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A Sweet Investment

Friday, 4 May 2007 | 3:29 AM ET

Chocoholics be warned – the recent decline in the price of cocoa, the main ingredient for chocolate, won't necessarily mean a Cadbury's bar will be any cheaper at your candy store. Sorry chocolate lovers but prices are not set to melt any time soon.

The price of cocoa has pulled back from the four-year highs seen in March. Let's recap recent price action. Benchmark cocoa futures in both London and New York fell in late April on speculation that increased rains in the world's top two producers, the Ivory Coast and Ghana, will ease the stress on the April-September mid-crop, helping boosting supply.

Despite the recent decline in cocoa prices, the overall fundamental picture remains positive for prices. Although increasing rainfall will benefit
supply in West African producers, some analysts say the damage from earlier drought will mean late season rains will not do enough to make up the
losses.

Supply-side the picture does look grim and that's positive for prices longer term. World production of cocoa will drop 5.5% in the year ending
September, according to the International Cocoa Organization. Fears of a supply crunch sent cocoa futures in New York to their highest in almost four years.

Red-hot commodities from oil to grains are in vogue. Hedge funds and speculators have piled into resources betting price gains still have momentum. As a rule of thumb though, the individual investor would be well-advised to steer clear of taking a punt on the pure commodity market be it coffee, cocoa or sugar.

Listed companies like Hershey's and Cadbury Schweppes provide an entry point for the average investor. Still, these companies are not a direct proxy for the cocoa market since they hedge their purchases to counter price volatility.

Probably the most viable way to play the cocoa market's bull run are through the ETF route. Commodity specific Exchange-Traded Funds are out there though cocoa has some ground to make up in terms of the commodity's weighting on most ETFs.

What do the high cocoa prices mean for producers in in West Africa? In spite of the bull market, farmers in the Ivory Coast -- the world's top producer of cocoa -- haven't benefited.

The stark reality is that impoverished farmers in the West African state simply don't have the cocoa beans to sell, a situation they've had to live with for the past six months because of the lack of rainfall and below-average main crop. Farmers are holding out for better rains to boost the mid-crop. If prices remain reasonably firm, then they should start seeing some cocoa supply return in July.

The irony of West African cocoa farmers not benefiting from rising prices highlights how vulnerable producers in developing countries are to the adverse weather and the market volatility it creates. Commodities grown chiefly in the developing world -- are the key raw materials for the kind of gourmet coffee brewed in Starbucks outlets worldwide and the luxury chocolate brands produced by Nestle and Cadbury's.

Consumers and some companies concerned about the welfare and sustainability of commodity producers in the developing world have driven the push for 'Fair Trade' label in products. The Fair Trade label simply means farmers who produced the commodity that went into the product are paid fairly. Think of it as a guide for socially conscious consumers when buying goods that originate primarily in Latin America, Asia and Africa.

From a purely corporate perspective, big business seems to be taking higher cocoa prices in their stride -- for now at least. Nestle, the world's largest food company, reported stronger than expected first-quarter underlying sales in April. Stronger demand boosted sales by more than 6% to just over $20 billion.

Despite the rosy headline sales figures, the company warned it may grow profits at a slower pace primarily for the reasons we've just been outlining -- higher raw material costs not only from cocoa but coffee, grains and milk. Profitability may slow, Nestle said, since it won't be able to fully compensate for cost increases through prices. That should provide some relief for chocoholics craving for their next fix of the dark stuff.

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