The past few weeks have seen cocoa prices spike out of their long-standing range of between $2,000 and $2,500 per tonne (Chart 1).
West African cocoa producers are heading into the final few weeks of their mid-crop seasons. The Ivory Coast, Ghana, Nigeria, and Cameroon will all harvest significantly smaller crops than they did last year. There are no great surprises, though. The final numbers are very close to estimates that have been on the street for several months.
As expected, there’s been no improvement in Ivorian arrivals as the mid-crop progressed. In fact, the arrivals are 80,000 tonnes, or 5.7%, below last year at this time, compared with 3.8% at the beginning of July. Forecasts for the 2011-12 combined main and mid crops are at about 1.35 million tonnes, down from 1.5 million tonnes a year earlier. That estimate will be revised upwards, because we are already at that level, but not by much, and that’s where the bearish news ends.
Ghanaian mid-crop arrivals are much weaker than last year’s, currently at just over 51,000 tonnes. Last season, the mid-crop reached 107,000 tonnes. With very little time remaining, total mid-crop will not climb much more. That would bring total production for 2011-12 to somewhere between 825,000 and 850,000 tonnes, sharply below 2010-11 output of over 1 million tonnes.
While these poor production performances for the world’s two largest producers have more or less been known for some time, prices were restrained by anemic demand.
Grind activity over the past few quarters has been very weak. The most recent data for the North American and European grind, released in July, showed dismal results for the second quarter. The North American grind fell 9.8% from a year earlier, the largest drop in three years. The European results were even more dramatic – down 17.8% from the previous year, the biggest quarterly loss in 12 years! The bears were in control – or so they thought. Ironically, prices began to rise almost immediately after the quarterly grind data were published.
Butter ratios had fallen all the way down to 1 times the spot London bean price, after peaking at over 3 in 2007. With slim profit margins, the incentive to grind was weak. It seems, however, that actual end-user demand was not quite as weak as believed, because butter inventories were run down to the point of bona fide tightness. In mid-July the butter ratio began to rise. In Europe the ratio has now shot up to 1.6. At 1.4, the increase in the Asian ratio has been more moderate, but still indicative of a much tighter market.
Although powder prices have retreated from the peak set last year, the increase in the price of butter has been substantial. The combined butter/powder ratio (Chart 3) should provide enough stimulus for processors to ramp up grinding activity.
On August 28, The International Cocoa Organization (ICCO) reduced its estimate for the size of the global deficit, from 43,000 tonnes to only 19,000 tonnes, on account of the sharp drop in second-quarter grindings. Based on the explosive upward move in the price of butter, however, it’s hard to imagine that grinding activity has not increased over the past few months. Third-quarter grind number will be released in mid-October, and we expect to see much stronger activity reflected in the new numbers.
Not surprisingly, speculators have taken note of the rally. The spec community has been net short this market for the longest time and in the space of just several weeks has whipped around to the long side (Chart 4). So we can expect some volatility.
But make no mistake, with the drop in 2011-12 West African output and now that demand has improved, there’s much more substance to this move than a fleeting short-covering rally. The rally is deeply rooted in long-term supply and demand fundamentals. This includes producing nations with potentially volatile output and – despite current economic woes – a long-term broadening of the consumer base, as developing countries adapt to Western snacking habits.
Raises stops to $2,300 per tonne, basis the nearest contract month. Close only.