The Parable Of Coffee And The Blind Traders

09/02/05 08:18:49 AM

by David Penn

The end of a downtrend and the resumption of an uptrend loom in coffee futures.

Security: KCU5, KC
Position: N/A

O how they cling and wrangle, some who claim For preacher and monk the honored name! For, quarreling, each to his view they cling. Such folk see only one side of a thing.

--From the parable of the blind men and the elephant

Just about everyone knows the famous parable of the blind men and the elephant. While the tale changes a bit depending on the teller, the basic story involves a number of blind men each touching a different part of an elephant. When asked to describe the elephant, each blind man does so based on his limited experience/exposure to the elephant. The blind man who touched the elephant's tusk said that an elephant was shaped like a plowshare. The blind man who touched the elephant's trunk reported that elephants were shaped like snakes. And so on and so on until the wise man (or raj, in the original Indian version) stopped the confusion by way of the quatrain above.

Just how wise you have to be to fool a bunch of blind men is perhaps one of the outstanding questions of such folktales. But the lesson on the importance of seeing a thing as a whole rather than by its parts remains a potent one--and one that came to me as I looked at a few charts of coffee futures in the wake of Hurricane Katrina.

Figure 1: After falling more than 30%, coffee futures bounce in the face of concerns that Hurricane Katrina will significantly damage major stores of green coffee in southern Louisiana.

Graphic provided by: Prophet Financial, Inc.

Among the economic concerns that have come up as a result of the hurricane is what will happen with the coffee crop in Louisiana. According to one story, approximately 27% of the "green coffee" supply in the United States is located in hurricane-vulnerable parts of southern Louisiana. Given that backdrop, it is understandable that many would begin to believe that coffee futures were likely to rise--perhaps sharply--until questions about the supply of coffee could be resolved.

And looking at the nine-month chart of coffee in Figure 1, two things would be readily apparent. The first is that coffee has indeed "perked up" (forgive the pun) in recent days, as storm fears have been most intense. Still, the chart of coffee futures presents a commodity that has been in a severe bear market since the first days of spring, falling more than 36% from its March 2005 high.

However, the other "blind traders" have their say as well. A longer-term look at coffee futures presents a view of the commodity that, while consistent with the view in Figure 1, nevertheless puts coffee--and its potential Katrina-inspired bounce--into a truly bold new context.

Figure 2: Does a downside break of this three-year trendline spell the end of coffee's nearly four-year bull market?

Graphic provided by: Prophet Financial, Inc.

To be sure, this context would be a great deal more bold if coffee futures in Figure 2 (a chart of continuous futures) had found support on the back of the upper boundary of that tremendous trend channel that extends back to late 2001. Nevertheless, the chart of coffee shown in Figure 2 serves as a reminder that coffee futures were in a strong cyclical trend throughout 2002, 2003 and 2004--a trend that only accelerated in late 2004 and into 2005. Moreover, we can see that the 2005 bear market in coffee shown in Figure 1, can also be seen in Figure 2 as a retracement or pullback to the level at which coffee first broke free from its trend channel in late 2004. Measured this way, the 2005 move down represents a retracement of between 38.2% and 50% of the bull market from the 2001 low.

From this perspective, any further declines--rather than the Katrina-inspired bounce many fear will take place--will find coffee moving deeper back into its multiyear trend channel. And any meaningful move higher will find coffee testing the upper boundary of the trend channel for resistance. The trading implications for coffee futures, in either instance, are clear.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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