Coffee ETFs Tumble, What's Behind The Slump?

Coffee – a top-performing commodity in 2014 – returned a fabulous 50%. The winning streak continued into the New Year as drought conditions in Brazil – the primary driver of coffee’s incredible run-up last year – continued to play foul. Brazil is the world’s top coffee producer and supplies about one-third of the world’s coffee (read: Can Coffee ETFs Continue to Stimulate Robust Returns?).

However, coffee prices have recently been badly hit, falling to their lowest levels in a year as improving weather conditions in Brazil took investors by surprise. Moreover, there are expectations of more rains going forward. This has raised fears of abundant supplies, dragging coffee prices lower.

Also, increasing output levels from Colombia and some Central American countries have boosted the supply of coffee. Coffee plantations in Central American countries have recovered from the disease known as la roya more strongly than previously projected.

Moreover, Volcafe – the coffee trading arm of ED & F Man – has forecast a smaller global coffee deficit of 1.4m bags in 2015-16 compared with a deficit of 8.9m in 2014-15.

Market Impact

Due to the mercy of the rain gods in Brazil, Dow Jones-UBS Coffee ETN (NYSE:JO) and Pure Beta Coffee ETN (NYSE:CAFE), the two ETNs tracking the commodity coffee, have slumped badly in the last few trading sessions. The products have lost more than 10% in the past one week, erasing the beginning of the year gains. They are now down roughly 14% year to date.

Given the recent crash, investors might want to stay away from these products for the time being to avoid any further losses. Below, we have highlighted some of the details about these funds, for investors who wish to play the two ETNs cautiously.

JO in Focus

The most popular option in the coffee market, this ETN holds front month coffee futures for exposure to the commodity. The note charges investors 75 basis points a year in fees, and looks to follow the Dow Jones-UBS Coffee Index.

The product usually sees volumes of about 70,000 shares a day. It has amassed about $52.1 million in assets so far. JO has lost 11.7% in the past one week.

CAFE in Focus

This ‘Pure Beta’ ETN adopts a slightly ‘active’ approach. The product charges investors 75 basis points a year in fees, and looks to select the futures contract that best mitigates the impact of roll yield on the underlying investment.

Unlike many commodity indices, which roll their exposure to the corresponding futures contract schedule, the Index may roll into one of a number of futures contracts with varying expiration dates, as selected using the Barclays (LONDON:BARC) Capital Pure Beta Series 2 Methodology.

This product is still overlooked by investors, as it has just about $6 million in AUM, while about 6,000 shares change hands each day. This ETN has lost 15.7% in the past five days (see all Agricultural ETFs here).

Bottom Line

Many experts, however, believe that the recent fall in coffee prices is just a temporary phenomenon. After last year’s severe drought, regular rainfall is required to ensure good production this year, which seems quite unlikely.

In fact Commerzbank (XETRA:CBKG) notes, “with the outlook of another unsatisfactory coffee harvest in Brazil amid much lower inventories as a result of strong exports, we are looking for coffee prices to climb over the next few quarters.”

On the same lines, the International Coffee Organization expects total global coffee production to drop to about 141 million bags of beans this year, from 146.7 million last season, due to Brazil’s weather problems.

Given this, investors should clearly wait for a clear trend to emerge before investing in coffee products.

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