Cocoa Cornering? The Soft Underbelly of the Commodities Markets

Jul.20.10 | About: Starbucks Corporation (SBUX)

This is not the summer for the corner Starbucks (NASDAQ:SBUX). This is the summer for the Starbucks corner. First, there was an episode in coffee. (Yeah, Arabica, not the kind of stuff you’ll usually find at Starbucks, but work with me here.) And now, cocoa. There were huge deliveries stopped on LIFFE’s cocoa contract, which calls for delivery in various European warehouses. There are reports that a single trader stopped all the deliveries. The name mentioned in this episode is Anthony Ward.

The cocoa market has moved into backwardation and there are reports of a large differential between European and U.S. cocoa prices. (I haven’t had time to run the data yet.) The coexistance of a backwardation with large stocks is frequently symptomatic of a manipulation–a corner.

Stories say that Ward is speculating on short crops in the coming season. But if that’s true, he could profit on that view without taking delivery- he could just buy futures. And if he’s right, the futures price will rise and he can profit by liquidating his futures position. Also, if he believes that there will be a shortage in the new crop, that view is best acted on through a purchase in the new crop contracts, not taking delivery.

Furthermore, a looming shortage in the new crop should lead to a rise in the new crop price relative to the old crop price in order to encourage the holding of stocks to meet future shortages. The reverse has happened: Rather than the curve moving to contango, it has become severely backwardated. Thus, non-manipulative explanations are hard to credit.

The commodity markets, especially for the softs, are relatively small compared to the amount of money that can be amassed by hedge funds and others. This means that the markets are potentially vulnerable to manipulation. It looks like that’s going on in the Starbucks commodities this summer. Look out, sugar!