After a turning in a strong finish to 2010, most commodity ETFs have fallen in recent months as investors have piled into the relative safety of U.S. dollar as an alternative to risky assets during these tumultuous times. This flight to the greenback has tempered demand for many commodities, the vast majority of which are grown or produced outside of the U.S. but trade in U.S. dollars. In fact, the PowerShares DB Commodity Index Fund (DBC), the most popular and liquid ETF in the Commodities ETFdb Category, is down more than 11% thus far in 2010, while the iPath Dow Jones-AIG Sugar Total Return Sub-Index ETN (SGG) is down an astounding 41% in the same time period (also see Basics of ETN Investing).
But not all commodity products have had a tough run recently. The iPath Dow Jones-AIG Coffee ETN (JO), an exchange-traded note linked to the Dow Jones-UBS Coffee Subindex Total Return, has been on a hot streak as of late. The index underlying JO consists of one futures contract on the commodity of coffee, and posted close to a 5.7% gain on Friday. That surge pushed the fund into positive territory on the year, making it one of the better performers in the commodity ETF category. There are several reasons as to why coffee has managed to buck the trend of most of the ‘soft commodities’ and post a gain in 2010, but the vast majority of JO’s gains can be traced to supply issues which have riled markets in recent weeks (also see the Definitive Guide To Coffee ETFs).
One of the key supply issues originates in Vietnam, the largest grower of lower-quality robusta beans which are mostly used for instant coffee. Many traders had been betting on lower prices but “the market has now realized that the Vietnamese crop, the largest in the world for robusta, is smaller than previously thought,” said Jose Sette, head of operations at the International Coffee Organization in London. This has led to short-covering in the market which has helped to send prices sharply higher in recent days. Additional good news for investors in JO came in the form of more humid and damp weather in Colombia, which is expected to curtail production from the third largest exporter of the crop. Meanwhile the African nation of Uganda, which is the biggest exporter of coffee in the region, has had supply troubles of its own as of late. Coffee exports are expected to fall by as much as 17% this month due to a drought and ongoing issues from a disease that destroyed the coffee crop in 1996-1997. All of these events have chipped away at global production of the crop; worldwide production is expected to slide almost 6% for the 2009-2010 growing season.
These supply issues look to give JO a nice boost in the short to medium-term and could help he coffee ETN continue to outperform other soft commodities such as sugar. In addition to providing a solid return, the fund may also provide investors with solid levels of diversification. The fund has a correlation with the S&P 500 index of just 0.19, and just 0.14 with the Barclays Capital U.S. Aggregate Bond Index (see more information on JO’s fact sheet).
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Disclosure: No positions at time of writing.