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Daily Intelligence Briefing

Thursday, October 5, 2023

Identifying Change-Driven Investment Themes

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.

I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

Starbucks Looks to Save Coffee From Climate Change, Rolls out New Breeds to Counter Rust Fungus

Summary: Climate change and its external consequences pose a long-term threat to global coffee supplies. Though the arabica coffee crop could be harmed by rising temperatures alone, it is also very susceptible to the incurable coffee rust fungus. This fungus, which has now infiltrated virtually all coffee-growing regions of the planet, has shown it can wipe out up to two-thirds of coffee bean shipments in certain nations.


Starbucks’s strategy to counter the spread of the rust fugus includes the distribution of specially-bred seeds to farmers around the world. The creation of six different breeds of fungus-resistant coffee trees may yield results, but if these preventative efforts prove ineffective, an eventual outbreak of coffee rust could threaten global coffee production indefinitely.


Related ETF: Invesco DB Agriculture Fund (DBA)

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A report from the Inter-American Development Bank (IADB) notes that changing climates across the globe halve the area suitable for growing coffee by 2050. Arabica bean crops, the more fragrant and high-end species of coffee, are very delicate, meaning small changes in temperature and precipitation trends can pose a serious threat to the very precise growing conditions that make Brazil’s coffee harvests so exceptional. Moderate temperatures (between 64 and 70 degrees Fahrenheit, to be specific), shade, regular rainfall, and an environment that’s generally free of frost and pests has made Brazil the top global producer of coffee beans. Though shifting temperatures might begin cutting into the size and quality of Brazilian or Central American harvests, it would also make other regions more hospitable for coffee harvesting. However, the chief concern is not necessarily rising heat in growing areas, but the threat posed by pests and disease that thrive in warmer conditions. Chief among those is the dreaded rust fungus.


Coffee rust fungus (“Roya” in Spanish) is a dangerous and incurable plant disease likened to cancer, which grows quickly in dry, warm climates. MRP has been following the accelerating spread of the Roya for several years, which has spared virtually none of the world’s coffee-growing regions. During a 2019 outbreak of Roya, MRP noted Costa Rica saw a staggering 66% fall in October shipments in one month, its lowest monthly export volume in almost 40 years, followed by another 30% slide in November of that year. The Atlantic has previously reported, increasingly unseasonable warmth and other climate abnormalities have made Brazil’s arabica harvest that much more susceptible to coffee rust outbreaks.


Hawaii, home of the popular Kona brew coffee, had been one of the last coffee climates still untouched by the fungus, which travels on the wind and can infect many trees before it is even noticed by farmers. That changed in March 2021 when coffee rust somehow made its way to the pacific islands and spread quickly. By July of that year, Hawaii’s Department of Agriculture reported that the invasive pathogen has now been found on all major islands in the state.


The long-term changes presented by the externalities of rising temperatures could one day be devastating to the coffee harvest, potentially pushing up the price of the commodity significantly. CNN reports that Retail coffee giant Starbucks, who has a massive stake in coffee remaining plentiful and affordable throughout the world, has long been working on solutions to blunt the rust fungus threat. After pairing hundreds of varieties of coffee trees in a bid to breed more fungus-resistant crops, the company has landed on six that may be able to better repel the Roya while also meeting the company’s standards for flavor. Starbucks has begun distributing its six climate-resilient coffee tree varieties to farmers with no restrictions on who they sell the resulting crop to. The Guardian writes that the coffee giant buys from about 400,000 farmers across 30 countries and, over the last five years, it has given away three million climate-resistant seeds annually.


That all sounds good, but the only way to truly see how resistant these new trees will be to rust fungus will be a real-world stress test that seems to be inevitable. The unpredictability of when rust fungus will strike a serious blow to coffee supplies means the threat will be silently looming over coffee prices for decades as efforts to prevent its spread will meet an ongoing wave of ongoing climate change. Investors should remain aware of potential disruptions facing global coffee markets and MRP will continue to follow such developments as they become available.


Coffee futures recently ticked down to their lowest price in more than two years, continuing an aggressive downtrend that took hold in August 2022. Prior to that turning point, coffee played a significant role in bolstering MRP’s successful LONG Agricultural Commodities theme, which ran from April 2021 to June 2022. The Invesco DB Agriculture Fund (DBA), which we used to track the performance of this Theme, recorded a 29% return throughout that span, compared to a -1% decline in the S&P 500 throughout the same period.


Though there was a partial rebound in coffee prices throughout late 2022 and early 2023, prices broke down yet again and slipped below $150.00 per pound in late September. Last January, MRP shared our insights on the coffee market with Interactive Brokers. On their podcast, Time for a Coffee Break?, we correctly noted that “more suppressed pricing is ahead” and the resurgence was unlikely to persist amid an improving harvest in Brazil, as well as an aggressive bout of monetary tightening.


The only ETN that provided pure-play exposure to coffee futures, the iPath Series B Bloomberg Coffee Subindex Total Return (JO), was closed earlier this year, but coffee still carries a 10% weighting in the aforementioned DBA – making those contracts the third largest holding in the fund.


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