Coffee versus USD

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publication date: Jun 7, 2009

author/source: Guy Bower

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Below we have a chart showing December Coffee (the candles) and spot Euro (the dark line). It is very interesting to see how correlated these markets are right now.

Generally speaking a lot of US Dollar based commodities will have a high negative correlation with the US Dollar. The reason is simple supply and demand. Think about the value of these commodities from the non-US perspective. When the Dollar gets cheaper for example, the cost of these commodities falls when converted into foreign currency thereby increasing demand and thereby pushing up prices.

The relationship is not always strong. The chart below shows the Euro and Coffee prices. You can see the relationship has been very strong for the last two months and no so strong before then. If fact a good part of the recent rally in Coffee prices has been blamed on weakness in the Dollar (as shown by the strength in the Euro below).

Its current high correlation however is one of the reasons we are in the current Coffee spread (see Open Trades: Update). In a way, holding the spread is taking a position in the Dollar - a long position. If the Dollar continues the bounce from last week, we will see a correction in Coffee prices and an improvement in our spread.

This move did in fact start last week. The bounce in the Dollar (or weakness in the Euro), triggered selling in Coffee futures which was led by the front month expiries. This saw the spread between December and July contract widen by almost a whole point.

That's a pretty good move from a spread that is not normally volatile. In other words, there is good return potential from a spread that normally carries low risk.

-Guy Bower

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