Cocoa: The Sleeper Market of 2007

Transcription

1 THE HIGHTOWER REPORT Futures Analysis and Forecasting 141 W. Jackson Boulevard Suite 2 Chicago, IL / Special Report December 6, 6 Futures Analysis and Forecasting Futures Analysis and Forecasting Cocoa: The Sleeper Market of 7 The investment boom in commodities is still going strong, as the sector has seen a surge in demand by both traditional and non-traditional investors. The latest statistics by Barclay Trading Group, Ltd. indicates that money under management in futures rose to $156 billion in the 3rd quarter of 6, an increase of 4.25% from the previous quarter and 19.17% over the past 12 months. The recent announcement by a major commodity fund that it plans to lift its commodity exposure to $11 billion in 7, up from $6 billion in 6, suggests the boom in commodity investment shows no signs of abating. With investors searching for undervalued commodities that have a bullish fundamental setup, our pick for the sleeper market of 7 is cocoa. While many analysts think that the cocoa market is destined to see a minimal supply deficit or even a surplus for the 6/7 season, we think that both supply and demand patterns will eventually result in a much bigger deficit than the trade has generally been expecting. The ICCO estimates for the world cocoa balance out to the year 21 highlights a trend that we think will end up being larger than is currently expected. For the 6/7 season, recent statistics from the In Billions $16 $14 $12 $ $8 $6 $4 $2 MONEY UNDER MANAGEMENT In Managed Futures $156 Billion 3rd quarter 6, +4.35% from previous quarter, 19.17% increase in assets over the past 12 months. $ ICCO forecasted a 38, tonne surplus in world cocoa, but shifting supply/demand fundamentals since the estimate was announced suggest a deficit condition is likely to be seen. In fact, a major investment bank is predicting a world cocoa deficit of 65, tonnes for the 6/7 season compared to a 74, tonne surplus for the 5/6 season, largely based on the rising trend in global cocoa The information in this report may be considered dated upon its release and should not be considered interpersonal advice. This report is merely an opinion on the market and is a reflection of conditions as of its publication. Market conditions change! Traders should not consider entering positions without their own independent analysis of the market s current situation, nor without further consideration of any changes to the information contained herein that may have occurred since this report was written. The authors are not responsible for any verbal or written claims and opinions that might be provided in conjunction with this report. The trading suggestions contained herein have been provided merely as a general guide and only for the purpose of quantifying the authors opinions. This report includes information from sources believed to be reliable but no independent verification has been made and we do not guarantee its accuracy or completeness. Opinions expressed are subject to change without notice. This report should not be construed as a request to engage in any transaction involving the purchase or sale of a futures contract and/or commodity option thereon. The risk of loss in trading futures contracts or commodity options can be substantial, and investors should carefully consider the inherent risks of such an investment in light of their financial condition. Any reproduction or retransmission of this report without the express written consent of Hartfield Management, Inc. is strictly prohibited. 1

2 Cocoa: The Sleeper Market of 7 grindings. However, this deficit figure could be understated when you factor in that the top four world cocoa producers are lowering crop forecasts for the 6/ 7 season due to strikes and poor weather conditions after several of the top producers had expected bumper crops. Ivory Coast Production Declines In the Ivory Coast, the world s largest cocoa producer, harvest for the main 6/7 crop was initially expected to rival the 1 million tonnes seen for the 5/6 season. However, a farmers strike at the beginning of the 6/7 season has drastically slowed the arrival pace, and there is rising speculation that the harvest will never catch up. In fact, Ivory Coast exporters have reduced their forecast of the 6/7 cocoa crop to between 85, and 75, tonnes due to the slow arrivals and poor weather conditions. As of December 3rd, Ivory Coast arrivals were running 16.1% behind last year s pace with total arrivals coming in 66,842 tonnes below last season. While arrivals to ports have been picking up lately with the harvest moving into the peak period in December, dry weather conditions are lowering harvest expectations for the January through March 7 timeframe. Ivory Coast farmers in the western region are already reporting dry conditions, and they are particularly concerned that a lack of rain ahead of the Harmattan (high winds off the Sahara desert) could hinder pod development further. Farmers in Ghana have similar concerns, as they need more rain before the high winds start in order to ensure a good size crop and for their slow harvest start to pick up pace in the New Year and reach a production target of 6, tonnes. While the size of the Ivory Coast main crop continues to be debated, there is agreement that the quality of the cocoa crop has been compromised. In the beginning of the season, the farmer s strike caused cocoa beans to be poorly stored on farms, which lowered the quality of the crop as beans began to rot and turn moldy. While the poorest quality of cocoa arrived during October, heavy rainfall in the southwestern growing region has also caused pod rot and has kept quality concerns an ongoing issue. A flare-up in political violence recently in the Ivory Coast, including at the main cocoa industry port at Abidjan, may not go away any time soon, as the President 7% 6% 5% 4% 3% 2% CROP YEAR BEGINNING OTHER (14.3%) CAMEROON (4.61%) MALAYSIA (.86%) NDONESIA (12.82%) WORLD COCOA STOCK / GRIND RATIO NIGERIA (4.9%) WORLD COCOA BALANCE NET PRODUCTION - GRIND 5 through 21 = ICCO Estimates & Forecast Crop Year Beginning 66.5% MAJOR COCOA PRODUCERS PERCENT OF WORLD TOTAL GHANA (19.3%) BRAZIL (4.61%) % 34.3% 5 through 21 = ICCO Estimates & Forecast IVORY (38.88%) COAST 2

3 Cocoa: The Sleeper Market of 7 and UN-assigned Prime Minister are at odds over who is governing the country. This political power struggle has led to civil unrest and violence between supporters of the President and opposition forces who support the Prime Minister. If this unstable political situation worsens, cocoa could further be boosted by a higher risk premium being factored into prices. In another development, the head of road repairs in the Ivory Coast warned recently that the country s cocoa industry could be greatly affected with 2% to 3% of the crop unable to get to ports if road repairs are not done in the next 4 years. Cocoa Bean Quality In Question Adverse weather conditions are also causing other top cocoa producers to lower production estimates for the 6/7 season. Heavy rainfall in Nigeria and a lack of affordable chemicals and fertilizers have led to a breakout of black pod disease. As a result, Nigerian production, originally expected to be about 22, tonnes this season, is now expected to be reduced to 14,-15, tonnes. In fact, the main crop harvest, which usually runs between October and early February, is expected to end in December this year, as excessive rainfall and cold and damp conditions with little sunshine have lead to the prolific spread of black pod disease. Heavy rains are also lowering cocoa bean quality in Cameroon, although government officials there expect cocoa production to be higher than the 5/6 season s 164,553 tonnes. Moisture levels are high (up to 19% compared to the international standard of 7%), and damp conditions have prevented Cameroon farmers from properly drying beans. In addition, transporting the crop has been hampered by muddy conditions, leading to a high percentage of moldy beans being delivered to warehouses. With the Ivory Coast cocoa market already fretting over the ramifications of a lagging arrival rate and the Nigerian and Cameroon crops negatively impacted by excess rain, we wouldn t be surprised to see a supply side induced increase in the deficit of 5, to 9, tonnes. El Nino Impact In addition to the ongoing geopolitical/economic threat against Ivory Coast production, it is also possible that El Nino will serve to reduce production in Pacific growing regions in the year ahead. Back in the 1993 and 1994 El TOTAL IVORY COAST COCOA ARRIVALS METRIC TONS 1,, 1,, 1,, 8, 6,,, Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct /6 Marketing Year 6/7 Marketing Year IVORY COAST COCOA PRODUCTION Ivory Coast Provides about 41% of World Cocoa Lower 6/7 estimate based on poor weather conditions and slow arrival pace. 7 through 21 = ICCO Forecast GHANA COCOA PRODUCTION Ghana government Estimate 7 through 21 = ICCO Forecast

4 Cocoa: The Sleeper Market of 7 Nino timeframes, Malaysia saw its cocoa production steadily decline from 225, tons in the 1992/93 crop year to only 12, tons for the 1994/95 crop. However, it should be noted that Malaysian cocoa production appears to have been on a downtrend since the 1992/93 crop. With the ICCO expecting the upcoming crop in Malaysia to produce around 31, tonnes, this output could significantly be reduced as El Nino takes affect. Indonesia on the other hand has apparently worked its production steadily higher over the last 1 years and therefore could be the most critically impacted crop of all from the developing El Nino. El Nino Production Impact * Production Year over Year Change(in MT) El Nino Yrs (Crop year beginning) Indonesia Malaysia * Other factors besides El Nino may have impacted production and actual El Nino timing is difficult to measure NIGERIA COCOA PRODUCTION Lower 6/7 estimate based on poor weather conditions CAMEROON COCOA PRODUCTION The Indonesian crop is almost double the size it was back in the critical El Nino cycle of 1993/94, when the crop shrank by roughly 13, tonnes (see table). Indonesia s state weather agency has recently upgraded the El Nino weather pattern from mild to moderate, which could significantly reduce rainfall in several of the country s cocoa growing regions from December 6 through June 7. Due to a lack of rain as well as to insect infestation, the Indonesia Cocoa Association has lowered its 6 mid-crop cocoa output estimate, which will reduce total 6 production by 75, tons to 425, tons. If the El Nino weather pattern persists into the spring/summer 7, it will significantly undermine next year s production totals as well. Rising Cocoa Grind = Rising Demand With the top four world cocoa producers likely lowering production estimates for the 6/7 season, cocoa merchants in the Ivory Coast have recently begun to aggressively buy good quality cocoa beans, as there are rising concerns that the slow arrival pace will never catch up this season and cash buyers are now scrambling to extend coverage. We can understand buyers rising anxiety levels to secure high quality cocoa beans considering that world cocoa grind statistics have been Wet weather has significantly lowered the quality of the 6/7 crop although the size is expected to be a little higher than the 5/6 crop INDONESIA COCOA PRODUCTION Lower 6 estimate based on poor weather conditions. 7 through 21 = ICCO Forecast 4

5 Cocoa: The Sleeper Market of 7 World Cocoa Grind Year over year change (in percent) Q1 6 Q2 6 Q3 6 Pan European +9.2% +6.9% +4.6% German +35.4% +31.2% +29.2% US +2.7% +2.4% +4.45% Brazil (est.) 8.5% 2.6% 4.9% on the rise in 6 as demand for chocolate has grown. Germany s quarterly grind numbers have shown the biggest jump in 6 (see table), but the other major world cocoa grinding countries are also showing solid gains. Recent statistics show US imports of cocoa bean and cocoa bean products for September 6 rose 77.1% compared to a year ago, while August imports were up 98.6% compared to August 5. This surge in imports dovetails with the promotion of chocolate s health benefits and rising consumer demand. Cocoa Health Benefits Boosting Demand The National Confectioners Association estimates that sales of gourmet and dark chocolate in the United Sates are rising around 3% per year, leaving little doubt that demand for chocolate is on the rise. Recent health studies highlighting the natural benefits of dark chocolate due to its higher cocoa content have contributed to a shift in consumer tastes, and chocolate companies like Hershey s, Nestle and Cadbury-Schweppes are fulfilling this demand by either launching new high-end chocolate products or making dark chocolate versions of established candy bars. A recent study from Johns Hopkins University School of Medicine found chemicals in the cocoa beans had similar effects as aspirin on the blood, and affected the platelets which cause the blood to clot, thus reducing the risk of a heart attack. Therefore, the health benefits of eating chocolate to raise antioxidant levels, lower blood pressure, lower the risks of blood clots and to maintain a healthy heart have certainly caught the attention of consumers. The rising demand trend for dark chocolate is worldwide, with more products now having a higher percentage of cocoa inputs as consumers perceive a higher percentage of cocoa is healthier. In fact, the European based chocolate company Barry Callebaut, one of the world s leading manufacturers of high-quality cocoa, has created an entire website promoting the health benefits of chocolate. Perhaps most importantly, overall demand for cocoa is Q MALAYSIA COCOA PRODUCTION 24 High'89 7 through 21 = ICCO Forecast WORLD QUARTERLY COCOA GRIND World = Pan-Europe + US+Brazil 457 4Q WORLD COCOA CONSUMPTION 5 through 21 = ICCO Estimates & Forecast Lower 6/7 estimate based on poor weather conditions. 48 3Q CROP YEAR BEGINNING 399 5

6 Cocoa: The Sleeper Market of 7 already rising cyclically, and we wouldn t be surprised to see demand contribute another 2, to 3, tons to the deficit. MAJOR COCOA CONSUMERS PERCENT OF WORLD TOTAL In short, we think that May cocoa below the $1, level has been found to be too cheap. In fact, with the 6 net spec short extreme in cocoa peaking out just under 1, contracts around the October lows, it would appear that the technical situation generally look to support May cocoa prices above the $1,456 lows. We think a shift in the cocoa fundamentals with crop production shortfalls tightening supplies and rising demand from the global up swing in cocoa consumption spurred by the health benefits of chocolate certainly justify May cocoa prices trending back to the July 6 peak near $1,8. However, if there is a political deterioration in the Ivory Coast and a more intense El Nino impact on the Pacific region s crop production, then a rise in May cocoa to the $2, price level or higher is certainly attainable. With Ivory Coast farm gate prices recently rising and ideas that the October through March Ivory Coast crop is going to fail to meet expectations, we suspect that a major low is already in place and that longer term supply and demand fundamentals are poised to lift prices consistently into the coming year OTHER (27.43%) US (13.93%) MALYSIA (3.17%) IVORY COAST (1.23%) BRAZIL (5.85%) Monthly Nearby Cocoa - With 7 Projection EU (39.39%) Suggested Trading Strategies: 1) Buy May cocoa at $1,53, with an initial objective of $1,659 and an eventual longer term upside target of $1,72. Risk the position to a close below $1,44. 2) Buy a May cocoa $1,55 call for 91 and then sell a February cocoa $1,6 call for 36. Look for the February call to expire worthless and look to hold the May call into expiration. Risk the combination to a loss of $9 and use an objective of 36 on the long May call USD / tonne The information in this report may be considered dated upon its release and should not be considered interpersonal advice. This report is merely an opinion on the market and is a reflection of conditions as of its publication. Market conditions change! Traders should not consider entering positions without their own independent analysis of the market s current situation, nor without further consideration of any changes to the information contained herein that may have occurred since this report was written. The authors are not responsible for any verbal or written claims and opinions that might be provided in conjunction with this report. The trading suggestions contained herein have been provided merely as a general guide and only for the purpose of quantifying the authors opinions. This report includes information from sources believed to be reliable but no independent verification has been made and we do not guarantee its accuracy or completeness. Opinions expressed are subject to change without notice. This report should not be construed as a request to engage in any transaction involving the purchase or sale of a futures contract and/or commodity option thereon. The risk of loss in trading futures contracts or commodity options can be substantial, and investors should carefully consider the inherent risks of such an investment in light of their financial condition. Any reproduction or retransmission of this report without the express written consent of Hartfield Management, Inc. is strictly prohibited. 6