One of the simple pleasures of life is on a cold winter's day to snuggle up in your favorite chair with a nice warm blanket and drink a cup of hot, rich cocoa. Or just ask a chocoholic about the pleasures of eating luxuriant chocolates - true comfort food.

But cocoa can be more than something that makes you feel good by eating or drinking it; it can also be a good investment and make you money. Cocoa is considered to be a so-called soft commodity. Other commodities in that grouping include: coffee, sugar, orange juice and tea. (Learn more about these commodities in The Sweet Life Of Soft Commodities.)

Most soft commodities are united by two facts: production is concentrated in a small group of developing countries and mostly in tropical areas of the world. This makes these commodities more prone to output troubles due to weather, conflicts, credit shortages or the inability to respond to rising prices. For example, with cocoa the Western African nations of the Ivory Coast and Ghana account for 60% of the world's output, with the Ivory Coast accounting for 40% of production.

The Cocoa Market
Right now, things are not so sweet in the cocoa market for consumers, as prices are climbing. Cocoa demand is set to quickly recover from the global economic downturn, and is expected to grow between 1.5% and 3% in 2009-10. The pick-up in demand will create a market deficit for the fourth year in a row. According to the International Cocoa Organization, the worldwide cocoa deficit this year will widen to 73,000 metric tons as compared to 62,000 metric tons last year.

This will be the fourth consecutive year that cocoa production has lagged consumption. Forecasts that consumption will again outpace supply next year has raised fears that the cocoa market is entering its worst period of shortages in 40 years, since 1965-1969.

There are fears that the harmattan – the dry,dusty wind that blows in from the Sahara – may be too strong in the early part of the year. If so, flowering could be jeopardized and production would be seriously damaged in the Ivory Coast, Ghana, Nigeria and Cameroon. There are also worries that El Nino weather patterns will bring drought to south-east Asia and torrential rains to some areas in Latin America. This could affect production in Indonesia, the world's third-largest producer, and Ecuador, the seventh-largest producer. But the bull market in cocoa has its true roots in the world's biggest producer: the Ivory Coast.

The Ivory Coast
There was a poor harvest this season as Ivory Coast's cocoa crop was riddled with black pod, vascular streak and swollen shoot diseases, and drenched with too much rain. After a poor harvest this season, there are growing fears that the country's aging trees will deliver an even smaller crop in 2009-10, even if they get favorable weather. There are worries that falling output in the Ivory Coast will leave a lasting market deficit. (Learn more about how nature impacts the market in Preparing For Nature's Worst.)

Small farmers in the Ivory Coast – among the world's most heavily taxed growers – have neither the money nor the incentive to buy fertilizer or replant trees to increase output. In fact, many farmers have abandoned cocoa and switched to rubber as they seek higher returns. This may lead to Ivory Coast output to decline by as much 15% next year. Some are warning that production could fall by more than 100,000 metric tons in 2010, after a fall of about 200,000 metric tons in the 2008-09 season.

In fact, cocoa buyers such as Cadbury (NYSE:CBY) and Nestle (OTC:NSRGY) are so worried that they have launched programs to replant trees in a desperate effort to avoid a long-term decline in output. No one is certain whether these efforts will succeed. But lead times in new cocoa plants are long. From planting it takes three to four years before the plants yield anything at all. And even then they are probably several years away from being cash-flow positive. And finally, we have the fact that many chocolate manufacturers have yet to cover their needs for next year.

How to Enrich Your Portfolio
It all adds up to sweet times for investors in cocoa. Investors could play the cocoa market by purchasing cocoa futures or options on cocoa futures directly. But there is an easier way for American investors to gain exposure to cocoa.

There is an exchange-traded note (ETN) which trades on the New York Stock Exchange just like a stock - the Dow Jones-UBS Cocoa Subindex Total Return ETN (NYSE:NIB). This unleveraged ETN is based on cocoa futures and will mirror the performance of cocoa, minus the fees of course. The price of cocoa is down about 10% after recently hitting a 32-year high at over $3,400 a ton, so now may be a time to look at cocoa after its correction. The problems in the Ivory Coast look to be long-term problems, so investors still have plenty of time to get on board this upward trend in cocoa prices.

Investors may just want to sit down, relax and enjoy some hot cocoa. (Learn more about commodities investing in An Overview Of Commodities Trading.)

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: Vanguard Total World Stock

    Learn about the Vanguard Total World Stock exchange-traded fund, which invests in stocks located in numerous countries with a high level of diversification.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  3. Mutual Funds & ETFs

    ETF Analysis: BioShares Biotechnology Products

    Learn more about the BioShares Biotechnology Products fund, an exchange-traded fund that is focused on producers of FDA-approved drugs.
  4. Mutual Funds & ETFs

    ETF Analysis: SPDR EURO STOXX 50

    Learn about FEZ, the Euro Stoxx 50 ETF. FEZ tracks the 50 largest companies in Europe, making it the Dow Jones Industrial Average of Europe.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraShort Nasdaq Biotech

    Learn more about an innovative inverse-leveraged sector exchange-traded fund, or ETF, the ProShares UltraShort Nasdaq Biotechnology fund.
  6. Chart Advisor

    Value Stocks Offer Stability in a Volatile Market

    With volatility on the rise, investors are turning to segments of strength such as value stocks. We'll take a look at several ETFs that could be worth a closer look.
  7. Mutual Funds & ETFs

    ETF Analysis: Market Vectors EM High Yield Bd

    Learn more about the Market Vectors Emerging Markets High Yield Bond ETF, a fund dedicated to subinvestment grade foreign debt issues.
  8. Mutual Funds & ETFs

    ETF Analysis: First Trust Tactical High Yield

    Find out more about the First Trust Tactical High Yield fund, a debt security-focused ETF designed to produce high income.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI South Africa

    Learn more about the iShares MSCI South Africa fund, which is an NYSE-listed exchange-traded fund offered and managed by BlackRock.
  10. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P 600 Small Cap Growth

    Learn more about the SPDR S&P 600 Small Cap Growth ETF, a highly efficient fund that tracks small-cap equities in the United States.
RELATED TERMS
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  2. Brazil, Russia, India And China ...

    An acronym for the economies of Brazil, Russia, India and China ...
  3. Optimal Currency Area

    The geographic area in which a single currency would create the ...
  4. European Sovereign Debt Crisis

    A period of time in which several European countries faced the ...
  5. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  6. Crop-Hail Insurance

    A type of insurance that insures against crop damage caused by ...
RELATED FAQS
  1. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
  4. Is there a situation in which wash trading is legal?

    Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>
  5. Are there leveraged ETFs that follow the retail sector?

    There are many exchange-traded funds (ETFs) that track the retail sector or elements of the retail sector, and some of those ... Read Full Answer >>
  6. What are some of the most popular ETFs that track the retail sector?

    Some of the most popular exchange-traded funds (ETFs) that track the retail sector include the iShares S&P Global Consumer ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!