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Collapsing Cocoa

Collapsing Cocoa
March 30th, 2011
Reducing the Risk Premium
Despite ongoing violence and export disruptions in the Ivory Coast, cocoa lagged the commodity complex significantly over the past month. Of the commodities included in the CRB index, cocoa was the worst performer, down 19.7 percent (see chart). The next worst was orange juice, which was down only 10.23 percent. Despite the massive selloff, cocoa prices are now down only slightly from a year ago (-3.47%). What sparked this selloff? 
May 2011 Cocoa Futures
Courtesy of Bloomberg
Cote d’Ivoire
This conflict did not start after the election last year, but began almost a decade ago in 2002, when an uprising of mutinous military officers divided the country into a rebel-held north and a government controlled south. The election last fall was expected to re-unite the country, but the incumbent President Laurent Gbagbo who lost to former Prime Minister Alassane Ouattara has thus far refused to step down. Since the November election, government forces controlled by Gbagbo have engaged in battle with the Republican Forces controlled by Ouattara. 
In response, and with the purpose of cutting off funding to Mr. Gbagbo, Mr. Ouattara issued a ban on all exports of cocoa and coffee on January 24th. The market continued to rally for more than a month, as concerns grew about the quality of the stockpiles that have built up in Abidjan, the commercial capital and major export hub. While there is no shortage of cocoa beans (more on this later), the storage facilities holding the stockpiled crop were not designed for long term storage. Analysts warn that if the beans do not go to market the crop could rot completely, and even with a speedy resolution there could be significant quality issues. 
Ouattara Making Progress
Since making its high on March 4th, cocoa has fallen precipitously, perhaps as market participant shift focus to the otherwise benign market fundamentals. More recently, Ouattara’s Republican Forces have been making progress against the government forces, and this week took control of several villages only 240 km away from Abidjan. They have also taken control of roughly half of the prized cocoa growing region. Reports have been surfacing that Gbagbo’s forces have been refusing to fight and that there have been mass desertions and defections. This has taken some of the pressure off the market, as expectations rise for a forthcoming resolution, or at least for Ouattara to take control of Abidjan, and thus cocoa exports. 
The market didn’t even blink at the announcement on March 28th that the export ban, which was due to expire at the end of the month, would be extended indefinitely. Market participants have been obeying the order, in part due to fear that they will be double taxed (by both Gbagbo and Ouattara), and in part due to the threat that anyone who contravenes the ban may lose their export license and be banned from operating across the national territory.
Global Supply and Demand
While the Ivory Coast is the world’s largest producer, neighboring Ghana how grows roughly half as much, and exports have been surging this year. A recent estimate forecasts exports to rise 50 percent this year, from 400K tonnes to 600K tones. Overall, the International Cocoa Organization had forecast a global surplus of 119K tonnes, following last year’s deficit of 66K tonnes. Ivory Coast output was expected to rise 6.7 percent to 1.325 million tonnes. With at least 475K tonnes sitting in warehouses, not available to the market, and possibly rotting, the expected surplus could easily turn into a deficit. 
Speculators are Booking Their Profits
Since the market reached its peak, large speculative accounts (based on the CFTC’s data on large non-commercial traders) have been liquidating their long positions in cocoa. This has probably helped push prices lower, and signifies the change in sentiment. If these traders continue to sell their positions, this selloff could persist for a while.
Large Speculative Traders’ Net Position
Courtesy of Bloomberg
Cocoa is traded in New York on the Nybot-ICE Futures exchange and in London on the NYSE-Liffe exchange.
-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.