(Bloomberg) -- Coffee prices have been on a tear and for the traders who buy, sell and ship beans around the world this means navigating additional risks. They’re turning to alternative ways to hedge prices and avoid or delay the cash crunch caused by volatile moves.
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Futures prices for arabica beans — the variety favored for high-end brews — have gained around 70% in New York this year, breaking past the highest levels in more than forty years. Big price swings are a regular feature.
When prices move too high, too fast, exchanges or brokers that manage a trader’s positions require more collateral, or margin, to maintain sold futures hedges that have become unprofitable. With millions of bags of coffee held in stock or transit, that can mean billions of dollars in margin calls when there’s a big price move.
For a trader with cargo on a ship or awaiting final payment from an end-buyer, margin calls can drain their cash position quickly. Increasingly they’re turning to options and off-exchange solutions to avoid paying more collateral, or simply doing less business, according to traders and brokers.
The moves show how liquidity pressure is mounting in a market dominated by small players who aren’t prepared for these massive calls for cash. That’s contributed to further swings in prices with less on-exchange liquidity. Cocoa, the other hot commodity of the year, has experienced similar problems.
“It’s a seriously turbulent time and it’s very, very difficult for traders,” said Kit Gulliver, a director at UK-based coffee traders Origin Commodities Ltd. and Dragon Commodities Ltd. “You have to change the way you approach these things. Just sitting there doing what you used to is a recipe to bleed cash.”
Traders need to hedge coffee when they transport it from growers in countries such as Brazil, Vietnam or Guatemala to buyers largely in Europe and the US. When a trader commits to buy physical coffee at exchange-related prices they usually sell futures to protect, or hedge, against the value of that cargo falling. A consultant in top grower Brazil estimated as much as $7 billion of margin was called in the coffee market during November.
Banks have for some time offered big groups products known as “liquidity swaps,” where for a fee the bank essentially holds a client’s hedges for a set time. The structures mean that traders can avoid the associated margin calls until cargoes are delivered, although they may eventually have to pay up if prices don’t come down by the time their agreement ends.