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Commodity bears: Wake up and smell the coffee

After the kind of year the coffee market has had, both investors and consumers are finding the price a little hard to swallow. But while coffee may be due to come off the boil for the short term, its long-term investment potential may just be heating up.

That's because while the short-term rally in coffee over the past year has been all about supply shortages, coffee's longer-term prospects are all about demand. And, as with a lot of commodities, the focus there is on China. Put simply, the Chinese are developing a taste for the joe.

Crop woes are easing

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At their peak in early May, commodity-market prices for coffee had more than doubled in less than a year. The culprit for the spike was a shortage of supply, as the coffee crop was hard hit by bad weather. Droughts in Brazil and heavy rainfalls in Colombia hurt crop yields in the past year.

"Fluctuations in coffee supply are often larger than the changes in consumption, and are therefore central to price movements in the short term," said Ross Strachan, commodities economist at Capital Economics in London, in a recent report.

However, welcome rains have come to Brazil and the overall coffee crop this year is expected to be bigger than last year's. That, combined with a general pullback in commodity prices, has contributed to a drop in the coffee price to below $2.60 (U.S.) a pound from more than $3 in early May.

But while coffee prices could still be due for a further pullback, Mr. Strachan expects them to remain well above their levels of a year ago. That's because of the demand side of the equation – and China.

China demand percolates

"Demand from emerging economies continues to grow rapidly, as coffee becomes increasingly fashionable," he said. "In particular, coffee shops are increasingly popular with young people in China, especially in major coastal cities."

Mr. Strachan noted that while Chinese coffee consumption has been rising for a decade, it still remains low by global standards. Per-capita consumption is less than 2 per cent of that of the United States; even in neighbouring South Korea, per-capita coffee consumption is about 25 times higher. That suggests loads of growth potential for coffee drinking among China's massive population. (He noted that Starbucks plans to more than triple its outlets in China, to 1,500 stores, by 2015.)

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"In contrast then to our expectations for many other agricultural commodities, where the evidence of changing consumption patterns is weaker, we expect buoyant demand to keep the price of coffee high by historical standards," he said.

"The near-term risks are on the downside, given our expectations of a small increase in coffee production over the coming year and a general investor selloff from commodities. But the chances of a collapse in prices are relatively low."

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