🍫 Your Guide To Investing In Cocoa, Rich In Taste, Versatile In The Kitchen, Volatile In The Markets
Theobroma Cacao, or cocoa, translates to the “food of the gods”, and have first been cultivated by the Mayans more than 5,000 years ago. Cocoa trees need a number of years to produce the pods that contain the cocoa beans. All of the cocoa pods are commercially used, from the beans to the husk & the pulp surrounding them. So, before you take a bite out of that little decadent morsel of heaven, just know that it went through a lot to be in your possession. With demand from all over the world, cocoa represents an important commodity in financial markets.
What Can It Do For You
🧺 Portfolio Diversification. As always, adding commodities to your portfolio can help diversify and lower risk. Adding cocoa to your portfolio means owning an asset that tends to act differently to other asset classes, and even to other commodities.
💰 Profit. Like some of the other agricultural commodities, cocoa markets can also be pretty volatile. From seed to harvest, it takes a number of years. Once the cocoa tree is fully mature, it can be harvested twice a year. Because of this long growth cycle, the cocoa supply side may not be able to react quickly enough if demand changes, which can potentially lead to a shortage & a resulting increase in prices.
What Affects Cocoa Prices
There are several key factors that are involved in moving the price of cocoa:
- 🇨🇮🇬🇭 West African Supply. Roughly 60–70% of the world’s cocoa comes from West Africa, with Côte d’Ivoire (Ivory Coast) as the biggest producer & Ghana as the second. Any shocks in supply here can impact the price of cocoa.
- 👅 Consumer Trends. On one hand, research & publicity about the benefits of dark chocolate have increased demand, but the harms about milk chocolate due to its high sugar content can dampen demand for this product. Furthermore, as emerging markets become wealthier, the chocolate market here may grow, fuelling growth.
- ☀️ Weather. Weather can certainly have a big impact on cocoa prices. Cocoa trees are very picky, needing a right mix of wet humid weather & sun to produce good quality cocoa pods. Unfavourable conditions like heat waves or excess rain can impact cocoa production, restricting supply, which may then lead to price spikes. Furthermore, heavy rain can cause significant delays to cocoa shipments because of poor infrastructure (i.e. roads & equipment), which can lead to cocoa shortages.
- 🦠 Diseases. Recently, cocoa trees in Ghana have been ravaged by a disease with no known cure. Right next door if Ivory Coast, the biggest cocoa producer in the world. This can certainly restrict supply, pushing prices higher. Solutions that can prevent these diseases (or at least keep them at bay) should prevent supply shocks, and therefore price swings.
- 🌱 Multi-Year Growth Cycle. Because it the production cycle from seed to harvest is about 3–5 years, farmers may not be able to act quickly enough to respond to changes in demand. This can lead to cocoa shortages & therefore price spikes. In addition, cocoa is definitely perishable, which further adds to the problem of supply.
- 📈 Stock Levels. Stock/inventory levels can play a part in affecting cocoa’s prices. When a country uses its stock reserves, it suggests that there’s not enough supply to go around, which can then lead to speculation in the market. Alternatively, large stock/inventory levels will point to oversupply, which can depress prices. However, since cocoa it perishable, and depending on the storage conditions, the quality of the bean might quickly degrade.
- 💷 GB Pound Strength. Unlike most other commodities, the benchmark for the pricing of cocoa is in British pounds. A weak Pound compared to other currencies may incentivise foreign buyers to buy & drive up demand (since the EU, increasing prices, and vice versa.
What Is It Used For?
Surprisingly, cocoa is also a pretty versatile crop. Here are the 4 main commercial uses of cocoa.
- 🍫 Confectionary. Quite obviously, one of the main uses of cocoa is the creation of chocolate & other confectionary products.
- 🎂 Food & Beverage. Another main use of cocoa is the creation of other food & beverage types, like chocolate-flavoured drinks & desserts.
- 🍬 Cosmetics. Both cocoa butter and the husks & pulp of cocoa pods is used to make moisturising creams & soaps.
- 💊 Pharmaceuticals. Surprisingly, cocoa is also used in pharmaceuticals, used as suppositories, various ointments & topical preparations.
The Case Against Cocoa
Cocoa, like a couple of the other agricultural commodities, is still a pretty volatile commodity with significant price swings as seen in the past. There is a potential of an oversupply of cocoa if the top cocoa producing countries upgrade their infrastructure & allocates increased land use for cocoa production. On the demand side, concerns about chocolate’s link to obesity (especially milk chocolate) could lower demand. The increasingly popular trend of eating healthier can further lower this demand.
The Case For Cocoa
In the long term, cocoa outlook could potentially be positive due to a number of key reasons: benefits of dark chocolate, growing emerging markets & global warming. While consumers may stay away from milk chocolate due to its high sugar & fat content, there are benefits to eating dark chocolate, with a higher cocoa content. Since dark chocolate requires more cocoa than milk chocolate, this could fuel demand. Emerging markets like China is still a relatively underdeveloped market for cocoa, and has the potential to grow as a growing middle class can spend on luxuries. Furthermore, the impact of global warming & climate change on cocoa could significantly lower production as weather conditions become unfavourable, which could lead to supply shocks.
Popular Ways To Invest In Cocoa — Pros/Cons of Each
Like some of the other agricultural commodities, you can’t really invest in physical cocoa. Here are some of the more popular ways instead. If you’re still confused about how any of these work, refer back to our basics newsletter for a refresher.
- Cocoa ETNs. There are ETNs that invests in cocoa futures contracts. Note that for the ETNs that invests in cocoa futures contracts, on occasion, there may be times when the actual price of cocoa & the price of the ETN share may differ since they invest in futures contracts, a derivative investment. Regardless, they’re traded on stock exchanges, so they’re very easy to buy and sell. Depending on which broker you go with, you may be charged with trading commissions. ETNs also charge an expense ratio, or management fee that gets taken out of their total holdings and is then reflected on your account. Whichever ETN you choose, be aware of the fine print — the risks and costs.
- Cocoa Stocks. Unfortunately, there are no public companies that solely focus on producing & selling cocoa, but there are a variety of chocolate manufacturers you could choose from. Because of this, you aren’t directly following cocoa prices since there are other factors at play. As always, you may want to consider looking at the company’s annual reports (especially operational costs), portfolio of what chocolate products they have, and potential product-line expansion plans. You may also want to see how they source their cocoa, and whether or not they invest in cocoa futures contracts to fix cocoa costs.
- Cocoa Futures Contracts. A binding agreement traded on futures exchanges between two parties where they agree to buy/sell cocoa at a specified time in the future with an agreed-upon price. These futures contracts can be settled with physical delivery or with cash after the contracts have expired. Because you are using a significant amount of borrowed money, even small price changes in cocoa can either lead to massive profit, or massive losses beyond what you paid for, potentially leaving you in massive debt. They are certainly high-risk and not recommended for beginners. Further, fees associated with futures trading include broker commissions, and exchange/clearing fees.
TL;DR — Is It The Right Investment For You?
As always, it depends on what your aims are. Cocoa has a long growth cycle from seed to harvest, which means it may not be able to necessarily meet fluctuating demand quickly enough. This fluctuating demand can be represented by consumers who are purchasing dark chocolate with a higher cocoa content for health benefits, vs. consumers who are staying away from chocolate (especially milk) due to its high fat & sugar content. Upgrades in infrastructure in top producing cocoa countries or solutions to manage diseases could lead to an overproduction, which could then depress prices. However, in the long term, growing wealth in emerging markets like China could have the potential to be a major consumer of cocoa. Furthermore, global warming could disrupt the optimal weather conditions required for cocoa trees to thrive.
🧺 If you are considering adding cocoa to your existing portfolio or bundling it with a number of others, you may want to consider doing dollar-cost averaging (regular investments over time) to build your cocoa position so you can take advantage of the volatility in the market.
💰 If you are considering adding cocoa for speculation and profit, you may want to monitor the factors that affect cocoa prices mentioned above. In addition to monitoring the factors mentioned above, you may also want to consider performing some technical analysis on cocoa’s price chart to help consolidate trends and patterns to help with your decision. That being said, its prices can also swing unexpectedly, so be prepared and have an exit plan in place.
As always, if you are unsure, check in with a professional financial advisor before making any moves.