Pound Got You Down? Try Cocoa!

It seems counter intuitive that in a global economic slowdown, a commodity could rise, but cocoa has done just that. Despite weakening demand, cocoa has two bullish factors in its favor: supply shortages and the British Pound.

Supply Shortages

A survey conducted by the International Cocoa Organization (ICCO) found that in December cocoa bean physical stocks located in European warehouses declined by 19%, while stocks in the U.S. declined by 36% (YoY). Furthermore, Cote d’ Ivoire, the largest cocoa producing country and global benchmark, reported a 40% decline in the amount of beans reaching the port. The ICCO concludes that even if the supply situation improves it is unlikely to fill the hole. In March, the ICCO forecast ending stocks for 2008 would 1.6 million tons; however, in December 2008 those stocks were only at 1.056 million tons. Therefore, while economic conditions may result in reduced demand, supply is falling faster than expected.

British Pound

Cocoa futures trade at both the New Board of Trade (NYBOT) and the Euronext London Futures Exchange (LIFFE). The NYBOT quotes prices in U.S. dollars, but the LIFFE quotes in Pounds. Just as commodities that are priced in U.S. dollars soared when the greenback weakened, so too has cocoa. In 2008, the GBP/USD exchange rate fell by 27% and London Cocoa (priced in pounds) rose 66%. Year to date, the pound has fallen 5% vs. the dollar and cocoa has risen only 1%.

Of course, there is not a one for one relationship between the pound and cocoa, but the supply shortages coupled with a weak pound has created a very bullish scenario. If you do not have access to the NYBOT or the LIFFE, there is an ETN that tracks cocoa. The iPath DJ-AIG Cocoa ETN (NIB) is thinly traded, but is an easy way to get your cup of hot cocoa.

Disclosure: I am long cocoa futures and NIB.

Comments

[Mark Anthony:]

Interesting aspect. But I think you may have under-estimated the weakening of demand. Cocoa is related to discretional spending so the demand can be weakened much further if the price remains high.

It's important to make a distinction between discretional spending and non-discretional spending, when you evaluate demands:
seekingalpha.com/artic...

Jan 26 10:38 AM

[gapupgoat:]

Demand will increase. It is becoming known that chocolate is loaded with antioxidants and is not only a guiltless pleasure but downright healthy. And if there is any kind of untoward political development in Ivory Coast, cocoa could really take off.


On Jan 26 10:38 AM Mark Anthony wrote:

> Interesting aspect. But I think you may have under-estimated the
> weakening of demand. Cocoa is related to discretional spending so
> the demand can be weakened much further if the price remains high.

>
>
> It's important to make a distinction between discretional spending
> and non-discretional spending, when you evaluate demands:
> seekingalpha.com/artic...

>

Jan 29 05:43 AM