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Markets: Coffee: Ready For a Perk-Up?
New York: May 23, 2005
By John R. Stephenson

There are few things that North Americans enjoy more than a good cup of steaming coffee to start the morning. And with a Starbucks on ever corner, charging north of three dollars for a latte, you might just think that things are pretty good for coffee growers the world over. Think again. In fact, in the early 2000's, coffee prices hit their lowest levels in decades.

Most of us half-caf-latte-with-a-twist lovers have probably never realized that coffee itself is a traded commodity whose price rises and falls by the laws of supply and demand. And why would we? Based on the inflated prices we have been paying for our morning indulgence, it probably wouldn't occur to most of us that this is a commodity that just might be ready to finally start soaring after languishing for decades in the basement.

Over its history, coffee has arguably been the second most important commodity in the world after oil. But business has been terrible for coffee producers of late, with coffee prices plunging to 41.50 cents per pound in December of 2001. This is a long way from their high of $3.25 a pound reached in 1977. While things may look rosy in your local Starbucks, things are definitely bad in coffee land where the price of the bean has been below the cost to grow and produce that coffee bean for many years. With low prices and high costs, growers in the fourteen major coffee producing countries of the world have been exiting the business in droves. In Brazil, the single largest exporter of coffee in the world, discouraged growers have taken to ripping out their coffee trees and replacing them with more profitable crops such as soybeans and sugar cane.

Coffee, like all commodities, follows a boom and bust pattern. But unlike many cash crops, coffee takes a long time to come to market. How much time? Coffee seedlings take years (three to five years on average) to come to fruition. A lot of effort goes into the planning and planting of coffee fields. For starters, there's two main types of coffee beans that dominate the world market: robusta and arabica with arabica being the milder (half the caffeine of robusta) and less robust coffee that is preferred by North American coffee drinkers. Arabica beans account for seventy percent of total world production and are grown at high altitudes (generally over 3,000 feet) making Brazil and Columbia ideal producers for this most special bean. But both the robusta and the arabica bean are grown on coffee shrubs in tropical climates with lots of rain.

Once the beans are ready for harvesting they are picked, graded and sorted (usually by hand) and then bagged and shipped to roasters around the world who transform the green coffee beans to the various familiar shades of brown with the characteristic aromas that are known to coffee lovers around the world. It takes a lot of beans to make a pound of coffee. In fact, it takes some four thousand beans just to make a single pound of coffee. When you consider that the average coffee tree might produce just one to two pounds of coffee a year, you begin to realize just what a massive undertaking it is for the poor coffee grower to make a buck these days.

Not only is it difficult, time consuming and expensive to grow coffee beans but the weather, as in any form of agriculture, can wreck havoc with your crops. Every decade or so you get a bout of bad weather that curtails coffee production - this decade, we're still waiting for that bout of bad weather.

But what is really driving supply down is the classic boom bust scenario that you see in many commodities. The 2002-03 harvest was a record breaker with production soaring to 120 million bags. With good production years in the 1995 to 2003 timeframe, coffee production outpaced demand, which led to a backlog in inventory of a five-month, supply. Back then, analysts were grumbling about when all the inventory would be used up. The result of these high coffee inventories? The price of coffee crashed. In turn, many producers in Brazil and Columbia were forced to abandon their marginal coffee growing fields.

While things may be tough for the growers, we consumers have it pretty good. But many of us in North America would be surprised to realize that coffee is not as popular throughout the world as it is at home. While coffee reigns supreme in the United States and Germany (17 percent of world demand), followed by Italy, France and Japan (all at 9 percent of world demand) most of the Asian market is comprised of tea drinkers. While thoughts of Chinese coffee drinkers fill the imagination of coffee traders, the annual per capita consumption in this nation of tea drinkers is estimated at less than half a pound a year. Contrast this with America where the per capita consumption of coffee clocks in at some 20 gallons a year. While China and its Asian neighbors may have a way to go before their consumption rivals our own, there is reason for optimism. Japan, a traditional tea-drinking nation, has become a significant coffee consuming nation over the last several decades. But with more and more people switching from tea to coffee, the prospects for coffee demand look promising indeed.

With coffee supplies waning and demand increasing at a steady 1.3 percent a year, the fundamentals for higher coffee prices appear to be in place. While supply has started to dwindle over the last few years, demand has remained on a fairly smooth trajectory - setting the stage for demand to outpace supply for the next several years. This means one thing - higher coffee prices are likely here for some time.

Investors looking to profit from a strong bull market in coffee and other commodities should consider investments in commodity mutual funds such as the PIMCO Commodity RealReturn Strategy, the Oppenheimer Real Asset Fund and the Merrill Lynch Real Investment Fund.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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