A lot of action in the Cocoa Market so far this year. Many people have been asking me how to play it. If you don’t want to trade futures or options, you can always trade NIB iPath Dow Jones-UBS Cocoa Subindex Total Return ETN.
Battle Pits Cocoa Speculators against Chocolate Makers
On the morning of July 15, 2010, Nauck realized he was being attacked.
It was 8:30 a.m. on a cloudless, beautiful day. Nauck was sitting at his desk made of polished Oregon pine on the fifth floor of an old factory building with a view of the church spires in Bremen’s market square. Nauck was going through his mail. The quarterly figures were looking good, the company had just hired 62 temporary employees and the economy was picking up steam. As he was going through his morning routine of checking prices and stocks online and glancing at a few websites, Nauck saw something that startled him.
The price of cocoa was dramatically high. In just two days, it had risen by 132 British pounds (€148, or $220), and it was still rising. During the course of that trading day, the cocoa price in London would climb to £2,732 per metric ton, a 33-year high. It made Nauck fear for his livelihood, his workers and his factory — in short, for everything he was about.
Nauck is the majority shareholder and managing director of Hachez, one of Germany’s 90 chocolate makers. The company was founded in Bremen in 1890 by Joseph Emile Hachez, and Nauck’s grandfather was already a co-owner in the 1920s. In 1990, when the company was in trouble, Nauck took out millions in loans and bought shares in Hachez. As the company’s new managing director, he updated its product line to suit modern tastes.
‘Choc Finger’
Anthony Ward, the man behind the attack on Nauck, is sitting in an office in London. The fund manager and trader has been given the nickname “Choc Finger,” a play on the James Bond villain Goldfinger. In the industry, though, it is meant as a term of admiration.
Anyone who understands the basic rules of Ward’s game, commodity speculation, can also understand why the global economy is plunging from one crisis to the next.
Ward doesn’t like journalists, and he hardly ever grants interviews. Instead, he employs two public relations agencies, whose publicists can say a lot without saying anything.
A broad-shouldered man in his early 50s, Ward grew up in an upper-class family with a long line of merchants. His grandfather reportedly supplied the British Navy with rum. His office is in a black-painted townhouse in Mayfair, London’s most exclusive neighborhood.
“When it comes to money,” says a man who worked with Ward for years, “he focuses on this goal alone.”
Cornering the Cocoa Market
Ward had long spoken of his ambition to corner the world cocoa market, and he had already attempted to do it twice before, in 1996 and 2002. He embarked on his third attempt on July 15, 2010.
Ward’s plan could work because the global economy has become more and more complex. The price of cocoa has been rising — seemingly unstoppably — for the last five years. But this is only part of the global boom in commodities. Over the last year, the price of wheat has risen by $4.83 per bushel, to $9.03. In the same period, the price of a metric ton of corn has gone up from $3.46 to more than $7.00.
Commodities speculation fuels inflation in India, drives up the price of tortillas in Mexico, causes famines and fuels political unrest. Speculators act as accelerants — and the smaller the market, the easier their game.
Cocoa makes up one of the world’s smallest commodities markets. Indeed, the annual harvest amounts to only 3.5 million tons, with more than half coming from Ivory Coast and its eastern neighbor, Ghana. The average price per metric ton is £2,000, meaning that it takes only £7 billion to buy a year’s harvest.
The cocoa market’s simplicity makes it particularly vulnerable to speculative attacks and attractive for the billions of roving dollars and euros. Depending on the estimate, speculation in the commodities markets alone entails somewhere between $400 billion and $800 billion. Ten years ago, it was only about $5 billion.
Experts say the money comes from three sources: from private wealth investors or, in other words, the world’s super-rich; from banks trading for their own accounts and at their own risk; and, finally, from pension funds in the West investing the retirement savings of millions.
The cocoa business is actually very straightforward. During the harvest, traders buy cocoa beans directly from farmers in places like Ghana and Ivory Coast and, later, they resell them to chocolate makers in Europe. Since traders can’t know when manufacturers will buy their cocoa, there is an exchange, where traders and others can buy and sell goods at any time. Still, the downside for traders is that the price that the exchange offers is generally lower than the price that chocolate companies pay.
To make cocoa scarce, Ward had to manipulate how the cocoa business works. He had to lure traders away from the chocolate factories and convince them to sell their cocoa on the exchange, instead, because it was only there that he could buy large quantities of cocoa in an ambush-like maneuver.
Chocolates may not come easy on the pocket as cocoa prices surge ahead in the domestic market due to global supply constraints.
India imports more than half of its requirement of cocoa every year with demand increasing at a rate of 8% per annum. “With supply from Ivory Coast disrupted due to political problems, availability is low in most of the markets,” traders said.
Indian cocoa prices are now at a premium of more than 12-15% compared to the global markets. Dry beans at the farm gate are above R175 per kg while wet beans are selling at around R55 per kg in Kerala. “There is a scramble for cocoa and the supply is tight. Farmers are getting good returns for their crop,” Shiny George of Indian Organic Farmers Company.
Ivory Coast produces nearly 40% of the world’s raw cocoa, valued at about $3.8 billion. Interestingly, the wholesale price of cocoa has been surging ahead and doubled in the previous four years as global demand increased, particularly in India and China.
No one is taking the cacao or cocoa plant for granted these days. Chocoholics and chocolate manufacturers everywhere are anxious about the political turmoil in the Ivory Coast, the West African nation that produces nearly 40 percent of the world’s raw cocoa, valued at about $3.8 billion.
“Cocoa prices should come down by another $100, but not more, as there is a logistics nightmare waiting for the supply chain on the ground — banking, storage, trucking, workers, cash. No one will return until the guns are silenced.” – Luis Rangel, ICAP Futures
Alassane Quattara, the winner of the Ivory Coast’s November presidential election, suspended all cocoa and coffee exports for 30 days to cut off funds to incumbent President Laurent Gbago, who refused to leave office after a run-off election and who threatened to take over the purchase and export of cocoa.
While 68 companies are licensed to export cocoa from the Ivory Coast this season, the market is dominated by major international firms, such as Cargill, Archer Daniels Midland and Barry Callebaut AG. Among them, they bought 630,371 tons of cocoa during the 2009-10 season, more than half of the tonnage registered.
Cargill Inc.’s Ivory Coast unit honored the ban and suspended purchases. ADM told Dow Jones it was evaluating the situation, as did Barry Callebaut, adding it had sufficient cocoa stocks to cover its processing needs.
Even before the ban, the wholesale price of cocoa doubled in the previous four years as global demand increased, particularly in Asia. Uncertainty of supplies — and British commodity trader Anthony Ward’s attempt at cornering the cocoa market last year — led to cocoa powder prices holding at historical highs in 2010, and it appears volatility will continue to put pressure on prices.
Jim Rogers breaks down commodities from an old interview.
Jim Rogers : Missing out on Commodities?
Matthew Bradbard’s daily commodity round up:
Brace for the Fed as we expect it to be a market mover. Indecision in the oil market as prices close virtually unchanged today. If we fail to make a new contract high in the next few sessions we should resume the set back we’ve been forecasting, in June that would be a trade over $114.05. A settlement below the 20 day MA should confirm a move lower but before either scenario happens we’re just guessing, that level is $108.90 in June WTI. We suggest the sidelines in natural gas willing to be a seller on a spike higher. We cut losses for clients that still held bear put spreads in the June ES; it resulted in a loss of approximately $400/per position including fees.
0:20 It’s a one-sided directive in Europe. The ECB’s only job is to control inflation.
0:55 The big question is whether the U.S. dollar should be the reserve currency; it no longer is, it shares that role with the euro, other currencies, and commodities. But it’s not just gold being used as a substitute, but oil too, which is putting upward pressure on the market.
1:55 The euro is under “some cloud.” It is “quite inappropriate” for the ECB to raise rates right now.
2:30 China, and its inflation problem, is a serious concern. It stimulated its economy, but is now trying to reign in its rate of growth. It is putting restraints on the banking system, but now a shadow banking system is rising. Big banks may not be willing to lend, but the shadow banking system is growing out of control. Real risk of wage and price inflation. Real estate price spike has led to a wage price spike. The Chinese government should have let its currency inflate, but because they didn’t, they now face wage inflation.
4:40 China was the main beneficiary of globalization, and the big winner in the financial crisis.
6:00 State capitalism may have worked better in China lately, but it’s a mistake for others, like Brazil, to follow suit now.
“Two different directives govern the European Central bank and the U.S. Federal Reserve. In the case of Europe, it’s a one-sided directive. Their only job is to prevent inflation, and in the case of the U.S., it is more balanced, to maintain employment and financial stability.”
On whether the U.S. dollar is still a safe asset:
“There’s a big question whether the U.S. dollar should be the main reserve currency and in fact it no longer is because it maybe accounts for two-thirds of the monetary reserves. The euro is an alternative and there’s a lot of diversification into other currencies and even more into commodities. Not only gold, but actually oil is now an asset class for investors. That has put some upward pressure on the commodities.”
On whether the sovereign debt crisis has diminished euro’s chances of becoming a reserve currency:
“The euro is under a cloud, but that is exactly because there are some inflationary pressures from the price of commodities, particularly now oil and also food prices have risen. That is what has induced the European Central Bank to raise interest rates at a time which is, in my opinion, quite inappropriate…It is not appropriate in current circumstances when you have a number of countries that are suffering from too much debt and high interest rates that they have to pay.”
On China’s economy:
“China has really stimulated its economy full force very successfully and now it is trying to rein in the rate of growth, and is exercising very strong constraints on the banking system. But because of that constraint, and because of the big demand for money, a shadow banking system has arisen and is growing very rapidly. So while the big banks under direct central control are in fact refusing to lend, there is a shadow banking system that is growing out of control. There is a real danger there of wage price inflation because prices have gone up, particularly real estate prices have gone up because there was a real estate boom.”
“Therefore, wage demands have risen, and we now have 20%, 30% wage increases. The Chinese government has made a mistake not allowing its currency to appreciate, which would have controlled the price of inflation. Instead of that, we now have this wage pressure, which is a little bit out of their control.”
Violence continues as former president refuses to concede defeat
What began as the week when Laurent Gbagbo would finally concede defeat ended with the Ivory Coast strongman defying the world from his bunker in Abidjan. After watching his area of control shrink to only a few pockets of the lagoon city, his forces pushed back dramatically overnight on Friday with an assault on the French ambassador’s residence.
AFP reported yesterday that Abidjan’s Golf Hotel, headquarters of the internationally recognised President-elect, Alassane Ouattara, had come under attack. The UN evacuated 17 British citizens from the high commissioner’s residence, which is close to the Gbagbo compound.
The heavy weapons that had supposedly been destroyed in joint UN and French air strikes re-emerged as Gbagbo loyalists retook some ground. Arrayed against the 65-year-old loser of November’s election are the combined might of the French Operation Licorne (Unicorn) force, UN peacekeepers and Mr Ouattara’s ragtag army.
The violent standoff has created its own tale of two cities: each day the commercial capital seems poised to return to normal but at night the shooting starts and everything becomes uncertain.
It is not a war with a single frontline. The complications of Abidjan’s lagoon is matched by the complex of alliances that rule its neighbourhoods. In the south of the city, the long queues for food outside the only working supermarket show the struggle to return to normality.
I had a feeling Laurent Gbagbo wasn’t going to roll over.
Gbagbo forces advance again in Ivory Coast
And as if silver bulls needed some more good news, here is a report from the Morgan Stanley metals desk…
I was told on Wednesday that big buying went thru on Tuesday in may atm silver calls which should make the market short gamma.
A short gamma position will become shorter as the price of the underlying asset increases. As the market rallies, you are effectively selling more and more of the underlying asset as the delta becomes more negative.
So what that means is that the SELLER of the calls, probably bought Physical to delta hedge themselves neutral. As this market jumps just about 1-2% daily (this week alone +6.5%) they would need to now re hedge to bring themselves back to neutral by BUYING more Physical as SILVER goes higher, essentially driving the market Higher still and so the chase goes theoretically moving the market higher causing them to buy more to hedge and moving the market higher, thus buying into rallies.
Now they could BUY puts also to create positive Gamma as well to offset some of that pain they are not bound to the Physical for their hedge. Lots of what if’s but that’s the idea.
On the other side if Silver were to gap lower, this would not help either as they would need to SELL Physical into a falling market to re-hedge themselves.
Great in a slow steady market, nightmare in a volatile
Jim Rogers: Buy the rmb [renminbi, the Chinese currency].
Bill Bonner: We are in a period much like the period following WWI, in which the great debts and losses of the war had to be reckoned with. It is an era of great risk. The U.S. faces many of the same challenges faced by Germany and England after WWI. Like England, it has huge debts. It is a waning imperial power. And it has the world’s reserve currency. And like Germany, it is attempting to fix its problems by printing more money. This is not a good time to be long either U.S. stocks or U.S. bonds.
Peter Schiff: Don’t be suckered into the idea that recovery is just around the corner. The current climate is like living in a hurricane or earthquake zone; it’s important to stay vigilant because you never know when disaster will strike. Physical gold is the financial equivalent of a flashlight, first-aid kit, and store of canned goods. It’s a basic way to protect yourself from any eventuality. From there, if you’re looking for returns, there are plenty of foreign markets with strong fundamentals, as well as commodities that feed those markets.
Investing in the U.S. is now driven largely by force of habit. It’s a habit you should resolve to break.
Jeffrey Christian: Do not invest based on what you believe, but on what you know. Gold is a market, like other markets. It rises and falls. You probably want to stay long gold on a long-term basis, but may want to cull the weaker gold assets from your portfolio in the first quarter, and put some hedges in place to protect a long-term core long gold position against the potential of significant price weakness over the next two years or so. Such a period of weakness would be an excellent time to add to one’s gold assets.
John Williams: As an economist, I look for the U.S. dollar ultimately to lose virtually all of its current purchasing power. Accordingly, for those living in a U.S. dollar-denominated world, it would make sense to move to preserve wealth and assets over the long-term. Physical gold is a primary hedge (as is silver). Holding some stronger currencies outside the U.S. dollar, as well as having some assets outside the United States, also may make sense.
Steve Henningsen: Dramamine (for volatile markets), a stash of cash (for potential investment opportunities), and move some of your assets offshore if you haven’t already.
Frank Trotter: My advice is first to look at the other side of your balance sheet – the liability and risk equation – before seeking out absolute gains. What are your goals, what resources do you already have to meet those goals, and what events (health, income stream, upheavals) might impact these risks? Place some assets to hedge these risks directly, then look to diversify globally into markets with higher growth potential than we see here at home, and that may balance your global purchasing power risk. Almost like a religion, we have had the phrase “Stocks are the only legitimate hedge against inflation” beaten into our heads. I say, look at assets that define inflation like commodities and currencies and evaluate where these fit into your risk portfolio.
Krassimir Petrov: Last year I recommended silver, and I would stick to silver again, despite the phenomenal run in 2010. Then it gets tricky. I usually don’t recommend diversification, but now I would again recommend a broad portfolio of commodities. Investing in 2011 should be easy: stay out of real estate, out of bonds, out of fiat currencies, and out of stocks; stay fully invested in commodities, overweight gold and silver.
What to watch in 2011: stay focused on the sovereign debt crisis and bond yields. Spiking yields will trigger the next stage of the crisis.
Bob Hoye: Once past the early part of 2011, the best returns are likely to be obtained from the junior gold exploration sector.
