New York trades at the highest level since February 24th 1998

-20 economies agreed on higher capital for banks and signed a compromise to reduce fiscal deficit by 2013. In the US, the Volcker-rule was approved, but a slightly different version that gives banks some trading room and funds’ sponsorship possibilities (within smaller limits for both). On the last trading sessions equities and commodity indices have been trading into different directions, but it is too early to assure if these two assetclasses will start to have inverted correlation again. Coffee gave it is contribution to the delinking process, running higher on Thursday, while many participants were still sleeping. Those who were short calls (options) had nothing to do to cover their exposure early in the morning other then buying futures on a thin market, and at one point the “C” was rallying US$ 16.00 cts/lb. Origins took the opportunity to sell, but not enough to curb the fund buying enthusiasm. By the way, once more the rally started in London, and then took New York along. Technical Focus: London keeps making new highs regardless the overbought condition of technical indicators. Only if the market breaks below 1645 it could start to trigger some sell-stops, but as long as it manages to hold the 1600 area it might just be called a correction of the uptrend. The “C” is consolidating and to kick sell-stops a move and close below 155.40 is needed. RSI and stochastic are overbought but if it trades sideways for sometime it can do the job of alleviating the condition.
Fundamental Focus: One of the references that we had to believe that the market would rally
towards the middle of the 2nd half of 2010, was the high differentials out of Central America and
Colombia. The simple rationale behind it was just a convergence of the board with diffs, therefore
we said on our presentation in Guaruja that a US$ 30cts/lb gain was quite feasible (but timing is
everything). I thought the weight of the Brazilian crop, which is not small, was the sole reason for
the “C” to be capped until there, and then the market would be free to escalate. Although it did not seem to be a consensus, many thought the same, but the surprise element played out, independently of being intentionally provoked as the lovers of Conspiracy Theory say. The reality is telling us that even though the market rallied 35 cts from where it was trading a couple of weeks ago, the differentials did not ease much. For mild coffee the reason is quite simple: they have little to none inventories being carried, and those who were holding back on their selling, certainly are not in a rush now.
On the Brazil side, it is not that difficult to figure out that producers are taking the opportunity to sell as the COT have showed us, but as several players were short differentials and were getting hurt, the basis did not dilated as much as one would think. BM&F/New York arbitrage is trading at US$ -21 cents/lb, or about 6 cents weaker than it was trading on June 9th. Bears are saying that they were able to buy coffee in Brazil at replacement cost of US$ -28 cts/lb, but for those who were paying R$ 300.00 per bag before the rally, a R$ 320.00/bag in fact represents only US$ 11.00 per bag more, comparing to US$ 46.30 /bag that ICE rallied. The constraints now are
how much more the buyers of physical can take, given that besides paying for the coffee they buy, they also have to send margin to the exchange. A sudden move higher like the one we just saw forces treasury departments to follow closer the trader’s position and risk might limit the exposure. If the market does not rest or go lower, it can trigger cash-flow problems. Back to 1997 the reason the market rallied was scarce availability/producing of mild-coffee, the same reason we are seeing today. Although ICE certified coffee is now at 2.3 million bags, and 13 years ago it was only 20K bags, the composition of the certs does not supply the industry of fresh washed coffee, which was the reason the board was being dragged lower. So the market got used in trading high differentials that got unlinked with New York, and now everyone is scratching their heads as the “C” went up but diffs did not. Does it tell you that more gains are needed? What if you sell the market at US$ 170.00 cts and funds buy another 10K to 15K, taking prices to US$ 200.00 or higher? People were looking to buy US$400.00 cents call today, and a couple of trades took place with the US$ 300.00 strike. In 2008 when the market traded at US$ 171.90 cts funds had a 55K lots long position and the OI was at 189,811 lots. Today they probably have a 40K lots net long (all futures only) and the open interest is at 164,101 lots. Weak-hands that are still short are afraid of being forced to cover their position, and as margins keep going higher the market can become even more volatile.
To finalize we should say that the more Brazil sells at current price-levels, the less they will need to sell later on, so differentials will get a lot tighter again.
Those who have coffee, and money, should not let this opportunity pass. At one point the market will have a strong move lower, but it is tough to know if it will first make shorts suffer or not.

The Conclusion
New York trades at the highest level since February 24th 1998. The last leg of the rally took place early in the morning, and caught the people that were short calls, which were forced to buy
futures to cover their exposure as the pit was closed. London once more started the move, and today it closed near the highs, causing fear on those who are short. Origin selling is mostly coming out of Brazil, as other origins do not have much coffee, but exporters and dealers need the market to calm down not to constrain the cashflow.

Differentials have not changed much besides the US$ 35 cts rally, mainly because no CAM or Colombia have coffee enough to sell. If we compare the fund position to the last time the market traded at US$ 170ish, they got long 55K lots of futures and the open interest was at 186K lots. Assuming today they have a 40K lots with an OI of 164K lots, they could buy another 10K to 15K lots as the number of contracts open keep increasing. The more Brazil is selling the market
on the rally, the least it will need to sell down the road, which does not mean that the “C” can not
drop US$ 20 cents of more once funds decide do sell.
The question is: Will the market trade higher first to then collapse, or it has seen the highs for now?
Funds (that are long) are certainly getting the positive variation margin, therefore giving them
more bullets to play right now. Use options to buy price-protection for levels that
you feel might provoke cash-flow constraints.Have a good day and good trades.
Best Regards,
Rodrigo Costa