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  • QA 051
    Question:
    What role do 'investment funds' play in the coffee trade?
    Background:
    The question was 'what do investment funds do' and has been taken to refer to the role such funds may be playing in the coffee trade.
    Asked by:
    Exporter - Rwanda
     
    Answer:

    Investment funds mostly work with financial instruments but many also get involved with commodities by trading them, usually on the futures markets. Funds that specialise in such trading are often called commodity or hedge funds. All 'funds' operate with one objective: to realise profits for their investors and, depending on their mandate, many may do so in any sphere of activity.

    Futures markets generally are discussed in chapter 08 whereas the use of futures markets to manage risk is extensively reviewed in chapter 09. However, briefly…

    Futures markets exist because of risk. When a coffee producer or trader wishes to offset risk he or she has to find a counterpart to assume that risk. Futures markets bring these parties together: the one interested to dispose of risk - the other interested to accept risk, believing it can be turned into profit. That other party can be anyone, i.e. not necessarily someone directly involved in the coffee trade - for example one of the commodity or hedge funds…

    Funds take views on the future. They do their own research into the basic or fundamental supply and demand situation of a commodity, and arrive at a theory. If they think prices will rise they will buy on the futures markets - if they think prices may fall then they will sell instead. Funds can seek exposure to commodities as a whole asset class with their positions spread amongst several different commodities, not because they feel that coffee is under or over valued but because they believe all softs or all commodities are under/over valued. In this way it is believed that they have some form of hedge against inflation.  They use futures contracts because it is easier to trade a commodity through the futures markets: one is not obliged to own the physical goods.

    The financial muscle of the funds is considerable and they probably are the greatest source of speculative activity on the futures markets for coffee. They can influence price movements and are at times the subject of adverse comment in coffee circles where their actions are mostly considered to be pure speculation, not always positive for the orderly trade in coffee. But there are also funds that now view commodities in general as an asset class and are willing to take large long-term positions, rather than just trade purely on technical signals as they once did.  Such funds will take on a long-term view across a basket of commodities based on global economics. Sometimes this could seem to be at odds with the basic outlook for an individual commodity, for example coffee…

    But speculators, including funds, also provide liquidity to the futures markets. Without speculators it would be much more difficult to match sellers and buyers of risk - there might be times when it would be difficult to offset risk in which case the cost of doing so might rise.  Some therefore argue that they in fact are an essential element in the coffee trade… We would agree that speculators do indeed add liquidity as they look at many aspects of the global economic picture and not just the fundamentals of a particular physical market. It would make risk management for a coffee market participant almost impossible if every user of the market had the same view…

    Whatever, it is more important for producers/exporters to realise that 'funds' and 'speculation' are here to stay. The best advice we can give is to try and be aware of what drives prices on the futures markets in London and New York. The daily reports available on www.liffe.com (London) and www.theice.com (New York) are the most obvious and first choice. In New York the US Government's Commodity Futures Trading Commission analyses speculative positions, including those of 'funds' - see www.cftc.gov And, also of interest, futures traders depend heavily on charting - see section 09.07.04 and www.futures.tradingcharts.com for more on this. Individual analysts and market intelligence services also provide reports that analyse both market trends and speculative positions - see for example www.jganesconsulting.com and www.coffeenetwork.com (both on subscription basis).  Finally, the International Coffee Organization publishes a monthly market review that pulls together many elements in the market place. These reviews provide excellent general overview and comment - visit www.ico.org and look under Executive Director's Office.

    Posted 07 October 2005

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