ETF Investor Appetite For Coffee Heating Up

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ETF investors are starting to pour into coffee. After dripping a whopping 30% this year, a fresh bull market in the commodity could be brewing, a commodity expert says.

IPath DJ-UBS Coffee Subindex Total Return SM Index ETN ( JO ) rose 0.5% Tuesday, after gapping up 2.6% Monday. A more thinly traded note,iPath Pure Beta Coffee ETN ( CAFE ) surged 0.8% Tuesday.

On the NYMEX, coffee for December delivery traded at $1.67 a pound Tuesday. Coffee for July 2014 delivery traded at $1.90 a pound, which suggests traders expect more scarcity in the future.

The rally Monday was mainly driven by short covering due to fears Hurricane Isaac would disrupt shipments from South and Central America into New Orleans, the earthquake in El Salvador and traders closing out positions ahead of the Federal Reserve's scheduled speech Friday, said Jack Scoville, vice president of the PRICE Futures Group, a Chicago-based brokerage.

"Fed meetings excite people to get out of shorts and head to the sidelines," he said.

Bull Market Brewing

Shawn Hackett, president of Hackett Financial Advisors in Boynton Beach, Fla., sent out a special alert to his clients last weekend recommending coffee as a buy. He projects coffee will reach $2.50 a pound over the next 12 months and $4 a pound over the next two years.

Heavy rains this summer in Brazil damaged Arabica coffee crops and caused trees to bloom prematurely, hurting their ability to flower and grow buds abundantly, Hackett wrote. As the world's largest coffee producer, the South American country accounts for about a third of all global supply. He expects Brazil to produce 45 million bags next year, 10 million fewer than this year.

"Also, the likelihood of El Nino-reduced Robusta crops in Vietnam and Indonesia next year will further exacerbate this impending supply squeeze," Hackett wrote. Commercial traders -- the so-called smart money -- have loaded up on coffee contracts. Hackett says he hasn't seen them this bullish since 2003 and 2008.

"Both times preceded fantastic multiyear bull market moves," Hackett wrote.

The dollar-denominated commodity has been rising like most others, owing to the greenback's weakness on expectations of more quantitative easing.

Investment Risks

The biggest risk to buying commodities is a recession, which would weaken demand. Bag counts from producers are "notoriously unreliable," says Mark Garrigues, an independent commodities trader. It's in the producers' best interest to keep supply data secret.

In his 25 years trading coffee, he's noticed the market tends to find new supply when nominal prices reach $2.75 to $3 a pound.

Commodities markets suffer from "price contamination," in which suppliers withhold shipments because prices have increased since they signed the contract. There's always a risk that the coffee won't make it to the port or get shipped on time, Garrigues says.

Technical View

JO has slumped 30% year to date and 45% in the past 12 months. JO trades below both its 50- and 200-day moving averages, which is very bearish.

So far it appears to be staging a countertrend rally in a downtrend that started in May 2011. Its IBD Accumulation-Distribution Rating declined from an A to C over the past six weeks, which is bearish. Its Relative Strength Rating is a very low 10 on a scale of 1 to 99.

As an ETN, JO is a debt note that tracks cocoa and coffee futures prices synthetically. It doesn't own actual contracts in the underlying commodity. Investors must trust the issuers to deliver those returns, which can be affected by the issuer's credit quality.

PowerShares DB Agriculture Fund ( DBA ) tracks 11 different commodities contracts, holds a 7.5% weighting in coffee. It's up 3.5% year to date and down 12% in the past 12 months.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: CAFE , DBA , JO

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