chart reading, trends, and Peet's coffee...

I just heard the CEO of Peet's coffee on TV. He explained how Peet's had "lost" money this quarter hedging their coffee purchases. They bought coffee futures in advance, and then the futures price kept dropping. The reason given by the CEO of Peet's for buying coffee futures was "because we thought it had reached a floor." Here is the chart:


http://futures.tradingcharts.com/chart/CF/W


Now, ask yourself on what basis did this CEO conclude coffee had reached a floor? Did he visit farms in South America? Meaning, did he enjoy unique or "asymmetric" information - meaning information which the person taking the opposite side of the trade did not have? Or did he think it had reached a "floor" simply because it was so much lower than where it had been?


Whatever reasons he had for believing coffee had reached a floor, you have to assume they were not secret. In fact, you have to assume even farmers knew them. So, everybody knows they should be buying, and yet somebody is selling? This is proof, is it not, that any such "information" is wrong!


In reality, all the information does is tell you on which side of the market people are likely to be accelerating or postponing. In this case, since the "information" said coffee should be higher, accelerated buying should be propping up the market, postponed sales should be over-hanging it, and the price of coffee should continue to drop.


But the real question is, what is some CEO doing trying to time the coffee market? This is just what I was talking about in my "a different kind of phone call" post. Hedging is fine, but trying to figure out when to do it or not is not a job for your average businessman. All trend-traders do is to try to fade - do the inverse of - busninessmen's bad (but typical) decisions.


So since businessmen sometimes hedge, and they sometimes don't - and they will be leery when you try to sell them a hedge, and resist moving the locus of decision-making for their business to you - all you really need to do is say, hey, do what you're going to do, only I'll pay you to tell me, so that I can do the opposite! Don't sell hedges to businessmen, buy information!


In this Peet's case, the information you could have bought from people in the coffee business would have been that 1) buyers are hedging, and they don't need to pay you any profit margin to tell them how, and 2) sellers are postponing hedging, and trying to sell them a hedge is just banging your head against a wall. So you buy the information, and then just sell the coffee futures short yourself.


eLROY

Thats a riot,but I like Peets as an alternative to StarBucks.I have a real life story that is similar.In the early 80's I was a local on the IMM.I also did currency arbitrage for about two years on the exchange.I moved to NY and applied for

a FX position with Pepsi hedging their foreign

exchange exposure.They told me that some times they don't hedge if they have a strong feeling regarding which way the dollar is going to move.

I said "so you speculate".They said we don't speculate we just don't hedge.Needless to say

I didn't get the job.

Of course, everybody in a particular industry (homes, routers...), whether buyer or seller, will generally be bullish on their own industry when prices start to collapse.


Have you checked out NITE lately?


http://bigcharts.marketwatch.com/qui...=0&o_symb=nite


This thing is STILL a short.


eLROY

Find me a company that is speculating in the futures market so I can short their stock!!! Find me a company which hedges in the futures mkt (like a coffee maker) and I would consider buying it.


Did the CFO say whether or not they have an ongoing hedging strategy? or does he just sit back a choose a direction?

My guess is that they have a lot more information that a chart trader. They probably have a better pulse on supply/demand and were under the impression that it was a smart move. Lets face it, if that was the case an executive isn't going to come out and say that! He will just say hedge mumbo jumbo because only people like Leroy and other futures market players will laugh at it. The average shareholder will just accept it because hedging is a very important tool for commodities dependent companies like Peets. Its easy for this type of move he detailed to go wrong though, all the coffee countries are trying to act like OPEC since they can't even pay their production costs right now. They all say they are destroying their worst 20% of the crop and blah blah blah, but obviously they need about 40% destroyed and they need to stick to it. These are almost exclusively very poor countries though so sticking to quotas is almost certainly not going to happen, especially with the dollar endlessly strengthening on them. Since coffee is traded almost exclusively in dollars, even to non-dollar countries like Japan, the coffee producers are afraid the dollar will eventually drop and they will make a lot less money so they are trying to take advantage of it now. However, that means everyone is coming to market with export beans in a worldwide recession. Coffee is a luxury that most people can easily cut down on so its high supply, low demand...a recipe for price disaster. At least that is my economic view of it. I usually avoid reading charts, it just confuses me with the traders supply/demand versus the theoretical supply demand that exists in the consuming marketplace.

You say they have a lot more information than a chart trader, and that is certainly true. They can see demand trends at a million different stores, new low-cost processes coming on line, and so on. But my argument is that the net effect of this "information" - and the unpredictable ideas and inventories resulting from it - is to make the marketplace less coordinated, because people don't know how to adjust to it, and react to it non-redundantly.


Meaning, suppose there is no information, so the buyer and seller both always just hedge as soon as they know they will need to, 9 months out, on a regular basis. Now suppose, suddenly, there is unusual "information" so the buyer doesn't hedge right away. Is the seller to assume the buyer is out of business and will never buy, or is he to assume he will eventually hedge double to catch up? Should the seller hedge double right away, or wait?


Any time a participant in the supply chain takes an irregular action, or an action outside pattern, it plays havoc with the next guy along the line, who can only see the points immediately to his left and to his right. Serial changes in supply and demand become impossible to extrapolate or plan around. People start to react to the same supply-chain-external or supplementary information at the same time, without knowing the other is doing it, and it swings double back the other way.


So when you say "information," understand that the real information is simply whether your counterparty has accelerated, postponed, or will never come back - whatever ideas have gotten into his head. If it were really possible to make much use of extra-supply-chain information - meaning information other than your counterparty's patterns of how much he is willing to pay for how much in what frequency, Soviet Agriculture would have been a huge success.


All information basically comes down to two categories - how much I know I will be buying, and how much I know my counterparty will be selling. If I know I will be buying less, and my counterparty knows this too, he may sell less, making it appear to me as if he has less to sell...


Blah, blah, blah...


The point is, you have to reflect your own conditions to your counterparty, not your beliefs about his conditions back to him, and him likewise to you, so that neither has any clue of actual conditions. Otherwise, it's just oscillating redundancy, and a feedback loop. What if I stock up on extra coffee because I think the price is going to rise, and the producers also hold back more inventory because they also think the price is going to rise, and the overhang at both ends is invisible?


If people could figure out what other people wanted to buy or sell other than by looking at what they are buying and selling, the USSR would have been a whole lot more prosperous. When people try to time the market, it becomes extremely choppy, because everybody has to extrapolate everbody else's blip, it's really no more complicated than that.


eLROY

I was talking about direct party visibility, I was talking more along the lines of parties two or three steps up in the supply chain. They would have no troubles getting their supply from the supplier, this was apparently just an attempt to enlarge earnings. I will create a completely fictional scenario to illustrate what might have happened at Peets.


Say you are a florist. You buy your flowers from a variety of suppliers and have plenty of supply and credit so there are no operational issues. Say now you go to Las Vegas for your annual florist convention or whatever you might call it. While there you meet with people that aren't suppliers, but maybe the shippers or export specialists for roses in New Zealand and Australia. They are at the show to drum up business from others, but in the spirit of a convention they talk to anyone. You have a drink with one of these guys and he tells you that there could be some issues with deliveries in 6 months because a big batch of seedlings were lost in a train-wreck. Now this isn't exactly directly affecting you, but you could see how this all filters out. You go to the markets and buy futures contracts on roses figuring the 10% Australian rose contribution to world supplies is in jeopardy and prices are going to go up. You figure this hasn't really been public news and since its FAR down the supply chain order you got a chance to make some money off of it before the markets hear about this and adjust their prices. Problem is you talked to only one guy and based your scenario on this. He isn't an economist, heck he doesn't even know all the suppliers in the market, just the big exporters! Turns out that this guy doesn't know it, but the domestics have plenty of extra seedlings that they sell for only a slight increase over what the exporters were shipping in. Further the shipping guy doesn't know that Brazil quietly slipped in a tax cut for its rose producers due to the fact that the brother of a key senator is a rose farmer. Since its negligible to the tax revenues, the news pretty much ignores this fact. Only people that know are the rose farmers themselves and they figure these types of laws can be repealed quickly so they go bonkers with production this year. Further compounding the situation is good weather in western Africa which makes for a crop 10% better than the year before. Suddenly what the guy thought was a shortage becomes a glut and he is stuck with a bad bet, all because he had a drink with a guy that really had a small pulse on the market and was speculating with what is to come in a few months. So you went a few steps above your level of the chain for information and it STILL was incorrect. You speculated instead of hedged, but you don't want to tell that to anyone. You tell the market you were afraid of price increases because an increase of 20% would have rendered your business model close to break-even. You don't tell them that you really were speculating because of information you heard that wasn't really reflected by the public. And furthermore it had nothing to do with your interactions with the guys you deal with directly either above or below you. You had no information of a change in demand from your customers or supply from US distributors.

So you're saying he's a dumb sucker one way or the other. Ideas = inventories, wherever they may come from, and I only wish I could personally talk to every person on Earth. Or at least pay them to lay down tells in my own private central database! I thought you were suggesting Peet's makes money all the time on unique chain information - which may be the case - but you were just saying he's a liar.


I still say the number-one factor people use to determine what is "cheap" or not is the historical price. If flowers have been at 10 forever, and today some guy tells you they are going to rise 10 more points from here, most people will be eager to act on the tip if they are at 8 from 7, but not so eager at 12 from 11.


So sure, I would totally go for your clever elucidation that this guy thought he was being smart with some unrevealed scheme, and is now just making a reasonable-sounding excuse. Except, that I have heard his official explanation over and over, from a million people, in a million situations. People actually believe that stuff!


Moreover, it is often not even individual people thinking, but somehow an orgnaizational structure which accelerates purchases as prices drop. Meaning, for it do be a drop to price X today, there was generally a bounce from price X at soem point in the past. So today's survivors may be yesterday's dip buyers.


eLROY


P.S. A funny story, about how I first really came to understand Turtling in the the mid 90's. Every couple months we would restock on olive oil. Usually, I'd start keeping an eye out for a promotion, or loss leader at a boutique, as soon as the bottles started getting low. But one day, an unusual discount turned up out of the blue, when I didn't even need oil, so I bought an extra bottle. Then maybe two weeks later, there was another sale somewhere else, even lower, so I bought another, maybe two more. Then the price kept going even lower, and stuck, only I didn't buy any more oil for like a year, even as my use increased! So I had to laugh, what must my curve look like to the seller, when I demand 1 unit at 15, 2 units at 12, 3 units at 9, and zero units at 8??

Hi wildbill,


On 12/7/01 coffee put in a 25 year low of 4150, on the NYBOT (CSC) exchange (arabica coffee) symbol KC.


On the weekly chart coffee has been in a downtrend since 1997 from a high of 32000. The close today 3/5/02 was 4840.


At some point well see a move higher, a weekly close above 5000 would be a good sign. This market has a tendency to really 'jump' higher. It also has a reputation for making traders very poor.


At this time I'm only drinking it, no plans to trade it.


As you suggest there's lots of coffee around.


SteveB

The coffee is around partially because the supply grew to meet the surge in interest in "quality" beans. At least that is my thinking. With Starbucks and other premium coffee brands becoming the rage over the last few years, I think farmers overreacted. Part of the problem is that I don't think total demand for coffee changed all that much, it just followed population and economic growth trends mostly. People didn't necessarily drink more coffee, they just switched into more premium stuff. Premium stuff meant people were willing to pay more, but it meant more quality beans. Problem is that quality beans isn't something you just plant specifically. What it created was the demand from farmers to produce more and more beans in hopes of getting quality and also I would guess that the presence of more money in the market might have also falsely signalled more overall demand. So the farmers, spurred on by their governments, thought bean farming was in a renaissance and they produced into glut. The glut has finally forced the farmers into doing what they should have done in the first place and that is to destroy the least quality of their crop so as to yield close to the same total crop, just better stuff that is demanded by the market. Hard though to tell a farmer or anyone that its in his best interest to destroy his crop because the market will do better. That is telling him to sacrifice some smaller amount of money so some other guy who happened to make the best quality stuff can make even more. The only way its accomplished is as the "cartel" of sorts is doing, buying coffee on a national basis from everyone and then destroying what isn't quality. I forget the economic law at work here, but its something that clearly came because the marketplace was misinformed. They read the signals wrong. They are starting to get the supply right though, but only after years of suffering. As the world economy improves, consumption will increase. Further it could be a very powerful increase. Lower-income countries are starting to get a taste for coffee these days. China used to never consume coffee, now they are slowly catching onto it. Latin American countries always thought coffee was something along the lines of Nescafe, but they are coming more into a Starbucks-type crowd too, at least those that can afford it. Coffee will make a strong long-term surge in the near future, its just that this is a commodity that almost everyone trades on too short a time horizon to really take advantage of it. Once again it will be dictated more by the rational actions of the marketplace suppliers...that damn economics thing again!