Soft commodities languish after glut

Alfredo Ortega, a coffee farmer in the south of Colombia, is struggling. The grower of four acres of arabica coffee, the high-quality bean sought after by espresso aficionados, is having to work harder as prices plunge.

After hitting a 30-year high of $3 a pound in 2011, arabica prices fell to a four-year low of $1.327 a pound this year.

Mr Ortega is not alone. There is a similar trend across the so-called soft commodities market, which includes coffee, sugar, cocoa and cotton. Farmers responded to a big rise in prices in the past five years with a combination of increased planting, better husbandry and larger applications of fertiliser and pesticides. As a result, production rose, sending prices down.

The price weakness could last. Unlike agricultural commodities such as corn or wheat where seeds are set down every year, coffee bushes continue to produce beans and cocoa trees keep growing once planted. In short, it is a lot easier to increase production in response to rising prices than to cut it when prices fall.

"For many of these crops you will get a return crop of at least two seasons," says Kona Haque, soft commodities analyst at Macquarie in London.

The potential for lower prices for longer matters beyond the mountains of Colombia. For years soft commodities markets such as coffee and sugar were largely handled by consumers such as Nestle and Kraft, and by trading houses including the Neumann Kaffee Gruppe, Louis Dreyfus Commodities and Cargill. But in the past decade mainstream investors such as pension funds and mutual funds have gained exposure to soft commodities through popular indices such as the S&P GSCI and the Dow Jones UBS.

The potential for weaker prices for years has another structural root. Unlike the cereals markets, where increasingly growers are large and sophisticated businesses, many of the soft commodities rely on small farmers in developing countries.

Smaller growers often have little choice but to sell what they grow even if the prices are low, exacerbating the price declines. Some farmers in countries from Colombia to Ethiopia may even be tempted to try to boost production to offset the decline in prices, further increasing the downward pressure.

In the sugar market, the prospect of a bumper crop in Brazil, the largest producer, has sent prices this month to 17.13 cents per pound, the lowest since July 2010. The problem for sugarcane growers is that once planted, cane will continue to deliver strongly for three to four years. "Surpluses can hang around in sugar," says Jonathan Kingsman of sugar consultancy Kingsman.

The sugar market has a flexible source of production, however. Beet sugar, planted every year, alllows producers to respond quickly to the price weaknesses. The US, Russia, and Europe are expected to cut back output this year, while Ukraine could reduce the area for planting by as much as 40 per cent, according to analysts. But with cane still the main source of sugar, production will remain high.

The continuing fall in prices will eventually filter through to global sugar supplies as failure to plant cane results in falling yields. After a 6.1 per cent jump in output in the 2011-12 season, production grew 2.2 per cent in 2012-13 and is expected to fall only 1.6 per cent the following year, says Macquarie.

Cocoa is suffering similar problems. The cost of the main ingredient in chocolate has fallen almost 40 per cent since the market hit a 32-year high of £2,411 a tonne. Cocoa prices stand at about £1,538 a tonne, afer falling to a 10-month low of £1,382 in March.

Levels of husbandry rose as prices rose in 2009, and in Ivory Coast the combination of better husbandry and good weather resulted in a record 1.6m tonnes harvest in 2010-11. Since then output has fallen, but global output has remained at historically high levels, as have inventories.

In the arabica coffee market, a bumper crop in Brazil - the largest producer - for the second year running has depressed prices. The Brazilian government last week increased the official guideline price for the higher-quality bean by 17 per cent, raising hopes that the agricultural ministry will intervene to support the market.

The bottom for markets, say analysts, is when production growth stalls to a point where consumers start turning to inventories for supplies. "The turning point is when you are dipping into stock," says Ms Haque.

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