As the market has sold off over the last few weeks, a variety of assets are now trading at big discounts to their long-term potential. Perhaps some of the biggest discounts can be found in the commodities sector. With rising global populations and more citizens attaining middle class status, the need for an ever increasing amount of resources is great. One of the more interesting plays with in the commodities sector is coffee. Growing global demand coupled with shrinking supplies is having a dramatic effect on prices. With more bad weather, supply concerns and rising emerging market demand on the way, coffee prices could shoot higher in the long term. For investors, the recent downturn in asset prices, could spell out an opportunity to add some java to a portfolio. (For more on commodities, read How To Invest In Commodities.)

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Nicely Caffeinated
Despite the recent prominence of energy drinks, like Red Bull, the world still gets the majority of its caffeine fix from coffee. Currently, the worldwide market for java is actually larger than the market for silver. About $37 billion worth of silver was consumed last year. Total coffee consumption was north of $38 billion, and that market continues to getting bigger. The International Coffee Organization estimates that global coffee consumption rose 2.4% in 2010 to a record 134.0 million 60-kilogram bags. That demand continues to grow in the face of higher prices. U.S. coffee demand increased 2% from June 2010 to June 2011, and analysts predict China's coffee consumption will grow at 15 to 20% annually. Driven by students returning from abroad and a newly emerged Chinese international business traveler, China's coffee demand will certainly rise well above its current three-cups-a-year average. Industry leader, Starbucks (Nasdaq:SBUX) has already announced plans to triple its presence in the Asian nation over the next four years.

Consumers in India have also begun to embrace coffee, and have reduced their tea consumption. Relatively expensive Arabica beans have given way to cheaper ones, such as Robusta, to meet India's surging demand. In emerging Latin America, the story is also similar. (For more on commodities around the world, check out 4 Commodities Affected By World Conflicts.)

Weather Concerns
In the face of this increasing demand, supplies of coffee continue to diminish. Weather has wreaked havoc on producers' output. Brazil recently suffered an August frost that should decrease yields in 2012. The nation is expected to yield around 55 million bags in 2012. However, that amount will still not be enough to satisfy the estimated 64 million bags needed. Colombia, the third largest producer, suffered debilitating rainfall and its coffee exports dropped 38%. Colombia's recent harvest was the lowest level of production since September 1988. Finally, input costs for growers continue to rise. Fertilizer, irrigation and transportation costs all continue to rise. This will help keep the cost of coffee at higher levels.

Brewing a Cup
Despite the fact that coffee prices have surged nearly 387% since early 2002, the long-term promise for the commodity is great. As demand continues to rise, prices will continue to rise higher as well. Any weather related supply shocks will send coffee prices further skyward. To that end, investors may want to bet on the soft commodity. The iPath DJ-UBS Coffee ETN (NYSE:JO) is the easiest way to bet on coffee futures pricing, and currently sits at about $20 below its 52-week high. Investors can also use the iPath Pure Beta Coffee ETN (NYSE:CAFE), which uses a unique roll strategy for its contracts.

For those investors looking to avoid the volatility of the futures market, the coffee roasters with pricing power could be a great a buy. Nestle's (OTCBB:NSRGY) Nescafe brand has seen sales surge throughout Brazil, as the nation's coffee consumption is up 40% since 2001. J.M. Smucker's (NYSE:SJM) might be better as it has also been quite successful in passing on higher costs to consumers. It recently raised prices by 11% on its Folgers brand, and has seen great growth in its partnership with Dunkin' Brands (NASDAQ:DNKN) to distribute Dunkin' Donuts packaged coffee.

The Bottom Line
With global demand for coffee continuing to rise and supplies still threatened by poor weather, coffee prices have nowhere to go but up. This supply and demand imbalance could spell out opportunities in the sector, and investors have a variety of ways to profit. Investors can add a jolt to their portfolio either by betting directly on coffee prices or via roasting stocks like Green Mountain Coffee Roasters (Nasdaq:GMCR) and Coffee Holdings (NYSE:JVA). (For more on soft commodities, read Trading The Soft Commodity Markets.)

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Tickers in this Article: SBUX, JO, CAFE, NSRGY, SJM, GMCR, JVA, DNKN

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