Cocoa prices continue to falter, sinking to 10-month lows against a backdrop of mixed fundamentals (Chart 1). West African production is sluggish, but the demand picture has been a disappointment.
On the consumption side, fourth-quarter grinding statistics showed lackluster demand. The North American grind was up 1% year-over-year, and the Asian grind was 2.8% higher. In Europe, however, the world’s largest grinding region, the grind was down 6.2%.
We have been touting the bullish virtues of the explosive move in butter prices in recent months. The butter ratio doubled from 1 times the London spot price to 2 (Chart 2).
The prices of butter and powder, the two main products of cocoa beans, often move in opposite directions. The two individual markets can be very volatile, but when added together, the price has been relatively stable over the years (Chart 3).
When the combined ratio moved to the top of its range twice over the past two years, we believed that processors would increase bean purchases. But powder prices have collapsed in a serious way (Chart 4), which leaves little incentive to process any more than hand-to-mouth requirements. The collapse in profit incentive seems to explain the slow growth of grinding activity.
Ivorian farmers are harvesting the tail end of the main crop. Port arrivals stand at 939,000 tonnes, 6.6% behind last year at this time. It was a very dry season, which has resulted in inferior quality beans. Bean quality is determined by size. The acceptable level is a maximum of 105 beans per 100 grams. Many beans have been coming to port at 115 beans per 100 grams and are being rejected by exporters. Smaller beans are typically harvested from the mid-crop, but having such small beans as part of the main crop means that the volumes of arrivals are not an accurate reflection of supply.
While the poor quality is mostly a result of weather, it is also related to failed government reforms. Falling prices have not facilitated the forward selling program quite the way the government had anticipated. The minimum prices paid to farmers has fallen and the incentive to switch from cocoa to more profitable crops, such as palm and rubber, has increased.
Ghanaian output, as measured by exporter purchases, is 16.8% below last year at this time, which is substantially below the government’s estimate for a 5% drop. Cameroon was a minor player in West Africa, but had set a goal to grow 250,000 tonnes of beans. In 2010-11 that target was almost reached with output of 240,000 tonnes. The following year, however, disease and infestation reduced the crop to 220,000 tonnes. This year, primitive drying practices have resulted in rejection of beans by European buyers. We do not have an accurate estimate, but it would seem that output will fall again.
So while demand is in fact extraordinarily bearish, new supply flows from the major producing nations, as illustrated, may very well be in a perpetual decline. This has kept the global balance sheet from flying into an unchecked surplus. The International Cocoa Organization (ICCO) recently forecast a production/consumption deficit of 45,000 tonnes. This compares with last year’s 86,000-tonne surplus. That’s actually a conservative estimate. Some analysts are looking at a deficit of over 100,000 tonnes.
We were wrong about the demand side. However, the world’s supply sources remain highly vulnerable, both because of political instability and because of unsophisticated agricultural technology and financial planning.
We were stopped out of our long position at $2,300 per tonne. Stand aside, but stay tuned.
