Trading Places for a Cup of JO

Eddie and Dan traded orange juice in Trading Places. I'm investing in a cup of JO for my stock portfolio.

Eddie and Dan traded orange juice in Trading Places. I’m investing in a cup of JO for my stock portfolio.

I’m always trying to learn something new and look for new investment ideas. So a couple of months ago, I picked up “Hot Commodities” by Jim Rogers and started reading about commodities. I wish I would have read it back when the book came out in 2004 when the bull market for commodities was just getting started. It’s a great intro and it provides a great overview of the different dynamics of various commodities. His philosophy of investing in long-term trends also fits my style. Anyways, I did a bunch of research and recently invested in a cup of JO.

What’s a commodity?

Remember the movie Trading Places where the too old Wall Street bigwigs make a bet with each other that they can transform a homeless Eddie Murphy into a successful trader by having him switch places with Dan Aykroyd, a stock market hotshot. In the end, Eddie and Dan figure out that they are just pawns in the old men’s wager and they team up and make a killing on orange juice, turning the tables on the two old bigwigs. Anyways, frozen concentrated orange juice is a commodity. And so are oil, sugar, copper, gold, wheat, and other basic materials.

Commodities are cyclical and ultimately go up and down based on the balance of supply and demand–that’s the key to commodities as espoused by Jim Rogers. Unlike equities, where a bad company could go bankrupt and send the stock to zero, commodities do not go to zero. But they may stay at a low price for an extended period of time. Commodities have been hammered the past few years–pretty much led by the crash in oil prices. Oil is the biggest commodity and I’m still doing research on it. But my interest was perked (note to self: tell my son Matthew that this is a pun) when I read about coffee in Jim Roger’s book. I started doing a bunch of research and got more interest in coffee as an investment in its current commodity cycle.

Why is coffee so interesting?

Coffee is unique because even though it is an agricultural product that’s grown, it acts like a metal, as Jim Rogers phrased it. It takes three to five years for a new coffee tree to start bearing fruit (coffee beans are the seeds of the berries), so farmers can’t just switch their fields to coffee from one season to another, like one might do between corn and soybeans.

Coffee is not as directly tied to oil as are many other commodities. For example, the production (and thus price) of sugar cane into sugar is highly influenced by the price of oil. During oil price booms, Brazilian producers switch their sugar cane production from sugar to ethanol which reduces the supply of sugar and, thus, causes the price of sugar to rise. If I’m looking for a high correlation to oil, then I’d probably just invest directly in oil. So coffee not being tied directly to oil has its appeal to me.

But the interesting thing about coffee is that it’s like a high-maintenance spouse, or so I’ve heard (since I don’t have one myself–ha ha!). Coffee requires just the right climate (not too hot and not too cold–just like Goldilocks) and just the right amount of water and at the right time. What this means is that severe weather (droughts, frost, etc.) can wreak havoc on current year production. This in turn is what creates price volatility and major price spikes. And that’s what you want to take advantage of with commodities trades. And with climate change, severe weather patterns and events will only occur more frequently as we have witnessed over the past decade or so.

My trade:

I recently bought some JO as an opportunistic medium-term trade rather than a core investment I plan to hold forever. JO is the iPath Bloomberg Coffee Subindex Total Return ETN, which tracks a single, front-month coffee futures contract. An ETN is an exchange-traded note and is similar to an ETF, in which most index funds are traded. JO trades like a stock so you don’t have to mess directly with the more complicated futures contracts.

A combination of factors starting in 2010 (Certified stocks of coffee beans were running down to extremely low levels and coffee stocks of coffee beans in general were drawing down; from a macro standpoint, quantitative easing made money cheap and some of that money was flowing into agricultural commodities; and there was a very strong technical break out causing the trading higher. Corrected–see note below.) caused coffee prices to spike to over $3.00 per pound in 2011 and a severe drought in Brazil (where over 30% of all coffee is grown) in 2014 caused another price spike to $2.25 per pound. I’m playing for a similar peak in the cycle.


Those price spikes resulted in corresponding prices to JO of $80 and $40 versus its current price of $19.50. I’m targeting a spike in the price of coffee to over $2.00 per pound and a similar move in the index price of JO to over $40. I might have to hold this for five to ten years to realize that spike. But, if JO doubles in 7 years, that’s a pretty good 10% annualized return.

Coffee prices can spike and then return to a more balanced normal in a short time frame, so I’ll have to keep an eye on this regularly.

My investment thesis:

Coffee appears to be near a trough in its cycle. It’s not at historical lows, but at a price significantly below the major price spikes coffee has had over the past 40 years. Consumption of coffee continues to grow worldwide–plus I’m a believer in the long-term demand for coffee in China as it continues to develop. Production also seems to be growing in balance with demand. Here’s some of the stats:

  • Coffee prices are currently at multi-year low around $1.266/lb. From the chart below, there were seven peaks in price above $2.00 per pound during the last 40 years–that’s one ever six years on average.


  • Global demand is strong and growing. The International Coffee Organization (ICO) forecasts that the demand for coffee will increase by nearly 25% over the coming five years. Currently, consumer intake of coffee stands at 141.6 million 60 Kg bags of beans; but by 2020, coffee demand is slated to rise to 175.8 million bags (each weighs approximately 132 lb.). Source: Time. Global demand compound annual growth rate (CAGR) of 1.05% for 2011/12 to 2015/16 growing seasons. Source: USDA’s Foreign Agricultural Service.

 Global #coffee consumption has increased by 2.5% annually since 2000. That’s a 38% increase since that year. We humans like our coffee. A discussion about coffee consumption growth rates on Twitter inspired us to take a look at our database and calculate the historical increase in the consumption of our favorite drink. By the way, we are in the process of completely redesigning our website so that information like this is more easily accessible. Follow us here on Tumblr, Twitter, and Facebook for updates. Thanks to @ArteBiancaDeli and @Newlite_co_uk! Hope you’re enjoying your coffee. Cheers!

Source: ICO.

  • Global production is in line with demand. Production has grown from 142.2 million 60Kg bags in 2011/12 to 148.3 million 60Kg bags in 2015/16 for a CAGR of 1.07%. This is in line with consumption’s CAGR of 1.05% for same period. Worldwide ending inventory stocks are trending back down and forecast to be 36.7 million 60Kg bags this year. Source: USDA’s Foreign Agricultural Service. And certified stocks of coffee at New York’s ICE exchange warehouses are under 1.4 million bags, a level not seen since 2011. Source: ICE.

  • Other issues:
    • I see government investment or initiative to develop coffee production by China as a possible overproduction risk. China does have some tea growing areas (famous Pu’er region) where farmers are now switching to coffee for the higher prices they can obtain for coffee. Local government seems to be investing in coffee in that region too, so there’s a potential supply glut in the future. However, I also believe in the trend towards high quality demand, which I think mitigates the glut of poor quality beans. It may also take a few more years for new producing countries like China to learn and develop processes of quality coffee growing, which mitigates some of the risk in the medium term. Another mitigating factor on the production side is that harvesting is very labor-intensive (hand-picking), which also hampers mass production for most producers (Brazil farms coffee on plains and uses machine harvesting).
    • There’s also a supply side risk that, because of the spikes in coffee prices in 2011 and 2014, farmers added to their coffee acreage in the past couple years. If so, those trees will be producing in another couple of years and add to the production counts, thus putting downward pressure on the price of coffee.
    • On the positive side, I think a push toward more Fairtrade and sustainable coffee adds some upward price pressure for coffee. Prices paid to farmers are increasing and input costs, like fertilizer, are rising too. If it costs more to grow coffee, then the price we have to pay for it needs to go up.

Additional resources:

Lessons to my kids: Always do your homework and formulate your point of view before making an investment.

Disclosure: The author is currently invested in JO. Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation. The views expressed in the article are the author and the author’s alone.

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