Coffee spiked recently when commercial participants in the robusta market realised that it would be beneficial to hold contracts to expiry rather than buying coffee in the spot market. That led to a spike in robusta and arabica prices as speculative shorts rushed for a shrinking exit. Now that price spike seems to be over an reasonably strong supply projections from Brazil and Colombia argue against prices remaining at current elevated levels (although this is projected to be more significant in the 2010-11 season). Demand growth is expected this year but only because structural drivers of demand such as EM growth are continuing — which is not an argument for prices to remain at the top of a spike.

Technically, the price is making a triangle, and the fundamentals argue for an impending breakout to the downside. In addition, the supply and demand page suggests that demand has not increased since the spike — where, remember, the increase was for technical reasons — and the price has only remained at elevated levels because supply has continued to fall. Now supply is starting to pick up, and that should lead to market falls. In addition, speculators (presumably large trend followers) got very long of the market as it spiked, and the speculative net long position is now as large as at any time since the soft-commodity jamboree of 2008. In other words, there is nobody left to buy.

Today’s early rally gave the opportunity for an entry with a stop at 1ATR, above the post-spike highs, and a profit target north of the 200-day moving average and the prior trading range.

It is hard to make an argument not to trade!

Stop loss page shows approx. stop and profit target positions; intraday chart shows approx. entry point.

Update: You might say, “but there hasn’t been a breakout here.” And you would be right. As the first market personality page below shows, breakouts have not worked as a trading strategy in this market historically or recently. The second page shows what has recently changed — there has been no slow change of trend, just a short-term rise in volatility, all skewed to the upside. This is consistent with the hypothesis that the recent spike was technical in nature and can be expected to correct (this is not to day it will do so before hitting my stop, of course).
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