Monday, May 30, 2011

Starbucks & speculators: Is manipulation of the coffee market a good or bad thing?

, On Thursday May 26, 2011, 12:02 pm EDT
Starbucks (NASDAQ: SBUX) has stopped buying coffee? Wha--aat?
Before you panic, girlfriend, let us assure you that no one is here to take away your double-caff, extra hot, no foam, skinny cappuccino.
Recent media reports are saying that the friendly neighbourhood java joint has ceased buying coffee until prices drop. Back in January, Starbucks reported that the high prices were going to cut into the company's profitability, but it wouldn't pass the costs onto North American customers just yet.

Last week, John Culver, president of Starbucks Coffee International was reported as saying, "We do believe, however, that prices are going to fall again. For this year, we have locked our coffee costs but we watch the market closely."
Locking in coffee costs does not mean a coffee lockdown. This does not -  we repeat - does not mean that Starbucks won't be buying any more coffee to serve you this year. What it means is that Starbucks has ensured a stable price for their beans, fixing a price with their suppliers for the duration of 2011.
Jumping bean prices

Coffee prices recently hit their highest point in 34 years. Normally, the price of a commodity rises when it is in short supply. The less there is, the more valuable it becomes, and the more people will pay to get it for themselves. However, coffee beans, which are mainly produced in Africa, South America, Central America and Asia, are not in short supply.
The CEO of Starbucks, Howard Schultz, recently told the Wall Street Journal, "In my history of following this for 30 years, coffee has never stayed very long at these kind of levels without some kind of catastrophic event like weather and we don't have that."
Why so high?
Some industry analysts claim the supply of coffee is being stretched, due to the increasing demand of a growing world population, especially young coffee-drinking professionals in emerging markets. Others suggest poor crops in key coffee-growing regions have reduced supply.
However, according to Mr. Culver, the high price of coffee is not based on any facts, and shortage of supply is not an issue. In an interview with a Swiss newspaper he said, "Speculators are at work here."
What's a speculator?
A speculator is a certain type of investor who buys or sells financial assets with the purpose of making a quick profit. While investors tend to buy and hold, looking for long-term returns despite price fluctuations, speculators seek to cash in whenever prices change.
Typically, speculators take large risks in anticipation of price changes. For this reason, speculators often use derivatives, such as futures and options, to buy or sell a commodity, such as coffee. These instruments give the speculator a pre-determined price, allowing them to control how much they can gain (or lose) in the face of a price change.
In the case of coffee, Starbucks feels that there is a large number of speculators in the market, buying up larger than normal quantities of coffee and driving up the price. Although speculators probably do drink a lot of coffee in order to stay up all night to watch the stock markets around the world, they are unlikely to be buying this coffee in order to take possession of it. Rather, they are buying it up with the intention of selling it soon.
The upside to speculators
Speculators tend to be highly unpopular among investors, who see them as artificially making the price of assets more volatile (what with all their constant buying and selling). Yet speculators do provide a valuable role in financial markets. An asset is only as valuable as what someone else is willing to pay for it. The existence of speculators makes for a more "liquid" market — a market in which there is always a buyer available to purchase your asset. When an investor does choose to sell, she is more likely to get a good price with plenty of speculators ready to pounce.
What this means to your morning joe

If all this hasn't caused you to toss up your hands and turn to a nice cup of tea, it does mean that the price of your morning cappuccino may in fact increase as a result of the high commodity cost of coffee. Just not at Starbucks, who is kindly holding the line on prices for us. For now. Let's hope Mr. Culver is right, that prices will come down and we can all go back to drinking our already-overpriced lattés in peace.
Now if only he could do something about the price of gas. is a free personal finance and education site for women.

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