The Perfect Investment For Chocolate-Lovers

By Tony Daltorio | March 08, 2010 AAA
The Perfect Investment For Chocolate-Lovers

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.)

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