Cocoa turns tastier on short supply

Cocoa prices have been rising steadily from the beginning of this season. That has its moorings in fundamentals.

Barring brief periods of surplus, the world cocoa market has been in a state of structural deficit for over six years, with fluctuating year-on-year production and varying, yet steadily rising, consumption demand.

Stocks have declined from a high of 1.8 million tonnes (mt) in 2011-12, as production trails consumption. So how long will prices continue to rise? On current reckoning, the situation is likely to continue into next year as well.

Given the constructive fundamentals, speculative lengths in cocoa remain at historically high levels. Non-commercial participants (speculators) account for much of length in New York cocoa futures. On the bourses, prices have risen by 20 per cent in the last one year.

Recently markets have seen prices holding in a range following weaker-than-expected grinding numbers in the US and Europe. Early this May, on ICE, cocoa traded at $2,900 a tonne, up from $2400/t a year ago. Industry representatives suggest that demand indicators can drive the market direction in the coming quarters.

Major global cocoa producers include Ivory Coast (1.5 million tonnes), Ghana (0.8 mt) and Indonesia (0.4 mt) followed by Nigeria, Cameroon, Brazil and Ecuador. Even as the crop outlook in West Africa turns positive on improving weather, there is expectation that current high prices will encourage West African Governments to announce a remunerative price for 2014/15 main crop. At the same time, the demand side is not without concerns.

To be sure, cocoa demand has a positive correlation with world GDP growth. With steadily improving growth signals, there would be a natural expansion of demand. Major demand markets for cocoa include EU-27, the US and Russia. Emerging markets continue to expand their share in the world confectionery market. But rising ingredient costs are a matter of concern. What if chocolate manufacturers pass on their higher ingredient cost to consumers? Steadily rising cocoa prices, along with a rise in dairy prices, have squeezed the margins of chocolate manufacturers who are now forced to pass on the additional costs to consumers. This trend can hurt demand.

Despite these factors, cocoa bulls are not ready to leave the market yet because there is higher than normal chance of El Nino striking in July. In the event, it would be bullish for cocoa because of possible losses in Indonesia, Ecuador and Brazil. Indonesia has been experiencing dry conditions in the last two months. So, prices might go even higher, falling back closer to harvest time.

Overall, fundamentals suggest that the market could turn bullish in the latter part of this year and into the next year because of projected larger deficit.

Structural deficit is projected to be lower this season at about 60,000 tonnes; but next year the deficit is expected to expand to 100,000 tonnes. In West Africa, which accounts for a substantial part of world cocoa production, it is widely believed that farmers would look after the crop well with prices in the vicinity of $3,000/t.

If the rates were to fall below $3,000/t, one can expect strong demand from grinders and at the same time, funds will attempt to push prices higher.

All this suggests that for the next season, so long as deficit remains higher, prices should trade upwards of $3,000/t and towards $3,400/t. In sum, cocoa fundamentals aren’t all that bullish in the short term, but they are not bearish either.

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