In early May, we asked, “Is peace in the Ivory Coast enough to tame the cocoa bull?” (See Focus on Futures, May 11). The answer was negative, but we suggested using a relatively conservative $2,900-per-tonne stop close to protect long positions. The market has had ample closes below that level, so we are out.
We are well past the ousting of the incumbent president, Laurent Gbagbo, who lost the election, but refused to leave the presidential palace. About half the 470,000- tonne backlog of beans, held back by the winner of the election, Alassane Ouattara, to starve Mr. Gbagbo of revenues, has been shipped. Prices made new lows for the move as the impasse was resolved.
On the surface, it seemed fairly clear that the last vestiges of the bull were gone. According to official government estimates, the Ivory Coast was slated for a bumper crop. Ghanaian output (including beans smuggled from the Ivory Coast) jumped an astounding 50% above the previous season’s supply.
The demand side was not helpful either. First quarter grinding results from Europe and North America showed consumption was growing at a slower pace than production. Butter prices continue to slump, which means that there is no incentive for processors to buy more beans than they need to meet commitments.
Nevertheless, when viewed in the context of some serious bouts of across-the-board commodity weakness, with major corrections in even the strongest of markets, such as gold, corn, and petroleum, we observe that cocoa bean prices, with its alleged bearish fundamentals, held up rather well.
Most of the talk in the cocoa market has revolved around the 2010-11 Ivorian port arrival level, which is said to be running 15% ahead of last season at this time. That would put annual output at 1.3 million tonnes. Quite the amazing feat, considering all the turmoil that affected just about every facet of the production, mobility, and storage process.
We have absolutely no evidence to cast any doubt on the reporting of arrival figures. It is strange, however, that both the Ivory Coast and Ghana could post such fantastic numbers. Indeed, some market observers have suggested that a significant amount of Ghana’s “production” estimate is in fact smuggled Ivorian cocoa. It is difficult to believe the authenticity of Ghanaian estimates while accepting that Ivorian farmers were able to compensate for labor – and other – problems associated with the civil war and produce such a large crop.
Ghanaian officials insist that the 900,000-tonne-plus crop is the result of a significant escalation of fertilizer use and that they have brought tree disease under control.
The first signs of poor quality cocoa in the Ivory Coast have emerged. Press reports claim that the most recent port arrival included 15,000 tonnes of beans that were not eligible for export at all. The export standard was always 105 beans per 100 grams. Ivorian officials have lowered the standard for this year’s mid-crop to 125 beans per 100 grams citing “exceptional circumstances” as a result of the war.
So while the headlines may speak of extraordinary tonnage, the by-product content has obviously been compromised.
Second-quarter grind results for Europe and North America will be released in a few weeks. Even a small uptick will be bullish news, because we are now seeing an ever increasing amount of origin grinding activity. Indonesian and Malaysian grindings are estimated to be 20% and 10%, respectively, above last year’s.
If nothing else, the 2010-11 season has illustrated the vulnerability of the cocoa market to the Ivory Coast’s position of being the provider of one third of the world’s cocoa beans. We’ve muddled through, again, but just barely. It remains to be seen just how much of the 1.3 million tonnes is actually acceptable for Western chocolate manufacturers.
While commodity funds have generally been net-long commodities, cocoa has been an exception. They are giving up and have begun to cover their short positions, which leaves a fair amount of short covering fire power to exacerbate the rally that we feel confident is around the corner.
The bull is hardly tame. We recommend reentering the long side.