Your morning routine maybe getting a bit more expensive- especially if you use coffee to get your caffeine fix and get you going. It seems that coffee may have ordered one too many triple mocha whip-less half-cafs. Prices for the commodity have surged over the last few weeks as weather issues have cut supplies. Meanwhile, driven by emerging markets, global demand for caffeinated beverage continues to rise.
All in all, it looks like the commodity will be facing a classic supply/demand constraint problem in the near term.
Perhaps more importantly for portfolios, it looks like that problem won’t be abating anytime soon. For investors, the time could be right to add a jolt of java to their holdings.
Bad Weather In Brazil
Coffee is having one heck of year so far in 2014. Since the start of the year, coffee futures have surged a whopping 38% and recently had their best one-day gain in over a decade. The culprit poor weather in two of the commodities most prolific growing regions.
First, hot dry weather in Brazil is having its effect on the coffee crop. The nation is facing one of the driest rainy seasons in decades and that has damaged much of countries coffee crop. The sheer heat has hurt the crucial early growing stages of the plant. Analysts now estimate that nearly 10% of Brazil’s coffee crop will be lost to the heat wave. That’s a big deal as Brazil supplies about one-third of the world’s coffee fix and produces about four times the volume of the next-biggest grower Colombia.
On the flipside, Indonesian producers are having just the opposite problem- too much rain. Monsoon-like rains and winds have disrupted the critical flowering and pollination stages for the Asian countries crops. Both Java and Sumatra- Indonesia’s main coffee regions- have received as much as 30 inches of rain in the past month. That’s nearly 250% above average amounts. Overall, that’ll clip Indonesia’s coffee crop output by 17% this year to reach the lowest amount of production since 2011.
And yet demand continues to surge for the black bean.
According to a report by Switzerland-based ED&F Man Holdings, rising demand will cause global Arabica and Robusta supplies to trail usage by about 5 million bags throughout the year. Longer term, demand for joe is still expected to grow as many emerging market nations are now turning to the beverage in spades. Even traditional tea drinking nations- like China and India- are now embracing coffee.
Brewing A Cup
Despite its recent gains, the long term supply/demand constraints for coffee remain in place. For investors looking to hedge their routine adding a dose of exposure to the soft commodity is worth it.
The easiest way is through the Barclay’s (NYSE:BCS) sponsored iPath DJ-UBS Coffee ETN (NYSE:JO). The exchange traded note (ETN) tracks a basket of near-term coffee futures contracts and has been on a tear in 2014. Aside from the return potential, JO offers a truly now correlated asset- having only a 0.22 correlation to the S&P 500. Expenses run 0.75% for the fund. Barclays also sponsors the iPath Pure Beta Coffee ETN (NASDAQ:CAFE). This fund uses a unique roll strategy to eliminate the problems of contango in the futures market. However, CAFÉ hasn’t lived up to it hype in the returns department. Investors are better off in JO.
For those investors looking to avoid the volatility of the futures market, the coffee roasters with pricing power could be a great a buy. The last time coffee prices rose, both Starbucks (NASDAQ:SBUX) and Dunkin Brands (NASDAQ:DKNK) were able to raise prices for consumers. When futures fell last year, those prices increases stuck around, providing both firms with large profit margins. Analysts predict that SBUX as well J. M. Smucker's (NYSE:SJM) –owner of Folgers- may increase prices sooner than later. Even though they have sourced supplies well into the future.
Another interesting pick could be Green Mountain Coffee Roasters (NASDAQ:GMCR). Aside from making bagged coffee roasts/beans, the firm’s Keurig single cup brewing machines have taken the U.S. by storm. During the 13-week run-up to Christmas in 2011, Green Mountain sold 4 million of the Keurig machines. That number continues to grow and provides GMCR with plenty of pricing power for the K-cups needed to run the machines. (L5)
The Bottom Line
The world continues to drink more coffee. Yet, supplies continue to drop. The recent weather issues are exacerbating those supply constraints. For investors, it may be time to brew some coffee for their portfolios. The previous ideas- along with Tim Horton’s (NYSE:THI) –could be great ways to play higher coffee prices ahead.
Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.