For many years, the price of cocoa drifted in a relatively well-defined range. As late as 2020, I wrote about trading that range from my perspective as a cocoa permabull. Unfortunately, liquidity in the iPath® Bloomberg Cocoa Subindex Total Return(SM) ETN (NIB) dried up over time, and NIB was finally delisted in June 2023. The loss of the best vehicle for retail investors to participate in cocoa trading coincided with a with strong rally in cocoa. The very next month, the price of cocoa broke out and proceeded to quadruple in a stunning run-up. The weekly chart below of the cocoa cash contract showcases the scale of the move. The price accelerated in a parabolic move that only ended after a quadrupling in price.
Cocoa prices went parabolic this year. (TradingView.com)
Cocoa demonstrated the dangers inherent in parabolic moves. At some point, forces arrive to counteract the feverish pace of gains. Since resources are ultimately finite, buyers exhaust themselves. The underlying market can also react against prices through demand destruction, increases in supply to take advantage of high prices, changes in market rules, and/or the appearance of even the smallest reversal in news flow. Any one of these triggers can generate abrupt and violent price changes against the prevailing trend. Last week delivered just such a reversal in what looks like the top (for now?) of an epic price run-up. In its recent earnings conference call, Hershey (HSY) Chairman and CEO Michele Buck offered the following guesses about the apparent bubble popping (from the Seeking Alpha transcript):
“…that decline is just further evidence of the tremendous volatility that we’re seeing in the marketplace. It’s hard to peg what some of those declines. There are no new signals relative to supply and demand that are meaningful yet. I mean, perhaps some early signs about the mid-crop, which leads us to believe that more of the decline is driven by some of the non-supply, demand economic factors, but some of those other factors that we’ve discussed relative to speculators thoughts on regulation, etc.”
In this piece, I outline what helped get cocoa to these volatile levels, the prospects for future prices, and how retail traders can (partially) participate in cocoa trading through the Invesco DB Agriculture Fund ETF (NYSEARCA:DBA).
No (Short-Term) Demand Destruction
Despite the price run-up, overall global demand appears to remain strong. Quarter-over-quarter grindings increased in all regions despite some year-over-year softness in Europe and Asia.
- North America (the National Confectioners Association): North American cocoa grindings data for Q1 2024 showed a 3.7% year-over-year increase to 113,683 metric tons. A 9.3% quarter-over-quarter increase reflects an immediate demand surge, suggesting that manufacturers are anticipating rising consumption in the upcoming quarters.
- Europe (European Cocoa Association): European cocoa grindings rose by 4.7% quarter-over-quarter to 367,287 metric tons. However, the region experienced a 2.2% year-over-year decline, indicating a potential longer-term stabilization of demand.
- Asia (the Cocoa Association of Asia): Asian cocoa grindings increased 5.1% quarter-over-quarter to 221,530 metric tons. However, the numbers still marked a 0.2% year-over-year decline.
The grindings data is colored by the difficulty in getting access to raw cocoa. African Bank paints a dire picture of the prospects for future production resulting from a convergence of calamities. Inhospitable weather, including heavy rains last year, and high heat, fires, and droughts this year have destroyed crops. Diseased trees have reduced yields. Years of low prices to farmers have discouraged investment in farms. The International Cocoa Organization (ICCO) reportedly projected a cocoa deficit of 374,000 tons this season, a significant jump from last year’s 74,000 ton deficit. The inability to benefit from today’s high prices, even as input costs soar and currency devaluation lowers purchasing power, has motivated farmers to sell out and pursue more productive endeavors.
A Modest Supply Response
Latin American cocoa growers enjoy freer production markets where, for example, producers in Ecuador secure 80% of the selling price according to the Financial Times. This value capture is impressive especially considering the African Export-Import Bank estimates that West Africa only captures $10B of the $200B in value (not just price) from the global cocoa industry. The Financial Times also quotes Ecuador’s exporter association as saying that plantings will increase 20% to 600,000 hectares. According to Reuters, Ghana, the world’s second largest producer, has 1.38M hectares under production. However, Ghana’s cocoa output will collapse to 580,000 tons for the 2023/2024 season (a 22-year low per the Ghana Cocoa Board) compared to Ecuador’s 430,000 tons. This massive gap in productivity could favor Latin American producers over time.
The world’s largest producer Ivory Coast has suffered major production declines as well. Government and association data show Ivory Coast suffered a 30% decline in shipments from October 1 to April 28 with an overall projected record low production for the 2023/24 season, a 21.5% year-over-year decline.
In other words, the rush to increase production in Latin America is promising but will be far from filling West Africa’s supply deficits in the near future. Still, as soon as supply expectations turn, cocoa prices could fall rapidly.
Change in Market Structure
Parabolic prices forced commodity exchanges to increase margins for futures contracts. This tightening of liquidity forces speculators and traders to close out positions they can no longer afford which in turn reduces liquidity in the market. Reuters reported that open interest in futures declined from 400,000 lots in November to 243,000 at the latest count. Reduced liquidity can drive exaggerated price moves both up and down.
Per Reuters, the plunge on April 29th that marked the first bursting of the cocoa fever included a 17% price collapse of the most actively traded contract in New York, the largest intraday decline in cocoa as far back as 1960. Per Bloomberg, a measure of outstanding contracts dropped to its lowest level in 12 years: “the market is now stuck between extreme crop shortages and dangerously low liquidity.”
Hints of Better News Ahead
The cocoa outlook is so dim that even the smallest hint or suggestion of relief can contribute to a large price decline. Morningstar suggested that last week’s record weekly percentage decline in price (going back to 1959) came from fears of declining demand (not likely in the short-term per the grinding numbers above) but also speculation on better crop conditions.
Volatile Price Conditions
Connecting all the dots makes for an incredibly volatile trading situation. Pressures to secure supply and hold on to futures contracts are combining with trepidation over better cocoa crop and production news at any moment. Yet, the market includes some staunch price bulls. Bloomberg quoted Citigroup’s projection of a $12,500 cocoa price in “a few months.” One hedge fund expects at least a $20,000 price by year-end. The low liquidity in the market means that the opinions of just a few traders and speculators could indeed move the market in extreme directions either way.
West African Farmers Left Behind
Lost in the price shuffle are West African farmers. In Ghana, farmers are only allowed to sell their output to the government agency the Ghana Cocoa Board or COCOBOD. The well-intentioned management for price certainty to formers worked okay when cocoa prices drifted in a predictable band. But now the prices contracted a year ago are shutting farmers out of the benefits of price appreciation. They sorely need these higher prices to invest in farms to increase supply rather than abandoning them to other enterprises (or worse to the pollution of illegal gold mining in Ghana).
COCOBOD recently responded by spiking its “farm-gate” price by 58% for the remainder of the 2023/24 season. This belated action will provide some assistance. Per COCOBOD: “The increase in the producer price of cocoa has become necessary to enhance the income of cocoa farmers in line with the vision of the NPP government and in response to the rising prices of cocoa on the international market.” COCOBOD also increased the amount of allowable profit for licensed buying companies (LBCs) to help accommodate the increased farm-gate price.
The Ivory Coast also increased its farm-gate price by 50% for the mid-crop. Farmers in the Ivory Coast can directly sell to trade associations and private buying companies and thus tend to get better prices than farmers in Ghana in good times (thus smuggling from Ghana to Ivory Coast can be a problem).
While these increases are good for farmers, exporters may get hit hard. Some strapped exporters could go out of business as they sit on contracts negotiated last year with much lower prices. A price stabilization fund in Ivory Coast is supposed to handle such situations but of course has not been tested under these kind of severe conditions. If exporters and shippers shut down, cocoa’s supply problems could become further exacerbated.
The poor finances of cocoa farmers stands in stark contrast to the fortunes of chocolate titans. Fast Company recently reported on an Oxfam analysis claiming that the Ferrero and Mars families are worth more than the combined GDP of Ivory Coast and Ghana. Organizations like the African Cocoa Marketplace are working to forge a more equitable chocolate economy. The industry as a whole, public and private, will need to figure out and sustain a portfolio of alternatives to drive investment and opportunity into cocoa farms in order to avert even worse pricing crises in the future.
Invesco DB Agriculture Fund ETF (DBA)
U.S. retail investors cannot directly invest in cocoa equities. The Invesco DB Agriculture Fund ETF (DBA) provides cocoa exposure. As of the time of writing, 10.5% of DBA’s holdings are in the July 2024 cocoa contract. At cocoa’s peak, DBA held an even higher concentration in cocoa futures via earlier dated futures contracts. Still, cocoa remains the largest commodity holding in DBA. The top 2 holdings are financial instruments used to help track commodity prices and smooth the operations of the ETF. Now, with cocoa in backwardation (near-dated futures prices are higher than longer-dated futures prices), cocoa could cause an extra drag on DBA performance if prices continue downward. For now, DBA and the cocoa cash contract are closely correlated. Per the chart below, DBA peaked at its last major high on April 19th just like cocoa and first collapsed on April 29th just like cocoa.
The Invesco DB Agriculture Fund ETF (DBA) has triggered multiple technical signals and prospects. (TradingView.com)
From a technical perspective, DBA’s uptrend has come to an end with a breakdown below its 50-day moving average (DMA). From here DBA needs to hold support at its previous high set in March 2022 when Russia’s invasion of Ukraine sent the price of corn soaring (the corn September 2024 future is just 5.2% of DBA’s holdings). Further support could come from the March, 2024 breakout point. (See the points drawn above). A fresh 50DMA breakout would reestablish a bullish setup for DBA whereas bounces from lower support only setup short-term trades.
DBA is an imperfect trade on cocoa. However, as long as cocoa maintains strong price action, DBA is likely to remain correlated. Once/if that correlation ends, the cocoa trade would also come to an end. I will be checking the distribution of DBA holdings on a regular basis.
And yes, I am still a permabull on cocoa…
Be careful out there!
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