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Hot coffee

February 10, 2013

coffee_mug_with_beansAs I start my Sunday morning with a precious  cup of hot coffee in order to help me keep up with my kids’ energy, I find it fitting to write a post about the way I look at commodities in the context of investing. Currently, there is a global commodity bull market  happening. As famed investor Jim Rogers says “If the world grows, the price of commodities will go up due to high demand and if the global economy contracts, central banks will print a lot of money and push up the price of commodities through currency debasement”. As you know I am in the critical camp regarding monetary debasement/printing. After all, on a monthly basis, Mr. Bernanke is printing $85 billion dollars(not coffee beans) in the US alone. As for Mr. Draghi in Europe and Mr. Abe in Japan, they are all producing new money as well rather than coffee, wheat or palladium. And of course, the global population and world economy are growing as well. All in all, this screams for higher commodity prices in general.

If you live in the US, you will have noticed most prices going up rather quickly. A gallon of gas cost $1.20 ten years ago and goes for roughly triple that today. A cup of coffee however still only costs $1 at McDonald’s. Take a look at a long-term coffee chart below.

coffee price

As you can see, a pound of coffee cost 50 cents in the 1970s’ and currently goes for 141 cents. If you can find one staple commodity that costs less than triple the price from 40 years ago, please email me and let me know.

Let’s take the analysis a step further. In commodities, high prices are the cure for high prices and vice versa, low prices the cure for low prices. Why? Quite simply, as a commodity becomes pricey, it is more profitable to grow/mine the commodity and thus, supply expands as demand drops. In the case of low prices, the opposite happens. When a commodity nears the price of production, supply falls off sharply as the production of the commodity yields little to nothing. That supply shock plus higher demand at lower prices lead to a general reversal in price… Therefore, as long as a commodity does not disappear altogether, the bottom price is naturally around the cost of production. Coffee costs about $1 to $1.2 per pound to produce at the moment depending on coffee bean and location. Take a look at where coffee is grown.

coffe mapSource: Wikipedia

r(robusta bean), m(mixed), a(arabica bean)

Evidently, coffee grows around the equator and as such, you need to add approximately 10 cents a pound in transportation cost to the colder climates north. Given total cost of $1.1-$1.3 per pound of coffee and a current price of $1.41, this may be a perfect time to buy coffee. This does not mean that coffee cannot fall to the cost of production but your down side is probably limited to 10-15% while the upside is a multiple of that. Besides, if your purchase of coffee turns out a loser your Sunday morning cup of coffee should be that much cheaper as well. Another way to look at this would be to say you can buy your coffee consumption for the next 1,5,10,20 years today at close to 2013 production cost. Makes sense to me…

Finally, I’d like to add that other commodities such as cocoa, cotton,  platinum and gold are relatively cheap at current prices when viewed in terms of production cost. Cocoa and cotton trade at a similar premium as coffee. An ounce of platinum costs about $1600 an ounce to produce and costs only $1700 currently(6% premium) and gold costs about $1200 an ounce to mine and trades at $1670 an ounce(23% premium). I must add here that I don’t view gold as a commodity but rather as a currency. It is not consumed and serves as a monetary bench mark. Regardless, the price analysis for commodities can still be applied to gold as well, at least on the downside of the price range.

As Ray Dalio said in the interview I posted of him, giving “hot tips” is nonsensical because if he changes his mind the next day, what good will it do you? I couldn’t agree more. This post was designed to help readers understand commodity pricing. Coffee is currently very cheap but of course, it could become cheaper. Ben Bernanke could discover that printing trillions of dollars is not consistent with official US “strong dollar policy”. Coffee might go out of style as little children let their parents sleep in and relax on Sundays…

I don’t know about you but my coffee mug is empty and I can definitely use a refill.

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3 Comments
  1. Der Lord permalink

    Hi Richi!
    Dein Schreibstil wird immer smoother – gratuliere….
    Christoph

Trackbacks & Pingbacks

  1. About Currencies and Lattes | Market Owl
  2. Hot coffee, part 2 | Market Owl

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