Cocoa At The Highs - Is A Boycott Of Chocolate On The Horizon?

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About: iPath Bloomberg Cocoa Subindex Total Return ETN (NIB), Includes: AFK, JJS
by: Andrew Hecht
Summary

Cocoa rises to a new peak in 2019.

West Africa is the primary producer.

A Washington Post piece could spell problems for the chocolate companies.

Dictating ethics and morals around the globe - good luck.

NIB is the cocoa ETN product.

The price of cocoa has been making higher lows and higher highs since trading down to $2128 per ton on March 21 on the active month July ICE futures contract. At the end of last week, the price rose to a new high for the year, and at the start of this week, it was above the $2500 level for the first time since June 2018.

Meanwhile, it seems that the Washington Post has just discovered the fact that in the countries that produce the vast majority of the world's supplies of cocoa beans, many of the workers are child laborers. In the US and Europe, child labor laws protect the young, but in other, less-developed parts of the world, child labor remains the norm rather than the exception. It is possible that the piece in the newspaper owned by Jeff Bezos, the founder and largest shareholder of Amazon (NASDAQ:AMZN),will begin a movement to boycott chocolate. I say, good, that will leave more for confirmed chocoholics like me.

I am not, by any means, in favor of, nor do I support child labor. However, I am aware that there is a vast divide between the moral and ethical legal systems of the US and Europe and countries in Africa and other parts of the world. It will be interesting to watch if a "just say no to chocolate" faction starts to make lots of noise in the media over the coming weeks and months.

The iPath Bloomberg Cocoa Subindex Total Return ETN product (NIB) replicates the price action in the cocoa futures market.

Cocoa rises to a new peak in 2019

The price of ICE cocoa futures is at the highest level of 2019 and since June 2018.

Source: CQG

The weekly chart highlights that the price of nearby cocoa futures rose to a high at $2548 on Monday, June 10 which was not only the highest level of this year but the peak since the week of June 18, 2018. Price momentum has moved into overbought territory, and the relative strength indicator is at the upper region of a neutral condition. Open interest, the total number of open long and short positions in the cocoa futures market, was at over 269,000 contracts, not far below the highest level of the year.

Other than a spike down to $1901 per ton at the end of the March-May roll, the price of cocoa has made higher lows and higher highs since October 2018 and has been in a mostly bullish trend since 2017. Global demand has supported the price of cocoa, and the latest grind data suggests increasing consumption for the production of chocolate confectionery products around the globe.

West Africa is the primary producer

Over 60% of the world's annual production of cocoa beans comes from the West African countries of the Ivory Coast and Ghana. The economy of West Africa is highly dependent on cocoa production. In the Middle East, it is crude oil that is the raw material that powers the economies of the vast majority of countries, in the Ivory Coast and Ghana, cocoa plays the same role.

In the United States and western Europe, advanced social and economic systems have put laws in place to regulate businesses and protect workers. While child labor laws in the US have evolved, in other parts of the world they have not.

As the US became an industrialized nation, in textile mills, children were often hired together with their parents by businesses. Many families depended on the children's labor to make enough money to survive. The Fair Labor Standards Act of 1938 (FLSA) created the right to a minimum wage, and time-and-a-half for those working over forty hours each week. The Act also prohibits most employment of minors in "oppressive child labor." There have been amendments to the Act over the years that serves to protect worker's rights. FSLA restricts the hours that youth under 16 years of age can work and lists hazardous occupations too dangerous for young workers.

A Washington Post piece could spell problems for the chocolate companies

In a June 5 article in the Washington Post, the authors, Peter Whoriskey and Rachel Siegel, presented the case that the majority of chocolate around the world starts with child labor. The article focused on the cocoa farms and infrastructure in the world's leading producing nation, the Ivory Coast.

The authors presented a story where impoverished families from countries like Burkina Faso are sending young children to work on farms in the IC. Some of the kids are as young as 12 years old, and the article uses the term "trafficked" to describe their journeys to the farms where families send their children to work and earn money necessary for survival.

The piece makes a point that almost two decades ago, chocolate companies pledged to eradicate child labor. However, Mars, Hershey (NYSE:HSY), Nestle, and most others still cannot identify the specific farms where they source cocoa beans - much less if children are working at the source of the primary ingredient in their products.

The promises from the chocolate manufacturers began in 2001 when the US Congress decided to address the issue. While the idealistic motive caused the manufacturers to promise to eradicate child labor in West Africa's cocoa fields by 2005, the goal for 2020 now stands at 70%, which could be a stretch. The US Labor Department estimates the majority of the two million children working in the cocoa industry live on their parents' farms. A smaller number, which the authors call "trafficked," from nearby countries make up the balance. Many of the kids undertake dangerous work by swinging machetes, carrying heavy loads, and spraying pesticides. Even the local farmers admit that the work conditions are terrible and that the system is unfair to the children. The typical Ivorian cocoa farm of 10 acres creates an annual income of only $1,900, the income and earnings make the Ivory Coast a place where better opportunities are available compared to other countries on the African continent where starvation and sickness are widespread.

The cocoa and chocolate business collect around $103 billion each year in sales. Since 2001, it spent $150 million to address the problem of child labor. The article spelled out the sad and vicious cycle of poverty in Africa. As the cocoa business is the most substantial employer in the region, it benefits from the fruits of child laborers. However, without the money earned and sent back to countries like Burkina Faso, the starvation and rate of illness would likely be even higher, creating a moral and ethical dilemma. I encourage you to read the entire Washington Post piece, which is a sad commentary on the plight of the poor around the world, and particularly in Africa. The problem goes far deeper than the cocoa industry.

Dictating ethics and morals around the globe - good luck

There is a reason why the US Congress has some of the lowest popularity ratings in history. It seems that the body that makes the laws for the United States first concern is to hold on to power and run for reelection. When the founding fathers of the United States planted the seeds for a great democracy in the late 1700s, they envisioned Congress and the Senate as legislative bodies where citizens brought collective expertise to service a better good, before they returned to their communities and were replaced with others willing to give their time and experience in a noble cause. However, the legislature became nothing more than a home for career politicians, which is far from the original intent of the founders.

When election time rolls around every two years in Congress and each six in the Senate, many members point to legislative initiatives to encourage voters to keep them in office. Battling childhood labor and abuses around the world is not an issue where there is a great debate about if it is right or wrong. For a member of congress or a senator, a position on child labor in Africa is a safe issue and a chance to tell voters they are working hard and fighting for the rights of children around the globe.

However, the Ivory Coast, Ghana, and other African nations are not part of the United States or Western Europe. The leaders and government officials in Africa pay lip service to moral and ethical demands from the west. The sad fact is that the chocolate we consume will continue to provide jobs for kids, which creates money for food for families so they can survive. For most people in Africa, survival alone is the only goal in an impoverished society.

Cocoa grows only in countries that are close to the equator. West Africa will continue to be the hub for production. US and European politicians will continue to pressure chocolate manufacturing companies to address the problem, but they can only do so much as their suppliers are subject to an entirely different set of morals and ethics. Even a "Me-Too" or "Green New Deal" type of movement to boycott chocolate would likely be a failure as the demand is growing by leaps and bounds each day, and the fastest growing group of consumers are not in the US or Europe, they are in China and India. The Chinese and Indians account of a considerable percentage of the world's population, and their political and business systems do not take the same view of child labor as the US and the EU.

US politicians will continue to put pressure on chocolate companies, and it may result in some small, positive changes for the kids working in the cocoa business in Africa. However, the changes will never be enough to satisfy Western moral and ethical standards. The Foreign Corrupt Business Practices Act (FCPA) forbids payments to foreign government officials from US companies and individuals to gain contracts, source supplies of commodities, or any other business-related initiatives. To believe that the FCPA stopped the practice of foreign government officials from receiving payments or other forms of consideration is naïve.

We live in a complicated world when it comes to the differences between nations and their laws and customs around the world. The article in the Washington Post documented the heart-wrenching plight of African children working in the cocoa fields from the perspective of journalists who might be seen as cockeyed optimists and believe that they are educating readers in the interest of a moral imperative. Some of the audience that reads their piece may decide that they will boycott chocolate, but the chances are that most will continue to consume the epicurean delight in some form or another. Ridding the world of child labor is a noble cause, and those fighting for the kids say there is plenty of money in the cocoa and chocolate confectionery supply chain that could be pumped back into production that requires adherence to strict rules on child labor. I say, not in our lifetimes.

NIB is the cocoa ETN product

Meanwhile, the price of cocoa beans has been heading higher, and a shortfall of production in the world's second-leading producing nation, Ghana, is contributing to the rising price. While the Washington Post piece focused on the Ivory Coast, plenty of kids are working in the cocoa business in Ghana. Meanwhile, the most bullish factor for any commodities market is typically when supplies fall to levels that cannot keep up with demand. The latest grind data shows that consumers require more cocoa these days, and the technical trend since 2017 suggests that we could be on the verge of a bullish breakout in the price of cocoa beans.

Source: CQG

The monthly chart illustrates that cocoa is moving towards a level where it could threaten a challenge of the 2017 high at $2918 per ton. With the close of July futures at $2548 on June 10, a test of the peak would result in a rally of 14.5%.

The iPath Bloomberg Cocoa Subindex Total Return ETN product moves higher and lower with the price of cocoa futures. 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 (the 'index') 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.

Most recently, the price of July cocoa futures moved from $2307 on June 4 to $2548 on June 10, a rise of 10.4%.

Source: Barchart

Over the same period, NIB appreciated from $26.64 to $29.40 per share or 10.4%. NIB has net assets of $18.56 million and trades an average of 26,752 shares each day. The ETN charges an expense ratio of 0.75%.

Legislating the Western ethics and morals to cocoa producing countries in West Africa is likely to continue to be a losing battle. The price of the beans moves with supply and demand, and as of last week, it looks like supplies are lower than expected, and that could mean higher prices are on the horizon.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

The author is trading cocoa from the long side of the market