 R$/US$ to 5.7790 R$/US$ to 5.55 R$/US$ closing Friday @ 5.6970 R$/US$. There was the risk of the government, or rather, of Brazil entering a new political and economic crisis (when the same government tried to articulate a populist measure by trying to leave the Bolsa Família benefit outside the "spending cap". This attempt at a "coup" by the government has left the market in turmoil. At the peak of the crisis, on Wednesday, there were new rumors of resignation/dismissal of Minister Paulo Guedes; the Real even traded at the week's high (@ 5.7790 R$/US$); the Brazilian stock market index oscillated approximately 11. 000 points per day on Tuesday and Wednesday (between the opening/minimum/maximum/closing, with the index oscillating between 110.328-107.319-112.428-111.529 and 111.529-107.465-112.398-111.183 respectively). Volatility such as we have not seen in years! Brazil really is not for amateurs!
With all this volatility, many producers were just "watching" coffee prices fall in their terminals "hoping" for some new "relevant fact" in the market. Unfortunately this did not happen.
The good news of the week came from Olam trading company that announced an investment of around 130 million dollars to build a new soluble coffee plant in the city of Linhares, in the state of Espirito Santo!
For some weeks now we have been warning our readers to protect themselves against an eventual market correction. At the current price level, settling above 800 R$/buy equivalent for the producer, the Brazilian producer gets an excellent remuneration for his crop. He should be selling and/or locking in part of his positions (unfortunately this year, due to the drought, some producers will suffer financial losses. Others "will not receive better prices" for having decided to sell at "low" prices back there - nobody forced any producer to sell coffee for future delivery @ 560/600/650/700 R$/saca).
In our view, the only relevant fact that could make prices explode in the short term continues to be a new climatic effect such as a frost before the hour or during the period of the next Brazilian winter (May 15-July 30, basically). Without frost in the next few months we believe we have already seen the year's highs in R$/bag equivalent. With the rains of the last few weeks, with the recovery of crops and expansion of new areas, Brazilian crops 21/22 and 22/23 may again produce above 65-70 million bags.
Coffee producers are stunned by the constant price increases for soy and corn, and believe that the same could happen to coffee. Soy and corn are essential commodities for the composition of animal feed (the animal can't go without eating, otherwise... it dies!). What will happen if the world population stops drinking coffee, reduces consumption? Nothing! They will simply adapt, they will drink tea, water... If coffee prices continue to rise, there will come a time when we will see a disruption in demand. The "consumer's pocket" will speak louder. Coffee will become a product for the upper-middle class. There will be a surplus of coffee, prices will correct, and life will go on! We have seen this adjustment happen countless times with other foods (beans, tomatoes, chicken, beef), and then supply adjusts to demand and vice-versa.
Last week we had coffee reaching record prices, with purchase offers for future delivery for Sep-22 and Sep-23 between 800-850 R$/bag. A few producers took the opportunity while the majority preferred to wait, "hoping for higher prices, hoping to break the 1,000 R$/saca".
Greed spoke louder and blinded the reason for the laws of supply and demand, the laws of production cost x remuneration and expansion. Now many are afraid of the market realizing and negotiating again below 120-110 cents a pound! And the prices for the producer back to the level of 650/600 R$ / bag!
This week, prices have already retreated from the highs, with indications between 700-800 R$/saca for sales with future delivery for Sept-21 and Sept-22.
In the structures that we have been presenting to our readers over the last few weeks, if the producer had taken the opportunity and bought into the Set-21 and Set-22 Put-Spread on Monday itself in the strike +140 x -110 and selling the "Call" in the strike 170/165 cents per lb and fixing the Real @ 5.60/5.65 R$/US$, the producer had the opportunity to "lock" their sales between 825-1050 R$ / bag (provided that the Set-21 and Set-22 do not close below 110 cents per lb on the day of expiration of options).
Production costs in Brazil have undoubtedly increased over the last 12 months (due to the devaluation of the Real, increased fuel and agricultural inputs, among others). Production costs were between 400/450 R$/saca in 2020. Considering the increase in production costs, on average by 40%, then these costs have increased to 560-630 R$/per bag! Selling at 750/800/850 R$/per bag is not good? Capitalized growers continue to take care of their crops, pruning, fertilizing, and even expanding the planting of the crop in Brazil. Just as the Brazilian producer follows the daily oscillations in the New York and London terminals, so do other producers and industries around the world! They also know how to calculate, hedge, and have access to credit lines. At the current price levels, we believe that we will continue to see expansion both in new areas and in productivity. New technologies and varieties more resistant to weather conditions are being improved. Investments in irrigation are increasing. We will continue to have specific problems, logistics, climate oscillations around the world. And we will need to continue to monitor all the costs of the production and distribution chain. As we have already seen, the market "goes up the stairs and down the elevator"!
Based on last Tuesday's position the funds were long 42,796 lots (they increased the long position by +1,498 lots). If the funds decide to "turn their hand" prices could return to the 110/100 cents per pound weight.
With the advance of vaccination around the world, demand in the United States and Europe should return as early as May. What will be the consumer appetite in these countries? How will the purchasing power of these workers be? And what about the rest of the world? After all, coffee is consumed all over the planet, not only in the rich economies.
The main producing countries continue with favorable weather conditions for the recovery and development of crops for the next cycle, with the exception of India. We will continue to monitor...
We remain bullish on the market for the short/medium term until the Brazilian winter risk passes. Until then, the market can oscillate a lot, with Sept-21 possibly testing 120 cents/lb. If we have frost, then the sky is the limit!
Project into Set-21 and Set-22 with the buying of Put-Spreads selling Call-spreads. This way, as we have already shown here, if the market explodes the producer will be able to limit his losses and/or participate in an eventual explosion in prices.
Ps. If you want to speculate, as has been the goal of many of our readers, we suggest buying the 170 c/lb call on Sept-21 (it closed @ 3.93 c/lb - approximately 29.50 R$/bag).
A great week to all!
*Marcelo Fraga Moreira has been working in the agricultural commodities market for over 30 years and writes this weekly report on coffee as a contributor to Archer Consulting.
** Call" = call option
** Put" = put option
** Call-Spread" = simultaneous purchase and sale of 2 Call Options (buying the option with lower strike price and selling the option with higher strike price);
** Call-Spread Call-Sale" = simultaneous sale and purchase of 2 Call Options by selling the higher exercise price Option and purchasing the lower exercise price Option);
** Put-Spread Call" = simultaneous sale and call of 2 put options (selling the option with higher strike price and selling the option with lower strike price);
** Put-Spread Put-Sell" = simultaneous sale and purchase of 2 Put Options by selling the higher strike price Option and purchasing the lower strike price Option);
** CFTC" = Commodity Futures Trading Commission - an independent agency of the United States government that regulates the commodities futures and options markets;
Translated with www.DeepL.com/Translator
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