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Your Cup of Joe and the Occasional Chocolate Bar is going to Cost you More This Year

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By: Troy Kuhn
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Coffee bean prices on the New York futures market went up 20% in the week to touch a price of $1.72 per pound on Wednesday, breaking ten-year price records.

The last one year has seen coffee prices go up by as much as 50%, largely due to concerns of a shortage in coffee bean supply in this year. The worst droughts in decades hit Brazil’s coffee belt last month, destroying coffee crops and causing the commodity’s price to skyrocket. Brazil is the biggest producer of Arabica coffee, and a poor crop production in the area has potential to disrupt coffee bean supply all over the world.

Similarly, time is running out for the chocolate industry to secure supplies of its key ingredient—Prices for cocoa beans are also on the rise, albeit for different reasons. The commodity is surging on the back of increased demand in developing markets. Currently, cocoa is trading at a price of $2,950 per metric ton, which is the highest price recorded in over two years. Prices for March delivery contracts on the ICE Futures US exchange are up 3.5% to come in at $2,889 per metric ton.

Sugar price is also climbing upwards, largely because of the dry spell in Brazil—the country also happens to be the biggest producer of sugar in the world. The front-month contract for raw sugar, trading on the New York Commodity Exchange (NYMEX), settled for $0.1762, up 2.4%. Sugar spot price touched $0.1679 this week, the highest level recorded since December of last year.

Dry Weather in Brazil

Brazilian crop estimates have been revised after Brazil’s local weather forecaster, Somar, predicted that the weather conditions in the country will likely remain dry and unchanged for the season.

Arabica coffee plants are in their maturity phase at this time of the year, and unfavorable weather conditions mean that it is very likely that there will be a shortage of Arabica coffee in the market in this year.

Brazil, which happens to be the world’s largest coffee and sugar producer, has been subjected to the worst weather conditions in over six decades. Continuing dry weather in this region has pushed investors to increase buying in the market; Arabica’s first month contract was up 19% last week, peaking at $1.7750 on Thursday. The second-month contract (for May), on the other hand, settled at a lower price of $1.72 per pound.

Coffee prices are expected to rise in the long term primarily because of growing demand for the product in the developing world and the relatively inelastic supply of the  commodity. In short, the increase in demand has outstripped the increase in supply.

Growing Middle-Class in Developing Markets

It is no longer the case that the developing world produced coffee and the developed world drank it. Even Brazil, a country historically known to be the producers, and not consumers, of coffee beans, have witnessed an increase in local demand for coffee beans, which has added pressure on improving supply.

And it looks like this is not the case only for coffee beans—price for cocoa beans is surging because of increased demand.  Consumers in the developing markets are finding themselves in the middle class, eager to buy the affordable luxury items for the first time. Rising middle-class population in India, China, and Brazil is fueling extraordinary demand for chocolate and coffee, which in turn puts upward pressure on cocoa and coffee bean prices.

According to Euromonitor, a marketing research firm, demand for cocoa beans is expected to be higher than supply through 2018. Global chocolate sales are also projected to increase to 7.5 million tons this year.

Olam International Ltd., one of the biggest cocoa traders in the world, has projected cocoa demand to increase by 3.5%, which will lead to a deficit of 185,000 metric tons. Stock-to-use ratio—a convenient ratio used to measure supply and demand interrelationships of commodities—is currently at 34% and is continually trending downwards. The management at Olam International believe that the low stock-to-use ratio is indicative of the fact that cocoa price will rise moving forward.

Barry Perkin, who is the global head of procurement at Mars, Inc., shed some light on the increase in demand for cocoa beans: “there are hundreds of millions of people emerging into the middle class every year, and they are the chocolate consumers of the future, evidence would suggest that any population that emerges into a middle class will eat chocolate."

Bullish Bets in the Commodity Markets

Speculations about a surge in the prices of the three commodities have led to an increase in commodity bets in the market—US Commodity Futures Trading Commission (CFTC) data shows an 18% increase in net-long positions on 18 US-traded commodities to come in at 1.25 million contracts for the last week alone.

According to CFTC data, net-long positions in Arabica coffee have tripled this month, and are now at 24,291 contracts. Similarly, net-long positions for cocoa have increased four-fold at 83,038 contracts. Net-short positions in sugar have decreased 30% to 26,489 contracts—once again resonating with the bullish sentiments in the market.

Investor Insight

Instant coffee and ground coffee prices are expected to be much more sensitive to the ongoing coffee crunch. Coffeehouses, on the other hand, are not anticipated to get pulled under as they not only hedge against the commodity but also because coffee bean prices constitute a small part of retail coffee prices. In short, rising bean prices will not impact profits of coffee brewers like Starbucks (SBUX), Dunkin Donuts (DNKN), and Tim Horton’s (THI) by much. Starbucks, for example, purchases 500 million pounds each year, and bean prices make up only 8-10% of costs for the company. An increase in coffee bean prices, therefore, will have a marginal impact on pricing for the company, and its direct competitors in the future.

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