Cocoa: Demand joins the supply side in the bull camp

Focus on Futures: Cocoa

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.

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About the Author

Sholom Sanik is an analyst with Friedberg Mercantile Group Ltd. He can be reached at

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