Avoid The Trap: Strategies for Managing Market Volatility

Over the last two weeks, you may have noted that the market has rallied from $2.50 to over $3.00. Understanding sudden market movements is no easy task, but our team is always up for the challenge. We spoke with Zahraa Assaad, our Quantitative Trading Analyst, to understand what is happening.   

 Understanding Market Dynamics: Commercials vs. Non-Commercials  

In the coffee market, participants can be divided into two groups: commercials and non-commercials. This distinction is crucial to understanding recent price volatility and the pressure roasters have faced. 

• Non-commercials, such as funds, are financial players who trade contracts for profit without ever intending to take physical delivery of coffee.  
• On the other hand, commercials—like trade houses, roasters, and farmers— are directly involved in the physical coffee trade. 

This week, the market witnessed a key event: First Notice Day (FND). This marks the deadline for roasters to fix their contracts. This resulted in a dramatic price spike, with the market nearly hitting $3 per pound. What is behind this squeeze, and how can roasters navigate this? 

Why Are Roasters Being Squeezed? 

• Backwardation Makes It Worse: 
• In backwardation, current-month prices (like December) are higher than future months (March, May). So, they’re already paying a premium to secure your coffee now. 
• "Hand-to-Mouth" Buying: 
• Many roasters don’t or can’t buy far ahead because of high financing costs. 
• Instead, they wait to buy closer to when they need the coffee. This strategy works fine when prices are stable but backfires in volatile markets (like now). 
• Funds Exploiting Momentum: 
• Non-commercial participants aim to get the momentum right. They sell into weakness and buy into strength. Their motive isn’t necessarily to "hurt" the roaster. Instead, they react to market flows and systematic trading.  

This cycle is further amplified when: 

• Non-commercials start selling, which is absorbed. 
• Pressure absorbed creates upward momentum: i.e. prices start going up. 
• They then turn long again as momentum builds. 
• A technical breakout at $2.70 triggers additional buying. 
• Fear and uncertainty take hold, leading to panic buying from roasters. 

How Does This Cycle Work? 

Here’s a simplified example: A fund buys futures at $2.50, driving prices up to $3.00. Roasters need to secure coffee purchase contracts at inflated prices. The fund sells at $3.00, pocketing the profit. The fund then rolls its remaining contracts to the next month (e.g., from December to March) and waits for the cycle to repeat.  

What Can Roasters Do? 

Fix Early: Securing contracts at the time of booking reduces exposure to last-minute price spikes. By locking in prices earlier, roasters limit the opportunities for funds to manipulate the market. 

Avoid GTC Traps: General Trade Conditions (GTC) orders can be risky if funds target these set price levels. Instead, collaborate with traders to develop more strategic entries that avoid predictable vulnerabilities. 

Stay Covered for Longer Periods: Rather than relying on short-term purchases, consider covering coffee needs over a longer period when prices are stable. This reduces the frequency of exposure to market squeezes. 

Breaking the Cycle 

In summary, it’s worth noting that funds and non-commercial participants simply respond to market signals. Unfortunately, the current combination of backwardation, technical breakouts, fear and a lack of timely action by some roasters has created this ‘runner-chaser’ dynamic. Funds are driving up prices because of these dynamics before FND. By creating artificial price spikes, roasters may pay more due to your urgency. Breaking this cycle requires fixing contracts earlier and managing coverage more actively. 

As always, if you have any questions about this piece or other market-related questions, reach out to your trader. 

 Zahraa Assaad is a Quantitative Trading Analyst at Sucafina, based in London, UK. She holds degrees in Computer and Communications Engineering and Business Administration, along with a specialty degree in Advanced Machine Learning. As a member of Sucafina's Quantitative Trading and Research Team, Zahraa leverages Artificial Intelligence and data analytics to build predictive models that trade in the futures market, helping the company anticipate market movements. In addition to her trading responsibilities, Zahraa works within Sucafina's Research Department, contributing to the global estimation of supply and demand figures, providing key insights that support the company's strategic decision-making.