Where did all the cocoa go?

The 2010-11 marketing year for cocoa in the Ivory Coast ended on September 30. The crop reached – reportedly – a record 1.51 million tonnes. Although this was the year in which the vulnerability of the Ivory Coast’s position as producer of 40% of the world’s cocoa was exposed, the country – and its cocoa crop – survived for months without a government. The halt to cocoa exports allowed 500,000 tonnes of beans to pile up with the risk of spoilage, but the beans were apparently able to withstand the questionable storage conditions. Prices have responded accordingly – falling to mid-2009 levels.

Neighboring Ghana also produced a record by-far crop of over 1 million tonnes.

The fantastic output levels in the Ivory Coast and Ghana were compromised by number three producer Indonesia. Excessive precipitation allowed disease to flourish, and as a result, output will reach only 400,000 tonnes, down from its normal crop size of about 500,000 tonnes.

West African production for the new crop year, however, is expected to fall short of the stellar performances of 2010-11. The strength of this past season’s crop was due largely to unusually excellent weather, which cannot necessarily be repeated. There have been more reports of Black Pod disease than we can remember seeing in quite some time. Nevertheless, the Ivorian government announced recently that its forecast is calling for further increases to 1.6 million tonnes. The consensus among industry participants, however, is that new crop will decline. With only three weeks of data since the beginning of the marketing year to judge by, port arrivals are 44% below the same period in 2010-11.

The Ghanaian government’s forecast is more grounded and believable. It estimates that production will fall by about 10% to 15%, to between 850,000 and 900,000 tonnes, probably to reflect the improbability of seeing last season’s weather duplicated.

There is a distinct possibility that arrival figures might not be a true reflection of the Ivorian crop, because of the premium being paid in Ghana. With Ghanian farmers getting $2 per kilo compared with $1.5 per kilo in the Ivory Coast, smuggling could be rampant. That is what happened last year. In fact, we continue to view the size of last season’s reported Ghanaian output with some suspicion because of the largely inexplicable 40% jump from the 2009-10 season.

The overall demand picture is actually looking much stronger. We keep hearing that grinding activity in non-origin grinding countries has peaked because of the shift of processing to origin countries. Third-quarter results were very strong, though. The North American grind rose 3.42%, slightly higher than expected. The European grind was up 14%, considerably higher than expected. Both of these items were greeted with a yawn, as prices proceeded to trade down to new lows for the move.

Although butter prices continue to fall, powder prices have maintained their strength. The combined butter/powder ratio sits at multi-year highs, which explains the increase in grinding activity.

Open interest has soared to near record highs, a clear indication that at least part of the drop in prices was fund selling. The $200-per-tonne bounce off the lows is a short-covering rally in progress. Is there more to this rally?

Analysts are talking about a balanced market in 2011-12. How did that happen, with the two largest producing nations who grow more than half of the world’s cocoa beans growing record crops in 2010-11? In addition, the estimates we’ve been seeing are likely using a 2.5% to 3% annual growth rate for demand, when demand probably growing at 4% to 5% per annum.

Short-covering ignited this rally, but the fundamentals might carry it. We were stopped out of our long position at $2,800 per tonne as per our September 16 recommendation. Reestablish long positions in March cocoa, using a $2,650 stop, close only.

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