Activity in the cocoa market has been somewhat enigmatic. Without the benefit of any obvious bullish fundamentals, and in a generally weak commodity environment, it’s surprising that prices have been relatively strong.
West African output for 2012-13 has been running ahead of last year and at a stronger pace than analysts had forecast earlier in the season. With the main crop season long over and the mid-crop currently in harvest, Ivory Coast port arrivals stand at 1.38 million tonnes, 6% above last year at this time.
Port arrivals in Ghana, the world’s second-largest producer, are also well ahead of both last year and expectations. Early forecasts put total output at 800,000 tonnes. By the end of May, arrivals had reached 750,000 tonnes, so it’s a good bet that total production will reach 900,000 tonnes. Nigeria’s significance as a producer had been dwindling, but as a result of excellent precipitation this year, it will harvest a bumper crop of 280,000 tonnes, about 40% higher than in 2011-12.
Finally, in West Africa, Cameroon is maintaining its status as an up-and-coming producer with output expected to reach 230,000 tonnes, an improvement over last year’s 220,000 tonnes and just shy of the record 240,000 tonnes harvested in 2010-11.
Output from the world’s other significant producers, Indonesia, Brazil and Ecuador, is steady at the levels achieved over the past couple of years.
While prices of many agricultural commodities having been fading back into pre-bull-market territory, there are two issues that have kept cocoa prices at their current levels.
Weather in the Ivory Coast has not been conducive for the early development of the coming 2013-14 main crop, which is harvested in October. Below- normal temperatures and inadequate sunshine hamper the proper setting of pods at this stage.
Coupled with the government’s goal of protecting rain forests, output for the coming 2013-14 marketing year could suffer. A significant number of the country’s most productive plantations are grown inside forest reserves, many of which the government claims are occupied illegally by cocoa farmers. Soldiers have been evicting the small farm communities. If the program is successful, we could see a meaningful decline in output – regardless of the weather. The government seems to be indifferent to the harm it may cause the industry, because its agenda focuses on meeting European Union environmental standards.
Demand has also been helpful in keeping a firm tone in prices. Second-quarter North American grind data, released on July 18, showed a 12% jump over year-over-year, much higher than expectations of 2% to 5% and the largest quarterly gain in three years. The European grind was up 6%, in line with expectations. But it was the first year-over-year increase since the fourth quarter of 2011. The Asian grind rose by only 2%, but first-quarter results were revised to a drop of 2% from a previously reported slide of 11%.
Butter ratios have been rising steadily and are now at 2.3 times the price of spot London beans. That’s the highest level since 2009 and has provided an incentive for processors to buy beans for grinding. Although powder prices remain depressed, butter prices have been strong enough to lift the combined butter-powder ratio off its worst levels of the year (Chart 2).
The current 2012-13 marketing year will end with a surplus, but as illustrated above, the following season could very well see the balance sheet slip into deficit. Early estimates call for a deficit of between 60,000 and 100,000 tonnes for 2013-14. The uncertainty surrounding next year’s Ivorian production and the first indication in years that demand growth may outstrip output growth explains the market’s resilience and leaves the market vulnerable to a more substantial deficit.
We believe the market is in the midst of a long-term bottoming process. Commodity funds are long the market, so a lot of buying power has already been spent (Chart 3). Establish long positions in December cocoa on setbacks. Place initial stops at $2,100 per tonne, close only.