HardAssetsInvestor

Written by Julian Murdoch  |

July 12, 2010

Scarcity Vs. Starbucks: Going Cuckoo For Coffee

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With coffee riding 10-year highs, is there room left for investors to jump into this rally?

It's hard to find a commodity rallying harder in the short term these days than coffee. Spot coffee, as measured by the S&P Spot Coffee Index, is up nearly 20 percent year-to-date, and up almost 25 percent since its lows in April. In contrast, you could pick any major commodity index and find it's down for the year: The Goldman Sachs Commodity Index is down 12 percent; the DJ-UBS Commodity Index is down 9.8 percent and even the GreenHaven Continuous Commodity Index is down 4.8 percent.

Going back over the past two years, you'll find coffee's been one of the only solid performers in commodities:

The pale blue line labeled "KC1" shows front-month coffee futures up 13 percent since July 2008, while the red line, which represents the GSCI Index, is down a crippling 62 percent and change.

Of course, investing in coffee hasn't been without its costs. Like many commodities, coffee often trades in contango, i.e., tomorrow's contract is more expensive to own than today's. As a result, the long coffee investor has had to pay the contango-piper each month they've rolled their position forward. You can see that ding in the dark blue line on our chart: the iPath Dow Jones-UBS Coffee ETN (NYSEArca: JO). As you can see, while JO is still up a healthy 15 percent and has certainly performed better than the broader commodities markets, JO has still lost money over spot coffee prices.

Scarcity Vs. Starbucks

What's behind the pop in coffee prices is relatively easy to explain, and it all comes back to supply and demand.

According to the USDA, the demand picture for coffee remains strong:

Global Coffee Demand

With the exception of a minor hiccup during the 2008 financial crisis, when we all switched from coffee to hard liquor to calm our nerves, global coffee drinkers have become insatiable. The actual amount of coffee consumed in less than 10 years has more than doubled.