Commodity ETF Alert January 2010 Issue

I start every morning with a nice hot mug full of java… then I have a few more mugs before lunch… then a few after.

Sometimes I think I’m singlehandedly supporting Starbucks’ growth… not to mention the profits of a number of other coffee shops in the area.

I’m not alone.

Coffee is now one of the most widely consumed drinks in the world.  The commodity is the second most traded product… behind only oil.

Its popularity can’t be questioned.

All around the globe, consumers are craving the jolt they get from coffee.  And that leads to a huge trend I see pushing prices higher.

Skyrocketing consumption trends will drive the price of coffee up.

But I see more than just macro trends… The end of the recession and extremely cold winter weather will be short term drivers of coffee prices.

We can see this in a number of different ways… notably, growing stock prices and an uptick in shipping prices.

Before we get to all that, first a little history.

About Coffee Plants

Coffee is thought to originate in Arabia sometime in the 15th century.  From its humble beginnings, coffee has grown into a multi-billion dollar a year industry…

Coffee is an agricultural product and the coffee plant is actually more like a tree.  It grows to a size of 10-12 feet.  There are more than 15 billion coffee trees grown worldwide.  (Clearly we love our coffee!)

Here’s an interesting fact you can toss out the next time you’re drinking coffee:  The caffeine produced by the coffee bean is a toxic substance.  It’s produced to repel animals that would normally eat the beans.

Coffee beans grow over a nine month period.  They are then harvested and processed.  The long growing season makes this agricultural produce particularly susceptible to bad weather.

Coffee plants thrive in tropical regions, and as a result, can’t stand freezing temperatures.

Raw shelled coffee beans are grouped into 60 kilo bags (about 132 lbs).  Real coffee aficionados know there are only two types of Coffee beans that are important… Arabica beans and Robusta beans.

• Arabica beans account for over 60% of world production.  It’s the richest tasting and most expensive bean.
• Robusta is easier to grow, however, it has less flavor and is less expensive.

Where Beans Grow

A few countries dominate the production of Coffee beans… the largest is Brazil which produces more than 36 million bags annually.

As we mentioned above, Coffee plants are sensitive to weather.

It’s not uncommon to see Coffee prices fluctuate on reports of rain or cold weather in Brazil.  June is when the Coffee harvest begins. It’s always important to watch the markets around this time.

Other big producers include Columbia, producing 16 million bags, and Vietnam, producing 12 million bags.

Other producers include Indonesia, India, Ethiopia, Mexico, Guatemala, Honduras, and Uganda.  They all produce 3 million bags or more a year.

How Popular Is Coffee?

According to the Wall Street Journal, 54% of Americans drink coffee on a daily basis. That adds up to an astonishing 400 million cups per day!

And China is a big area of growth.  As China becomes more westernized, the demand from that region alone is expected to double in the next few years.  Tea has been a long time favorite in the country.  However, coffee is making inroads.

In 2006, Coffee demand in China was 45,000 tons… At the same time, US Coffee demand was 1.4 million tons!  And China’s population is 5 times the size of the US… you can see the growth potential.

Clearly the long term trends for Coffee demand are in place.  Short term, there’s a number of events pushing demand higher as well.

Short Term Drivers

The two big short term drivers in Coffee prices right now are the weather and the recession.  Let’s look at each one independently.

First the weather.  Right now we have cold fronts moving across the US and we’re clearly in the heart of winter.  The cold weather drives consumers to seek out warm beverages… and coffee is a top choice.

The other driver is the recession.  During tough economic times, many consumers cut back on their daily Coffee fix.  Now that we’re seeing positive momentum in the recovery, Coffee is sure to make a comeback.

The cost of a cup of premium Coffee is low.  As a result, we’ll see consumer demand return a lot more quickly than consumer demand for say… a new house.

We are already seeing the demand grow, just look at Starbucks (SBUX).

Starbucks, as you know, is one of the largest consumers of Coffee.  They are set to announce results on January 20.  If their recent stock price action is any indicator, the company’s announcement should be positive.  Just look at the chart.

Another way to measure increasing demand is to look at shipping.

Remember, most of the Coffee is grown in tropical regions.  To get the product to end up in markets like Europe or the United States, Coffee bags need to be shipped.

The easiest way to measure shipping is to look at the Baltic Dry Index.  You’ve heard me mention this index before.  It’s a way to track in general terms the cost of shipping freight across the ocean.

A big portion of the products shipped are commodities…

What we see is shipping costs are rising… and that implies more commodities are being shipped around the world.  Coffee is a major commodity that needs to be shipped… it’s another way to see demand taking place.

Clearly, Coffee demand is set to move even higher.  Long and short term drivers are in place.  So what’s the best way to profit?

ABOUT COFFEE

For this trade, I want to use the iPath DJ UBS Coffee ETN (JO).

The movement of the ETN is based on an index tied to Coffee commodity futures.  The ETN itself is traded on the NYSE Arca exchange.

TECHNICALLY SPEAKING

Both the 200- and 50-day moving averages are moving higher.  This is a great sign prices are poised to move even higher.  The JO appears to be riding the 50-day moving average up… as a key level of support.  Recent pullbacks give us a great entry point.

The key resistance level for this ETF is at $45 and again at $47.  With the recovering economy and increasing consumer demand, we could easily see Coffee surpass these levels in the next few months.

The iPath DJ UBS Coffee ETN (JO) is trading at $41.14.
Buy JO up to $42.50 per share.
Our Profit Target is $52.50.
Don’t forget your position sizing.

ENERGY COMMODITIES

After falling by 5.7% in November, the energy industry rallied in December, jumping 7.6%.  The big driver was oil prices.  Investors started looking to the New Year and optimism started to influence prices.

Oil is up and now trading over $82 a barrel.

Natural Gas prices also rallied as cold winter weather hit most of the US.  Here’s the deal… the cold weather is only going to get worse… and that means more demand for heating oil and natural gas.

I’m expecting the entire energy complex to continue moving higher on further cold weather and the economic recovery.

Our trade in Crude Oil (OIL) is going great!  We told everyone to buy when we were below $25.50.  Now we’re well above the buy up to price… I’m moving this to a hold.

Natural Gas (GAZ) recently climbed to over $15.  Long term, I see this as a great trade.  If you don’t have a position yet, consider buying this commodity below $15.50.

GRAIN COMMODITIES

Grain prices continue marching higher… economic growth assumptions are driving prices.  Corn might see a further boost this year as increasing ethanol production could be a big demand driver.

We’re still a few months away from the planting season… so we might see prices jump as uncertainty surrounding planting takes hold.

INDUSTRIAL METALS

Industrial metals really climbed last month.  Prices were up 9.0% on renewed optimism around economic growth.  Copper prices continued to rally, hitting our price target just a few days back.

Congratulations on a great trade!  Everyone should have grabbed gains of at least 56%.  If you haven’t exited the Copper trade, go ahead and take your profits now.

Our Aluminum trade continues to perform nicely.  We’re up 24% already… keep holding for bigger gains.

PRECIOUS METALS

Inflation continues to be the focus in the precious metals market.  After pulling back in December, both Gold and Silver have posted nice gains in the early part of 2010.

I’m expecting both commodities to move higher.  The key driver will be unemployment numbers.  As they improve, inflation concerns will worsen.  Our Silver and Gold trades are climbing… hold tight for now.

SOFTS

The softs complex racked up a gain of over 7.6% in the last month.  Coffee, Cocoa, and Cotton are up slightly.  Sugar hit new highs just a few days ago. 

The real mover is OJ.  Concerns over a freeze in Florida have caused prices to really jump.

LIVESTOCK

The livestock commodities seem to be range bound.  Low sales prices and climbing feed costs are giving a one-two punch to meat producer profits.  I’m watching closely for a breakout.

• This month we’re adding Coffee (JO) to the portfolio.  See above for all the details.
• Oil is now above the buy-up to price… I’m moving OIL to a hold.
• Copper (JJC) hit our price target… take your 56% profits now. Congratulations!

Category: Commodity Trading