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Juan-Cash Differentials Request *PIC*

Juan,

You had asked about my thoughts on Brazilian cash differentials and a current chart. Since 1970 there have only been 2 bull market moves in coffee that were not related to weather shocks.

They were the years of 1997 and 2010. In both instances, Brazilian cash differentials started moving upward in the prior fall i.e. fall of 1996 and fall of 2009.

In both instances, when Brazil cash differentials reached parity with NY spot futures the coffee market exploded higher within 30 days.

Brazilian cash differentials reached parity in December of 1996 and an explosive bull market began in January of 1997. Brazilian cash differentials reached parity with NY futures in May of 2010 and the market exploded higher in June of 2010.

Right now Brazilian cash differentials are at .90. For post harvest in Brazil historically these are extremely firm cash differentials. It would not take much of a supply pinch to bring this indicator to parity.

Our work suggests that the current Brazilian crop is 48 million bags which would suggest an Arabica production component of 37 million bags which would be 8.6 million bags less than what Brazil harvested last year. Of the 37 million of Arabica the quality of the crop is going to show a record amount of lower quality beans that will not meet the quality standers of the NY futures specifications nor the specifications for higher end roasters.

We feel that that actual higher quality reduction in Arabica supply is closer to 10 million bags. For reasons we won’t go into here it is our view that the USDA has been over inflating Brazilian production over the last 4 years to overcome their incorrect and too low Brazilian ending stocks. The "hidden stocks" that have been in Brazil have been used by USDA to increase production so that the USDA's numbers would work.

However, given the reduced Brazilian exports last year that should not have occurred and given the large reduction in CONAB coffee stocks it is our view that these "hidden stocks” are now depleted.

If we are correct about the above aforementioned then Brazil will only be able to export 28 million bags in the 2017/2018 marketing cycle down from 33 million bags. We no not see exports growing materially in any other region in the next cycle relative to what we saw this year.

This means a dramatic drawdown would be witnessed in green coffee stocks and in European and NY warehouse certified stocks during the high demand winter season.

Any clear evidence do such draw downs and any evidence that the current reduction in Brazilian exports is a trend change and not an aberration would likely send buyers scrambling for production.

So we expect the cash differentials to start responding by October to this scenario.

Of course should weather get involved during flowering this fall then a whole additional bullish dynamic would take hold.

Can the world get by with the above scenario and make it to the 60 million bag Brazil crop that will become available in August of 2018?

Maybe but it is a high wire act that any good hedger would not be willing to take.

We would also be looking at how bull futures spreads are acting. If they start tightening the spreads that would be another strong indication of tightness.

In the end our indicators will tell us if the above scenario is viable or if we are drinking too much of our own cool aid.

As of right now the rally has been mostly speculator short covering and our indicators have not yet given the green light that this is a supply tightness move. A correction would be expected once the short covering exhausts itself.

Remember all this should come to a head this fall when the current epic wedge chart pattern completes. Volatility is coming for coffee. Trade accordingly.

May God Bless the world coffee growers

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Juan-Cash Differentials Request *PIC*
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