Coffee smells stronger at a 5-month high

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Coffee futures touch a 5-month high on production drop and weaker US Dollar. But is there more room to the rally?

The May contracts for Coffee Futures continues to see a bullish run in the markets as prices touched a 5-month high on Friday. Coffee futures, KC_6K settled on Friday at 133.85 marking a third consecutive week of gains supported by a weaker US Dollar which is at a 5-month low and weaker production levels expected from Coffee exporting countries such as Colombia, Brazil and Vietnam. The rally comes after a rather frustrating and a prolonged bearish trend in the markets. In fact, since August 2015, Coffee futures have remained largely flat, trading within 138 highs and 112 lows.

Coffee production is expected to fall by 24% or around 3.9 million bags on a year over year basis in Brazil, according to some analysts at Rabobank. This is due to the drought that has impacted the Coffee crops in key regions in Brazil as well as in Vietnam, which is likely to impact the Robusta output. Some of the key Coffee contracts, including Arabica and Robusta, have managed to break out from their prolonged downtrend, raising speculation that there could be more legs to the rally. The fall in production in Coffee due to the weather in parts across the globe, due to the El Nino effect has also raised concerns that Coffee production is getting to be highly concentrated in just a few countries, according to another analyst, Judy Ganes-Chase.

The price moves in Coffee futures comes from a broad commodity rally over the past weeks. Gold, Crude Oil and equities have all managed to post significant gains especially after the Federal Reserve opted to leave the Fed funds rates unchanged at the March 16th meeting and struck a dovish tone in the markets sending the US Dollar weaker across the board while providing some bullish sentiment in the commodity markets. With the fundamentals currently pointing to a weaker output from the key Coffee producing nations, further, gains cannot be ruled out.

Technical Outlook – KC_6K/Coffee Futures

Following the long term descending triangle that prices consolidated into, Coffee futures broke out from the consolidation pattern, clearing the first resistance level near 126.70. A continued bullish momentum is likely to see prices test the next big resistance at 138.10 – 138.0, previously tested on three occasions around September, August and June of 2015. it is likely that the resistance level will hold on this fourth test which could likely result in a pullback in prices, falling towards 126.70. Establishing support on the broken resistance here could then pave the way for a break of the upper resistance (138.10 – 138.0) resulting in a potential rally that could see 159 – 160.20, which was a major support level that was broken. The rally to this level could then see the support turning to resistance and could see another pullback to the 138.10 – 138.0 to establish support.

Validating the view is the 200-day moving average, which currently stands just below the 126.70 level.

Coffee Futures Chart (Continuous contract): Breakout from the descending triangle
Coffee Futures Chart (Continuous contract): Breakout from the descending triangle

Although Coffee futures are still not out of the woods (the big test comes in at the 138.10 – 138 resistance) a break above the key resistance levels of 138 could certainly bring about a cheer in the commodity which has remained suppressed for well over half a year. Watch for the pullback to 126 region for Coffee futures to continue their rally towards 138. Above 138, 159 – 160.2 will be the next big level to watch. Alternately, failure to find support at 126 and a lower high below this level could see prices continue to move sideways.

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