Cocoa, a Huge Opportunity People Shouldn’t Ignore
Going
into 2018 traders are feeling good, U.S markets continue to hit all-time highs,
Emerging markets have just had their best performing year since 2009, for some
reason crypto currencies continue to surge, even oil is up for the 2nd
year in a row. However, one corner of the trading universe seems to have
forgotten that we are in the bull market, soft commodities like coffee, sugar,
orange juice and cocoa. While the fundamentals continue to look bearish for most
of these commodities, one has the potential to pose a remarkable comeback,
cocoa.
Most
people are unaware that cocoa, the main ingredient in cocoa powder that is used
to make chocolate, is traded, let alone have any interest in investing in it.
This makes sense, but while cocoa may not be as widely traded as other
commodities like oil or gold, cocoa futures do have enough volume and liquidity
to allow traders to speculate on prices. Often times the best opportunities
come from the places you least expect.
Cocoa
did not have a good couple of years, futures were down almost 20% in 2017 and
30% in 2016 on the back of a huge supply glut, one that is expected to continue
going into 2018. However, there are signs that the bear market in cocoa is
beginning to subside. To understand how cocoa prices can rebound it is
necessary to understand what caused them to melt down in the first place.
Cocoa’s
collapse over the last 2 years can be mainly attributed to a large crop in West
Africa that caused a huge surplus to occur (basic economics, when supply
outstrips demand prices go down). Over 70% of cocoa production takes place in
West Africa, from countries like Ivory Coast and Ghana. This means that cocoa
prices are highly sensitive to events in the region be the weather, political
or economic in nature. In this case, abnormally
favorable weather in West Africa caused countries like Ivory Coast to produce
far more cocoa than usual, over 2 million tons to be exact. Large supply
coupled with the fact that the global confectionary market experienced a broad
based slowdown during 2016, meant that a surplus of 347,600 tons formed, hence
falling prices.
 |
Chart Showing U.S Cocoa Futures from September 2016- December 29th 2017.
A large cocoa crop in West Africa created a massive supply glut and sent prices sharply lower.
|
By looking at the
chart it is clear that cocoa prices have bottomed out, and have begun to trade
in a range between $1,800 and $2,200 a ton. This seems to indicate that the
market has already priced in the large surpluses that exist in the market. At
the moment cocoa is trading at the bottom of its trading range that it has held
through most of 2017, following a steep sell-off in December. This heavy
December sell-off has sent many investors panicking, believing that a fresh
collapse in cocoa prices is imminent. These fears are widely overblown for many
reasons. The first of which is that this most recent drop in prices is keeping
with cocoa’s most recent trend (you can see this trend in the chart above). In
fact the December sell-off only strengthens this trend, which has cocoa trading
mostly flat.
Another reason
that fears are overblown is because a large amount of the selling can possibly
be attributed to a single party. This party is Anthony Ward and his cocoa and
coffee focused hedge fund, Amajaro. Anthony Ward is one of the biggest and most
prominent cocoa traders out there, so much so that the media has labeled him
Chocofinger. In December, Ward announced
that he will be closing Amajaro following the funds 1st annual loss
since its inception. It is possible that the sell-off in cocoa in December was
caused by Amajaro liquidating its positions, which considering that the fund
was said to manage over $500 million in outside capital were probably huge. If
the sell-off in December was caused by a combination of trend following and
liquidation by Amajaro, it is easy to see cocoa returning to the $2,200 level
at some point in the near future (that is a 20% premium to current prices).
However, it is
also possible that cocoa breaks lower at this point but this is also unlikely
due to a number of different fundamental reasons. Chief amongst which is the
declining surplus, which has consistently plagued the market over the last
year, as well as higher demand from emerging markets for chocolate.
Although
West African producers are expected to produce another large crop this upcoming
season, many analysts including those from Goldman Sachs and ABN Amro believe
that it will be significantly smaller than last year, due to excessive rain in
West Africa. Heavy rain increases the chance of disease in cocoa trees, which
reduces their output. Disease is already a problem in West Africa with an
estimated 20% of trees in Ghana (the 2nd largest cocoa producer in
the world) being infected. Low prices for cocoa have also hurt farmers’ incomes
which prevents them from buying much needed fertilizer and pesticides, which in
turn will make disease even more of a problem. The weather is not expected to
improve either, due to La Nina’s affect on West Africa (La Nina has
historically brought heavy rain to the region). Due to this adverse weather at
the beginning of the season, nobody expects cocoa production to be as massive
as last season.
 |
| Chart showing Cocoa production in Ivory Coast from 2009-10 season to 2016-17 season. Last season saw Cocoa production hit a record high. Current Predictions put 2017-18 main crop at 1.4 million tons. |
Another thing that
will likely support cocoa prices is a higher demand from the chocolate industry
as well as changing consumer tastes. Global cocoa processing is set to increase
3-5% next year as lower costs boost demand from the chocolate industry. The
chocolate market seems to have finally returned to growth in 2017 after over a
year and a half of declines. This renewed growth could have something to do with
the fact that demand from developing countries for chocolate, one of the most
popular and widely consumed products in the world, is starting to speed up.
There
is also a growing trend of people favoring dark chocolate over milk chocolate,
a trend that will certainly strengthen cocoa prices. This is because milk
chocolate accounts for 50% of the global chocolate market and is made of only
about 10% cocoa. Dark chocolate on the other hand contains over 60% cocoa. This
switch to dark chocolate is being fueled by a health craze that has people
cutting what they consider unhealthy fattening foods and sweets, in other words
milk chocolate. At the same time health experts and studies have begun to show
that eating a little dark chocolate could actually be healthy for you and even
prevent some diseases. This is due to dark chocolate and specifically cocoa
being rich in anti oxidants. Demand for dark chocolate is only expected to grow
as people begin to appreciate its potential health benefits and more natural production.
 |
| Chart shows Chocolate confectionary market growing 2.2% and 2.3% in Q3 and Q2 of 2017, following 6 straight quarters of declines. |
Another thing that
will help cocoa prices is a growing demand from the emerging markets. Demand
from Asian countries like China, India and the Philippines is expected to grow
from 3-4% a year, while demand from developed countries is predicted to grow at
a steady 2%. According to the ICCO
(International Cocoa Organization) and analysts at major banks such as Citi,
overall cocoa demand grew 5% in the 2016-2017 season, and is expected to keep
growing in the future. At the same time as demand is increasing supply is
decreasing with production from West Africa in the 2017-2018 season expected to
be 5-7% lower than last season (according to analysts from Citi Group). These
factors mean that the cocoa surplus is very likely to decrease in 2018.
 |
| According to worlds 3rd Largest Cocoa processor, Olam International, cocoa surplus is expected to fall to around 55,000 tons in 2017-2018 season. |
Based on both
technical and fundamental factors, cocoa prices look poised to make a comeback.
When you consider the expected lower production in West Africa, growing demand
for chocolate in emerging markets and growing popularity of dark chocolate, it
is very easy to see cocoa rebounding to $2,200 a ton sometime in early 2018.
Investors who want to get exposure to cocoa have several options. They can buy
cocoa futures traded in the U.S on the Intercontinental Exchange under the
symbol CC. For investors hoping to avoid the intricacies involved in futures
trading, there is multiple cocoa ETF’s out there. The best (the one with the
highest average volume) is iPath Bloomberg Sub index fund, traded under the
ticker NIB. Investors hoping to take advantage of the opportunity in cocoa can buy
this ETF which accurately tracks the price of cocoa.
However, there are
still risks. Even though the cocoa market is expected to become more balanced
in the coming season, a surplus will persist. JSJ Commodities expects cocoa
supply to outstrip demand by 88,450 tons in 2018. Although it is worthy to note
that much of the cocoa beans in surplus are not of useful quality, according to
Gerry Manley (head of Olam International) due their reduced fat content. The
surplus is also considerably smaller than last years. Despite this any surplus
will likely keep cocoa prices range bound until new fundamentals develop, but
this also could be a positive. If cocoa prices fail to break down further and
start trading flat it will likely force hedge funds (who have consistently
shorted the commodity) to liquidate their positions, this greatly improves the
chances of cocoa prices staging a recovery.
The cocoa market
continues to look healthier and barring any bearish news (such as a larger than
expected crop in West Africa) the cocoa market can very well become completely
balanced by 2019. If this happens we will probably see a break out past $2,200,
which would mean being bullish on cocoa now at these low prices could become an
extremely profitable going forward.
http://www.talkmarkets.com/contributor/Mike-Molman/?uid=50272
Sources:
https://www.agrimoney.com/search?q=cocoa#q=cocoa&topics=Cocoa
https://www.icco.org/about-us/icco-news/380-quarterly-bulletin-of-cocoa-statistics-november-2017.html
Image source:
Disclaimer: This material has been written for informational purposes only, it should not be considered as investment advice. Any investment decision should be made after consulting multiple sources and a financial advisor.
