Futures prices and
spot prices. Futures markets provide a public forum to enable
producers, consumers, dealers and speculators to exchange offers and bids until
a price is reached which balances the day's supply and demand.
Remember that only a negligible proportion of the
physical coffee trade actually moves through exchange markets.
The futures price is intended to reflect current and
prospective supply and demand conditions whereas the spot price in the physical
market refers to the price of a coffee for immediate delivery. In the futures
market the spot price normally reflects the nearest futures trading
position.
Carries and
inversions. When the quotation for the forward positions stands at a
premium to the spot price, the market is said to display a carry (also called forwardation or contango). The price of each successive forward
position rises the further away it is from the spot position. In order to
provide adequate incentives for traders to carry stocks, the premiums for
forward positions must cover at least part of the carrying costs of those who
accept ownership. Therefore, when stocks become excessive, the futures market
enables operators to enter the market to buy the commodity on a cash basis and
to sell futures, thereby carrying it. The carry will eventually rise to a level
where the premium covers the full cost of financing, warehousing and insuring
unused coffee stocks. This level of the forward premium is known as the full
carry. The holders of surplus coffee are now covered for the full costs of
holding these stocks.
The size of the forward premium or discount between
the various forward trading months quoted at any time reflects the fundamentals
of the coffee market. When coffee is in short supply, the market nearly always
displays an inversion (backwardation), with the forward quotation
standing at a discount to the cash price.
This inversion encourages the holder of surplus
stocks to supply them to the spot market and to earn the inversion by simultaneously purchasing
comparable tonnages of forward futures at a discount to the spot
price.