Cocoa Heads For The High

January 24th, 2020


Category: Cocoa

(Seeking Alpha) – The price of cocoa moved to just over $2850 per ton this week before pulling back. Cocoa beans are the primary ingredient in the chocolate confectionery products enjoyed by people all over the planet. Cocoa production thrives in tropical climates around the equator. Therefore, West Africa is the region of the world that produces almost two-thirds of the annual supplies. The Ivory Coast and Ghana account for the lion’s share of output. In the world of cocoa, the two nations are the OPEC of the cocoa market.

The cocoa farming, logistics, and related businesses are the center of the economies in the Ivory Coast and Ghana. With demand for chocolate rising around the world, the leading manufacturers of products that require cocoa beans have been working with the two countries on sustainability and reshaping the business away from a dependence on child labor. The trend in the cocoa futures market has been bullish over the past two and one-half years, and higher prices could be on the horizon for the soft commodity that trades on the Intercontinental Exchange. The iPath Bloomberg Cocoa Subindex Total Return ETN product (NIB) follows the price of cocoa futures higher and lower.

The rejection of a lower low lights a bullish fuse

On December 23, the price of nearby March cocoa futures on the Intercontinental Exchange traded to a low of $2388 per ton. The price violated the previous low of $2414 from October 8 on the March contract.

As the daily chart highlights, the price fell to a lower low by $26 per ton in late December, and then rejected the price below the $2400 per ton level. Since then, the price of cocoa has been climbing. Price momentum and relative strength indicators have both risen into overbought territory on the daily chart. The rally has been steady, so daily historical volatility is sitting at just above the 22% level.

Meanwhile, the total number of open long and short positions in the ICE cocoa futures market recently began to climb. Higher prices and rising open interest typically validate a bullish trend in a futures market. On Friday, January 17, the price put in a bullish reversal when it made a marginally lower low and settled well above the previous session’s high. This week, in a follow-through of the bullish technical pattern, cocoa rose above the $2800 level as it traded to a peak of $2859 before pulling back to the $2775 per ton level.

A bullish trend since 2017

The price of cocoa had been trending higher since 2017 when it fell to a low of $1769 per ton in mid-June. After reaching a peak of $2914 in 2018, the price corrected to below $2000. Since then, cocoa futures have been mostly making higher lows and higher highs, with the most recent peak coming on January 22 at $2859 per ton.

The weekly chart illustrates the bullish price trend since the 2017 low. Price momentum and relative strength on the longer-term chart have shifted to the upside, but both remain in the upper regions of neutral territory, leaving room for additional upside price action. Open interest recently began to climb with the price, and weekly historical volatility at 41.22% at the end of last week was the highest level in years. The highest the price variance metric got in 2018 was 40.96%. The metric pulled back to 33% as of January 23.

A surcharge supports the price of cocoa beans

Chocolate manufacturers around the world depend on West Africa for supplies each year. They have been working with the Ivory Coast and Ghana to address crop sustainability issues and the problems related to child labor in the region.

In 2019, the concept of a $400 per ton surcharge on supplies from the West African nations to assist farmers and the overall cocoa business was a supportive factor for the price of the soft commodity. The surcharge has likely caused each period of price weakness to be a buying opportunity in the cocoa market.

At the same time, as Europe appears ready to separate from the United Kingdom officially, the value of the British pound has stabilized around the $1.30 level against the US dollar. London is the hub of international cocoa trading. Many of the physical contracts for cocoa supplies use the British pound as a pricing mechanism. A higher pound tends to support the price of the primary ingredient in chocolate confectionery products.

$3000 is in the cards, $4000 per ton is possible

The demand for cocoa beans and all soft and agricultural commodities has been increasing because it is a function of the global population. At the turn of this century, there were approximately six billion people in the world. As of January 18, that number stood at around 7.625 billion, according to the US Census Bureau. The increase of over 27% in two decades means that more people, with more money, require more agricultural products.

Since chocolate is a treat enjoyed by people around the globe, its price is not as elastic as other commodities. Even if the price of cocoa beans were to double from the current level, the demand for chocolate confectionery products would likely remain stable. Moreover, dietary changes in Asia with the increase in individual wealth have made China and surrounding nations a significant part of the demand story of the cocoa market. The demand for cocoa beans in Asia has been on a one-way trajectory higher.

The quarterly chart shows that above the first level of technical resistance at $2914 per ton, the next stop is above $3000. The all-time peak in the cocoa futures market came in 2011 at $3826 per ton. Above there, prices above the $4000 level are likely in the cards for the soft commodity.

Rising demand is a reason to buy NIB on dips

The ever-increasing demand for cocoa beans because of population growth and increasing wealth is the most compelling reason for higher cocoa prices. At the same time, the potential for a rise in the value of the British pound and a $400 per ton surcharge on over 60% of the world’s supplies support a bullish view for the price of cocoa beans on the futures market. At the same time, since the weather is always the critical factor each year, any events that stand in the way of a bumper crop of beans could send the price of cocoa appreciably higher.

The most direct route for a risk or investment position in cocoa is via the futures and futures options that trade on the Intercontinental Exchange. For those who wish to participate in the cocoa market without venturing into the futures arena, the iPath Bloomberg Cocoa Subindex Total Return ETN product provides an alternative. The fund summary for NIB states:

“The investment seeks to provide investors with exposure to the Jones-UBS Cocoa Subindex Total Return. The Dow Jones-UBS Cocoa Subindex Total Return reflects the returns that are potentially available through an unleveraged investment in the futures contracts on cocoa. The index currently consists of one futures contract on the commodity of cocoa which is included in the Dow Jones-UBS Commodity Index Total Return.”

Source: Yahoo Finance

NIB has net assets of $56 million, trades an average of 134,340 shares each day, and charges an expense ratio of 0.75%. The price of nearby ICE cocoa futures rose from $2388 per ton in late December to $2859 per ton on January 22, a rise of 19.72%.

Over the same period, NIB rose from $27.44 to $33.42 per share or 21.79%. NIB did an excellent job replicating the price action in the nearby cocoa futures contract over the past month.

If cocoa is heading for higher highs above the $3000 per ton level, NIB could be the perfect tool to sweeten your portfolio.

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