Bullish coffee technicals are highly caffeinated

March 4, 2018 09:00 AM

The coffee market offers a very attractive risk-adjusted return from the long side given a very compelling set of bullish long-term indicators and patterns. Currently, there is an extremely speculative short position as a percentage of open interest in coffee as measured by the Commodity Futures Trading Commission’s Commitments of Traders data.

Typically, speculative shorts reach their maximum levels near major lows in commodity markets as they tend to be trend followers and not value buyers like the commercial operators who take the other side of the trade.

The net speculative positions as a percentage of open interest have reached a net short position of -21.5% of open interest. Only five other times before has this happened since 1986, and in each one of those periods, a very large rally took place over the following six months with 100% up moves or more. 

A quarterly view of coffee with the MACD long-term oscillator has triggered a rare buy signal recently that has only occurred four times since 1974. At each of these periods, a major bull market move took place during the next year. The last three times this occurred, it resulted in gains of 200%, 100% and 100%, respectively (see “Caffeinated market,” below). 

In addition to the COT data and MACD signals, a long-term coffee chart has been developing an impressive symmetrical triangular wedge pattern since 2011 (see “Imminent breakout,” below). The big rally in coffee prices into the 2011 top began the current symmetrical triangular wedge pattern. Typically, these symmetrical triangles are continuation patterns that further the trend that went into them. In this case, coffee had a major uptrend heading into this pattern, hence, we would expect this pattern to eventually break out to the upside.

The pattern will complete by the end of the second quarter of 2018 so a major volatility expansion event would be expected at any time from now through the end of June 2018.

When symmetrical triangles break out, they tend to move up by a magnitude equal to the distance between the left wide side of the triangle lines. The upside target would be a move to above the highs set in 2011 based upon this pattern’s upside tendencies.

The way to enter this trade would be to buy March coffee futures now and risk a weekly close below the lower up-trending support line. 

On a confirmed breakout above the down-trending resistance line, the first target for profit would be the halfway point near $2.25 per pound. The second area would be to take profits on the full move implied by the technical formation above the 2011 highs.

We would deploy a 20¢ trailing stop once a breakout has been confirmed up to the first profit point near $2.25. On a move above $2.25, we would deploy a 30¢ trailing stop up to the ultimate profit target above $3.00.

The initial profit point would generate a $1.00 per pound profit ($37,500 per contract) and the second profit point would provide a $2.00 per pound profit ($75,000 profit per contract). For a trader who buys two coffee contracts and takes profits in the manner we suggest, they may net $112,500, not including commissions.

If a trader enters the trade and gets stopped out below the up-trending support line, the risk would be 10¢ per pound or $3,750 per contract. That is a 30:1 reward versus risk ratio. Not bad odds. 

So, we have multiple arrays of divergent indicators/patterns that are all pointing in the upward direction for coffee prices during the months ahead.

While there are never any guarantees to the price forecasting business, one would have to like the chances for a sizeable coffee rally in the first half of 2018. Coffee represents one of the best long opportunities for 2018.  

About the Author

Shawn Hackett, commodity broker and author of the Hackett Money Flow Report newsletter (www.hackettadvisors.com), is a nationally recognized agricultural commodity expert with more than 18 years of money management experience.