Traders and merchants

Coffee traders and merchants move coffee from areas where it grows well (and cheaply) to places where it grows less well, or not at all. They transport coffee from surplus areas to deficit areas.  If coffee is worth more money in the US than in Brazil – and if that difference is more than the cost of shipping it (plus a little profit margin to make it worthwhile), then the trader or merchant will make it happen.

Coffee traders do not only move coffee from surplus to deficit areas. They also store and process it. They hold coffee at times when it is not needed (after the harvest) until a time it is needed (throughout the year). Coffee millers process coffee from a form in which it is not wanted into a condition in which it is wanted, transforming cherries into green beans. Roasters transform the green beans into roasted or soluble coffee.

Millers and roasters are, by definition, traders. A miller buys cherries and sells green beans, while a roaster buys green beans and sells roasted beans. Just as a trader may depend for his livelihood on his skill in buying coffee in one country and selling it in another, a roaster depends on his skill in buying coffee in one form and selling it in another. Millers and roasters are traders, and they need trading skills to perform their tasks correctly.

When you think about that a little, it becomes clear that what a trader is most interested in is not the outright price of coffee but the difference in the prices of that coffee in its different geographies, times and forms.  It is the price differential that matters, not the outright price. Traders like to limit their exposure to the outright, or flat price, of a commodity. They usually hedge their outright price risk, preferring to make their money on the differentials – the difference between the cost of the futures and the price of their particular coffee.

All traders – and that includes roasters – will try to reduce their risk of future price movements by hedging what they buy, taking an offsetting position for the same quantity in the futures market. Having purchased the physicals, a trader will sell futures as a hedge. When he sells the coffee, the trader will buy back their futures hedge; they no longer need to be protected against a move in the outright price of coffee because they don’t own it anymore.

Everyone involved in the coffee supply chain is taking and managing price risk. The farmer is perhaps taking the most significant risk by growing coffee in the first place. He may try to offset some of that risk by selling in advance – selling something that he doesn’t (yet) have.

The trader is taking a risk on the quantity that he buys but offsets that risk by hedging in the futures market. The roaster is also taking a risk; he has invested in his roasting machinery and has the risk that coffee prices will be too high to allow him to make a profit when he sells his roasted beans.

When I began my trading career with Cargill in the late 1970s, my first business card gave my title as ‘Commodity Merchandiser’.  But what is the difference between a trader and a merchandiser? Traders take positions on the markets, betting whether prices – or the differentials between prices – will rise or fall. Merchandisers move commodities along the supply chain, taking a tiny margin at each stage of its journey.

Traditional commodity merchandising has become more challenging and less profitable over time. It has become tough to make a margin just moving coffee along the supply chain.

One of the significant difficulties that merchandisers now face is that information is widely and freely available. It also travels incredibly fast. Technological change has reduced the potential for traders to arbitrage prices between geographical regions.

The other significant change is that governments and government agencies have pretty much left the coffee business. In the past, governments were often responsible for selling their country’s production, and this led to opportunities for corruption. Low-paid government officials were easy targets for unscrupulous traders; selling tenders were often rigged in favour of the traders that gave the biggest bribes. The markets have now been privatised, and this no longer happens.

In a world of instant information, it is no longer possible for merchants to take advantage of price differentials in various countries; instead, they now have to anticipate them. It is the point where a merchant becomes a trader. A trader predicts where shortages and surpluses will occur, and he takes a position in the market in anticipation of future price moves. As a result, analysis has become the lifeblood of trading.

It is not unusual for a trading company to employ more analysts than traders. Nor is it uncommon for traders to spend most of their time not on trading, but analysis. It is impossible to succeed in the commodity markets without an experienced group of traders and analysts to interpret and understand the mass of information that needs to be absorbed.

But analysis is not the only thing that you need to succeed in the physical commodity markets: you also need clients. Traders, therefore, have to keep in regular contact with their client networks, and they have to move physical coffee along the supply chain. There is now such an overlap between trading and merchandising that they are pretty much the same thing.

Merchandising coffee allows you to see the trade flows, helps with your analysis, and enables you to anticipate trading opportunities in the coffee market. But the margins on straight merchandising are now so thin – and sometimes even negative — that it is pretty much impossible for a pure coffee merchandiser to survive. The profits from trading subsidise the lack of profits, or the losses, on merchandising. In that sense, merchandising enables trading, and trading facilitates merchandising. They are mutually dependent.

© Commodity Conversations ®

This is an extract from my latest book ‘Crop to Cup – Conversations over Coffee’, available now on Amazon

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