Cocoa Prices Blowing in Saharan Wind
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Cocoa is another of the obscure soft commodities that has gone more mainstream with the advent of ETFs and ETNs for use by both institutions and individual investors.
Unlike as in the past, today investors have a play on the price of cocoa through the use of two exchange traded notes – the iPath DowJones-UBS Cocoa SubIndex Total Return ETN (AMEX: NIB) and the iPath Pure Beta Cocoa ETN (NYSEArca: CHOC).
Chocolate lovers' favorite commodity has certainly been interesting over the past two years. Due to both political and weather concerns in western Africa, cocoa hit a 32-year high in early 2011 at nearly $3,500 a metric ton.
Small cocoa farms in western Africa are responsible for producing 70% of the world's crop with the Ivory Coast being the world's biggest producer (40%). So what happens there largely determines the price of chocolate products around the world, affecting companies like Nestle ADR (NASDAQOTH:NSRGY.PK), Hershey (NYSE: HSY) and Kraft (NYSE: KFT).
Even though the political situation in the Ivory Coast has improved, the poor weather in western Africa is awakening the cocoa bulls again with the commodity recently jumping 15% in just two days. The dry trade wind from the Sahara Desert known as the harmattan has hit the Ivory Coast hard, keeping rainfall away for nearly three months.
Cocoa traders are still scratching their heads trying to come to a consensus on the direction of cocoa this year. Right now the majority of traders believe that production in the 2011-2012 crop year will be less than last year.
Most traders believe the market will shift from a surplus of 400,000 tons to a deficit this year, possibly in the range of 100,000 to 200,000 tons. Traders are basing their estimates on deliveries of cocoa beans to Ivorian ports, which has fallen very sharply in January.
No doubt those in the cocoa market will be anxiously awaiting the results of literally bean counters who examine cocoa tree pods for beans in order to estimate the size of the cocoa mid-crop, which is harvested between May and August.
There are serious long-term problems in the world's biggest producer, Ivory Coast too.
The Ivory Coast has two billion cocoa trees and many of them are very old. Their aging limbs make them more fragile and prone to disease such as Black Pod disease. The trees' age is why the yield from these trees has fallen by 15% over the past years to a level lower than Indonesia.
Also, due to heavy government taxation, many poor farmers in western Africa are abandoning cocoa and moving to crops where they can make a better living. So longer term, there will be less cocoa coming out of the Ivory Coast unless something changes drastically.
Of course, traders have to also look at the demand side of the equation.
Here there are worries that the European debt woes are weighing on demand. The European Cocoa Association recently said that grindings – a proxy for end demand – rose only 1.8% in the fourth quarter of 2011, far below than the forecast for grindings.
However, overcoming these worries is the continued strong growth in consumption coming from world's emerging countries, which is expected to continue to accelerate as greater number of their citizens move into the middle class.
With the expansion of the middle class in emerging nations and both the short-term and long-term production problems in countries like the Ivory Coast, cocoa definitely looks interesting in the months and years ahead.
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