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Coffee ETFs Soar on Brazil Drought Concerns

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In 2013, commodity investments were quite poor across the board. Speculation of a stronger dollar—and a heavy preference for equity investments thanks to surging markets—led many to abandon natural resource picks for the time being.

However, to start this year, commodity investments have been doing a bit better. Equities have been slumping while a number of commodity specific factors have also hit the market, leading to bullish conditions. While this has been the case in a number of segments to begin 2014, it has been especially true in the coffee market (also see Corn ETF Surges on Surprise Harvest Estimate Cut).

Coffee in Focus

Coffee had a horrendous 2013 as a huge wave of supplies hit the market, demand levels were uncertain in many corners of the globe, and general interest in commodities plunged. Though due to recent weather in the world’s top growing country—Brazil—the tide might be turning for this commodity.

That is because there is a severe drought in the country’s southeastern region, which is also the main growing region for the crop. Additionally, Brazil has seen the hottest January ever, and the least rain for the month in at least two decades, according to Marco Antonio dos Santos, an agronomist at Somar, for a Bloomberg article.

Add this drought into the fact that Brazil’s dry season is right around the corner in April, and there is plenty of concern that water levels available for the coffee will be rather low this year. And if this happens, it could definitely impact the crop and send fresh supplies of coffee crashing (see all the agricultural ETFs here).

Due to this speculation, coffee futures have been on a tear, with huge gains seen in the crop. Plus, thanks to the long term trend lower on coffee, there was also a bit of a short squeeze in the commodity, pushing coffee to a gain of more than 7% on the day, and 20% since the start of 2014.

Thanks to this boost, coffee is now riding high, and some investors might be looking at a way to target the crop, either as a long momentum play, or to make a bet on a slump in the product in the next few weeks. While futures are definitely an option, some investors might want to take an exchange-traded product route instead.

ETFs to Play Coffee

Currently, there are two ways to play the coffee market in exchange traded form. Either of these products could be interesting selections for investors seeking to make a bet on coffee, assuming it can keep up its new found momentum:

iPath Dow Jones UBS Coffee ETN

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 it looks to follow the Dow Jones-UBS Coffee Index.

The product usually sees volume of about 160,000 shares a day, but saw close to 900,000 shares move hands in Monday’s session. This came on a move higher of nearly 8.5%, though the ETN is still down over 18.9% in the past one year time frame (see 3 Commodity ETFs to Watch in 2014).

iPath Pure Beta Coffee ETN

For a slightly more ‘active’ approach, investors have this ‘Pure Beta’ ETN. 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.

This approach hasn’t really caught on with investors, as it has just under $10 million in AUM, while its volume is usually around the 25,000 share a day mark. However, in Monday trading, it saw volume of about 117,000 shares, while its price moved higher by nearly 7.9%.

Still, the ETN is down over 18% in the past year, suggesting it has a long way to go to get back to the positives, or even to hit the broad agricultural ETF (DBA - Free Report) and its -10% return over the past year.

Bottom Line

Coffee futures have been a terrible investment thanks to an unfavorable futures curve, and concerns over a supply demand imbalance. However, due to some very unseasonable weather in Brazil, some of the excess supply in the coffee world is drying up, suggesting that the tide might be turning in this market (also see the list of Leveraged Commodity ETFs).

Just remember that coffee investments have seen a very volatile history, and that big gains have gone up in smoke in a very short time period. So while JO and CAFE might appear intriguing, investors will definitely have to be nimble, as any changes in the weather could send these commodity products tumbling back on their long-term trend-line once more.

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