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Dr. Ken Rietz |
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Anyone who has been following the softs markets knows that cocoa has spiked over the last year or so. In this commentary, we will look at the various causes of that price anomaly, look at the current situation, cover future prospects, and consider trading possibilities. Spoiler alert: It doesn’t look good. First, here is the graph of the price of cocoa front month futures going back several years. |
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Figure 1: CME front month cocoa futures The futures prices during 2023 were running near the top of the normal range until about October 2023, when the prices began to split onto a higher range that went crazy during 2024. October 2023 coincided with a blast of rain that ruined crops. The first thing to consider is what caused this to happen? The overwhelming consensus is that this has come about because of inclement weather in Ghana and the Ivory Coast, the two largest cocoa bean producers. However, aging trees and some plant diseases also played a part. Specifically, the BBC pinpoints El Niño for the drier weather that is clobbering west Africa. Bloomberg reminds us that the normal and prudent stockpiles of cocoa beans have been overwhelmed by the severity of the weather, and the problem is not unique to any one processor of cocoa beans; it is a global crisis. Even in March 2024, Reuters was showing how grim things had gotten. Then in April, the Financial Times wailed about new all-time highs for cocoa. They talked about the prices encouraging planting new cocoa trees, but also noted that cocoa trees take 3 to 4 years before they produce beans. Before we can consider trading in cocoa, we must look at what the future holds. It isn’t pretty. El Niño has basically fizzled out, and there is no clear indication for El Niño or La Niña kicking in. That means that the weather patterns are not likely to change much. The universal attitude among cocoa suppliers is that the current crisis is not likely to improve, and among cocoa processors that the current stockpiles will not last very long. The forward curve for cocoa does not show any signs of relief. There are even predictions that several of the smaller chocolate-producing companies will fold. All of this points to the cost of cocoa beans spiraling upward, easily breaking the 10,000 USD/ton recent high, and not likely to come down any time soon. The simple way to play this is to buy call options on the cocoa futures, but that is potentially hazardous. The safer way to trade this scenario is with calendar (time) spreads, where you buy one long-dated call option and sell a short-dated option. This also leaves open the possibility of then re-entering by leaving the long-dated option and selling a succession of short-dated options, each of which can expire worthless, and eventually selling the original long-dated option. |