Coffee - A Recoverys Brewing In The Worlds Favourite Bean

With the inflationary impact of the bailouts by the world’s governments set to unwind over the next few years, coffee drinkers beware: your habit is set to get more expensive. But as belt tightening prevails in the US, it is the growing middle classes of China and India which will be affected most. Good job then that they can afford it - comfortably. And as Starbucks capitalises on the East’s thirst for coffee through its 80 new stores, investors can do likewise.

Finance professionals probably haven’t slept much over the course of the last few months. The collapse of Lehman Brothers triggered a ‘once a century’ series of events which we are still feeling our way through.

But as the dust settles, light has appeared at the end of the tunnel. Policy makers are setting timeframes on how long it will take before inter bank lending is resumed and estimating how many quarters of negative growth will be endured before the next positive quarter.

Amidst all the uncertainty of the collapsing financial landscape, two factors have remained strong and are central to the case for Coffee. Firstly, despite a recent bout of strength the long term outlook for the US dollar got dramatically bleaker as financial rescue packages have been unveiled. And secondly, despite fears of a global recession, the Chinese economy (a barometer for the health developing world as a whole) has slowed not stalled as many had anticipated.

We have stated on numerous occasions that in the US, a lack of fiscal restraint, loose monetary (interest rate) policy, ongoing trade deficits and a ballooning national debt have caused an increase in the supply of dollars now circulating through the global economy. The US$700 billion bail-out has added further fuel to the fire.

We remain of the view that as the US dollar continues to decline in value over the medium term, energy and commodity prices, as defined in dollars, will re-inflate. And the price of coffee will be no exception. While periodic corrections will occur, the full effect of the US dollar inflation will play out with significant consequences for the economies of America and the rest of the world.

Although there are signs of confidence returning to the inter-bank market, such is gravity of the situation in the US economy, Ben Bernanke has cited the possibility of a second stimulus package to reignite the ailing world powerhouse. So it’s a good job then that the acceleration of demand for coffee over the long term will emanate from the developing world.

The United States and Germany may occupy pole positions on the coffee consumers grid right now, but this may change in the year’s ahead. Fast growing emerging markets led by China and India are driving demand even today. And the end result is upward pressure on prices.

Focusing on the present, global demand for coffee is outstripping demand. The International Coffee Organization (ICO) recently estimated coffee consumption for the 2008 calendar year should reach 125 million 60kg bags. This is a jump of 2 percent from 2007 and is only fractionally above current production.

Looking ahead, the (ICO) expected coffee consumption to continue its upward trend in the coming years, likely reaching 150 million bags by 2015.

Furthermore, The National Federation of Coffee Growers of Colombia have estimated that demand will outstrip supply by 6-7 million bags this year as Brazil (the world’s largest producer) enters the least productive phase of its output cycle.

The Federation also added, ‘Overall consumption is growing faster than production, and global inventories will decrease further next year. Growth is not coming from mature markets but from emerging markets’.

This fact provides us with great cause for optimism. And China, the Middle East, and Russia amongst others are driving demand to hold up well in most cases in the face of slower growth in the US.

Increasing affluence in developing nations is leading to strong growth for the bean as western consumption habits spread. Despite fears of a global recession, China is still on for 9 percent GDP growth this year.

What’s more looking ahead, (according to Euromonitor International) coffee sales in China could reach US$3.6 billion by 2011, from US$2.4 billion in 2006. This represents a robust 50 percent increase.

This may explain why coffee chain Starbucks plans to open at least 80 outlets in China this year as consumers in the most populous country continue to ramp up spending. The country’s standard of living is increasing and China’s per-capita urban disposable income rose 16.2 percent in 2007, the seventh year in a row the number increased by more than 10 percent.

Similar types of growth are occurring in Russia where per capita consumption levels are low relative to more established markets such as the US and UK. Russian consumption, like the Chinese, is growing by double digits. Brazil and India are also contributing to the demand growth albeit at slightly slower rates.

So from our perspective, the demand side of the coffee equation appears quite healthy. Meanwhile, supply is not enjoying the same types of growth.

Exports by all exporting countries during August totalled 7.4 million bags, down from 8.1 million bags in July. Exports during the first 11 months of coffee year 2007-08 (Oct 2007-Aug 2008) fell by 4.5 percent to 86.6 million bags from 90.7 million bags for the same period in coffee year 2006-07.

And as we stated before, Brazil’s production cycle is entering a lean phase. If the effects of the drop in output are similar to those of 2007 (in which the world’s foremost producer saw output fall a whopping 21 percent) prices of coffee will jump considerably.

In addition a key dynamic in the story which can not be overlooked is climate change. Drought and flood continue to impact the supply of all soft commodities and coffee is no exception. The frequency with which crop devastating natural forces are occurring is on the up and, we believe the impact will no doubt be felt in the years ahead.

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