Coffee price hike not enough for Brazilian farmers to turn a profit

The US has been shivering under the so called ‘polar vortex’ for what feels like months sending natural gas prices up by over 25% since the start of the year. In contrast Brazil has been sweltering through the hottest January on record in parts of the country and the driest since 1943. This has resulted in a severe drought which threatens the country’s coffee crop and sent coffee futures prices up 23% since the beginning of January to around $1.36 per pound. Coffee prices hit a 34 year high in 2011 around $3 per pound before being pummeled due to bumper harvests in Brazil. 

According to Agrimoney the impact on coffee has been to retard the growth of seeds within cherries. According to Mr Brando, director at Brazil-based P&A International Marketing ”Usually from 100 kilogrammes of cherries, you will get about 55 kilos of seed. Now you might find you are looking at 50 kilos, 45 kilos or lower. You might be looking at the same yield of cherries, but that the seeds are not fully formed.” Next season’s crop may also be threatened. ”The branches are not growing, and the leaves are not growing on the branches. This is what I think people in the market are beginning to appreciate” Mr Brando said.

According to the US Department of Agriculture the price hike may still mean that Brazilian farmers are losing money on their crop. Production costs as measured in Guaxupe, in Minas Gerais, Brazil’s top coffee-growing state, rose 12% to $1.87 per pound in 2013-14 mainly due to higher fixed and after-harvest costs – for example insurance, transport and depreciation.

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Commodity prices in 2014: A strong start.

A strong start, with some firm underpinning. That’s the view of Barclay’s who note that commodity prices have increased slightly since the start of the year despite turmoil in several emerging markets, concerns about slowing activity in China and a strengthening dollar. The BRIC-40 equity benchmark index is down by over 8% since the beginning of January. As Barclays note given that this group of countries is where well over 50% of global commodity demand now comes from, and that it has accounted for nearly all the demand growth in recent years, the price performance of commodities looks very robust in comparison.

Some of the recent price support may prove to be transient. First, from an investor point of view commodities entered 2014 with speculators underexposed to the sector meaning that there could be little left to sell and minimal downside. Second, in many commodity markets prices are close to costs. Barclay’s estimate that almost 60% of aluminium producers  are unable to cover cash costs. However, that’s not to say that prices cannot remain below cost for substantial period of time as producers may be unable or unwilling to cut production. Third, the weather with extreme cold in the US supporting natural gas as well as other energy prices.

However, higher commodity prices may have some firmer underpinning.  There has been a  gradual but sustained tightening in price spreads with commodity futures curves moving towards backwardation. Of the 24 major commodity markets, 10 are now in backwardation including some of the primary markets including crude, soybeans, copper and natural gas. As Barclay’s notes the correlation between commodity fundamentals and price spreads is usually quite high, certainly tighter than between fundamentals and outright price levels. So this tightening up in commodity futures curves is likely a leading indicator that underlying conditions in commodity markets, either via gradually improving demand, supply-side attrition or a combination of both, are getting healthier.

However, as we note in another article today the canary in the room (China’s equity market) offers little support.