Evening Coffee by Societe Generale

BASIS NOT REFLECTING REPLACEMENT IN BRAZIL
                           
The FOMC statement was just “less-dovish” than the previous one and it was not even perceived as slightly-hawkish as the performance of the Dollar Index has showed to us. In a matter of three sessions the DXY gave back all the gains it had accumulated during the month of July, having a steep decline last Friday after the poor 2Q US GDP data and the lower revision of 1Q. Stock markets are pretty much unchanged with the S&P500 making new highs on renewed bets that “bad is good”, meaning that further quantitative easing will pop up from one of the top four central banks. A hike by the FED is now expected only by December, if at all, and this week non-farm payroll numbers will keep confirming that the peak average  job creation happened back in 2014 and has not stopped to slow down ever since. The weakness of the greenback did not interrupt the price fall of crude oil, which is under pressure due to seasonally high inventories and a reviving number of rig counts – the later likely to ease if WTI does not hold at least above the US$ 40.00 a barrel. Coffee in NY tried to break below US$ 139.00 cents/lb a couple of times not finding  follow-through selling on the recent lows and then attracting new buying with a 4.00 cts gain on the last day of July – helped quite a bit by the Brazilian Real moving from 3.2983 to 3.2284 on that day. Today the BRL slid and so did the “C” – a correlation that shall persist driven by algo-traders. London looks better on the charts besides today fall of US$ 30/ton, being a lot closer to the recent highs than arabica market. A slow summer month has already been felt on the below average volume traded in the past six days, likely to bring more volatility in the next four weeks. 

Fundamental Focus
According to Safras & Mercados Brazil has harvested 70% of the 16/17 crop, estimated by the same entity at 54.9 mln bags. If you ask local merchants in Brazil though they will tell you that it does not feel that much coffee is ready to be traded, but one of the reasons is the amount of forward deals that has taken place and therefore the farmers are concentrating their efforts to meet their compromises. Another factor impacting the internal market is the demand by the local industry, which is suffering to cover their needs in a year of lower conilon production. To alleviate the current high prices of lower grades the government has decided to sell half of its inventory, or about 611k bags, in bi-weekly auctions. The first one happened last week, when 67k bags offered were traded at average price of R$ 448.88 per bag. The whole situation in the major origin naturally make local traders/analysts very bullish with thoughts that the farmers will at no point sell coffee below R$ 500.00 a bag – not now at the period when more offers should be available, and even less down the road. Replacement levels being very steady, also a reflection of all the local demand and the perception that the coffee board will not trade much lower than prices seen recent, becomes a self-fulling prophecy, at least in the short-term. The next data that will get bulls more excited will be the July exports, likely to be near the low 2 mln bags figure – the lowest level of either Jul-13 or Jul-12. Differentials offered on the FOB market though, in general, are not reflecting the replacement levels mentioned, being still offered at historical “cheap” discounts (that is what the bears are looking at). In fact bears also see mild-coffees being offered at cheap differentials, exactly at the peak of the off-season. ICE inventories are not changing much, with coffees being graded and commitment lots being drawdown, therefore it remains at just about 1.3 mln bags. Those who are looking for a lower “C” market are also arguing about the stocks at consuming countries being kept at comfortable levels, with some final users saying that availability is enough and at attractive prices therefore not making them in any urgency to rush for more coverage. ECF last week said that on May 31st there were 12.078 mln bags in European Ports, 298,200 bags more than in April, and 28k more than the 12,050,767 stored a year ago. Bears also argue about the fund position that is at 35k lots, probably near 40K lots as of today, but who said that funds cannot buy more? At the end everyone is seating tight with their positions, some buying a lot of upside protection, as the risk/reward certainly favors for a rally in case there is a drought or any significant production disruption, while others are or have been short for quite some time and after suffering the pain when the market went to 155.00cts, why not to be resilient and wait for another 10 cents liquidation to then book some profits? As for the farmer’s “retention” in the old days we used to see producers holding back their sales until the market finally shows weakness and then the commercial short-position tends to increase with price fixation from those that do not want to be left far behind on selling their coffee – which sometimes coincides with price levels that are at the bottom of any given range (135 / 155 nowadays?). The best gauge, which will tell if the market will bounce or sink from current levels, will be the BRL at this point, either due to algo-participation or eventually natural player’s interaction. Dilma impeachment, to be confirmed in August by the Senate, could be the trigger to attract more money to Brazil, firming up the Real. On the other hand, inflation remains high in the country and green shoots are not significant to eventually make one very enthusiastic about the largest economy in South America. At the same time in a World thirsty for higher yields maybe Michel Temer becoming president and under his leadership taking the congress to approve reforms might be suffice to attract more inflow of money, which if it takes the BRL to 3.00 will make the recovery of the economy slower, but at least will sign that the country is back on the right path.

Technical Focus
A triangle formation was broken to the upside on Friday’s US$ 4.05 cents move in NY, given the impression that the market would trade above US$ 148.00 cents today and invalidate a head-and-shoulder pattern, but it failed to continue the positive momentum. Below average volumes make it harder for technical players, but it seems like August will not be a very active month, other than the spread activity that shall pick up from now on. Resistance for the Sep16 contract is at 144.70 tomorrow, followed by 146.35, 148.00, 151.30 and 154.80. Support levels are at 142.65, 140.80, 139.05, 137.00 and 134.60. London first resistance is at 1852, and then it will aim for the recent high, 1866, and 1913. Support levels are at 1806, 1782 and 1765. 
 
Have a good week and good trades,
Rodrigo Costa