Investors aren’t limited to only investing in the S&P 500 and the Dow Jones Industrial Average. Every week we share the market trends we are following. We are interested in whether the trends in those markets are continuing or if they are experiencing a temporary or complete reversal.
When we identify trends, we are only concerned about the price data and what it says about any given market. We don’t need to know why a trend has formed to invest, but our human nature wants to understand what is driving them. Each week we try to offer some perspective on what we think the most substantial moves are and what critical drivers are behind them. Here we look at what is going in our globally diversified, non-correlated Crystal Bay Ubitrend strategy.
Last week’s continuing trends:
- Iron Ore
- German bunds
- Cotton
- New Zealand Dollar
- Indian Equities
Last week’s reversing trends:
- UK Gilts
- US 10-Year Treasuries
- Chinese Equities
- Cocoa
- The Mexican Peso
What we are taking note of:
Christmastime is drawing near. The pre-Christmas season is full of horrors such as short days, cold nights, shopping crowds, and endless loops of Mariah Carey. Thankfully, coronavirus has confined us to our homes where we can find refuge from the cold and enjoy the pleasure of a steaming cup of hot chocolate. Which brings us to a unique and underfollowed commodity market, the cocoa futures.
Mankind’s desire to get high motivates much innovation. The fruit of the cocoa tree, endemic to Central and South America, was ignored until an unknown genius discovered that fermenting it creates an intoxicating drink. Thus hot chocolate started its history as booze. Its popularity spread far and wide throughout the Americas, and cocoa beans became a common currency before the Spanish conquest. The conquistadors recognized the bean’s potential and introduced it to Europe, the Philippines, and the Caribbean. Before long, cocoa was being grown in Africa and the rest of Asia as well. Europeans, having plenty of their own liquor, valued cocoa for its smooth and sweet taste and turned hot chocolate into the drink we enjoy today.
Cocoa trees thrive in hot and humid climates no further than 20 degrees of latitude from the equator. They found their most hospitable environment in West Africa, where they became a staple crop. Today, two countries, Ivory Coast and Ghana, produce 60-70% of the world’s cocoa beans; they’re the OPEC of cocoa. Weather in West Africa, together with the political situation there (Ivory Coast suffered two civil wars since 2000) drive cocoa prices on the world market.
In 2019, Ghana and Ivory Coast got together and announced a new policy, in effect from October 2020. Cocoa buyers have to pay a $400 per ton premium over the London cocoa futures price as a “living-income differential.” Confusion about how exactly this premium will be collected roiled the markets. Instead of buying cocoa from West Africa, users are buying beans from future exchange warehouse inventories. Stockpiles of cocoa at Intercontinental Exchange dropped by 44% since August.
Thankfully, the weather in West Africa has been kind to cocoa trees, and this year’s harvest is abundant, keeping a lid on prices. The decline in demand due to coronavirus is also helping keep the situation under control, with cocoa grindings, a measure of demand volume, dropping by 4% year on year.
In the long term, West Africa’s insistence on a premium will encourage other countries to develop their own cocoa tree plantations. Indonesia, Ecuador, and Nigeria all have the climate and agricultural know-how to become bigger players in the market. However, it takes five years for a newly planted tree to bear fruit, and therefore the market remains dependent on Ghana and Ivory Coast for now.
Cocoa prices have traded in a range since the end of the last civil war in Ivory Coast in 2010. Before then, they had wild swings; in the 1970s, cocoa price went up 10x. It will be interesting to watch whether the current equilibrium holds or whether cocoa has some excitement in store for us.
COCOA 1960-2020
