Extraordinary developments wreak havoc in cocoa

by Ron Sterk
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KANSAS CITY — If 33-year highs in London cocoa bean futures prices and historically high U.S. cocoa powder prices weren’t enough to attract attention in recent months, huge deliveries in the London market in July and second-quarter cocoa bean grind well above expectations certainly should have made traders and cocoa users sit up and take note.

Of all the agricultural, or at least food commodities, cocoa appears to be the most tenuous and unpredictable at present. What is known is global cocoa bean supplies are tight, speculative trading has been a key feature in London and New York cocoa bean futures markets, cocoa butter supplies are heavy, cocoa powder supplies are tight and cocoa powder prices are historically high. But it seems nothing with cocoa is quite as it appears, at least currently.

Starting with demand, many traders were fooled when second quarter (April-June) cocoa bean grind for North America came in at a 12.1% increase from the same period a year ago, well above average expectations of around 6%, and for Europe at a 12.7% increase, also better than expected. Several traders noted the sharp increase in second-quarter grind was compared with dismal grind numbers in the second-quarter of 2009. But to counter, the 2010 numbers were almost as good as the pre-recession second-quarter 2008 numbers, which most didn’t expect.

Cocoa bean grind typically is an indication of demand. While it was thought chocolate, and thus cocoa, demand was improving, expectations were modest due to continued global economic uncertainty. Hit hardest by the recession was consumer demand for high quality (more expensive) chocolate, which uses cocoa butter. Since cocoa butter inventories remain heavy, estimated by one trader at a 10-to-1 ratio to cocoa powder supplies in U.S. East coast warehouses (cocoa bean processing results in nearly equal amounts of butter and powder), the trade saw justification for a slow rate of demand increase. The trade is watching to see if the strong grind continues in the third quarter.

The real fireworks have been on the supply side. Cocoa bean supply was predicted for some time to fall short of demand in 2009-10, which typically would not be critical because of large year-over-year carryover stocks. Plus, cocoa bean supplies are expected to be in excess of demand already next year.

But in late July the world’s third largest cocoa trading company, Armajaro, in effect cornered the London market, taking physical delivery of 99.7% of all deliverable cocoa bean stocks in Europe. The 246,100 tonnes delivered is equal to about 7% of total world production.

The player behind the activity is Anthony Ward, a co-owner of Armajaro, according to press reports. Mr. Ward did the same thing in 2002, when his company was only two years old, taking delivery of 204,380 tonnes of cocoa beans, after which prices increased about 15% by some accounts.

Cocoa bean futures prices in London edged up to 33-year highs (they already were trading at 32-year highs) during the delivery period in mid-July, but futures prices in New York actually declined. Once it became known the deliveries were taken by a speculator rather than by a cocoa processor, prices eased, in part because Mr. Ward will have to “unload” the physical cocoa beans before new crop arrivals begin in the fall.

The real concern is what will happen over the next three months. The next delivery period for London cocoa bean futures is in September, and there literally are no beans to deliver in approved warehouses. With little old crop cocoa bean supply available, traders expect prices in Europe will in fact rise, providing Mr. Ward with handsome profits. Because of London trading regulations, there has been no indication of any illegal activities surrounding the actions of Armajaro.

That being said, traders expect only minimal impact on U.S. markets from activities across the Atlantic Ocean.

First, U.S. cocoa bean supplies are adequate, U.S. traders said. And traders point out that such an accumulation of contracts by a single speculative interest could not occur under U.S. regulations because buying would have to be connected to an end user of the beans. Further, and perhaps more importantly, much of the U.S. supply is sourced from different origins (growing countries) than are London cocoa beans.

At the end of the day, U.S. cocoa bean futures are trading in the same range as before the London delivery fiasco, and cocoa powder prices are historically high and are expected to remain so well into 2011, no matter what futures prices do.

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