How to Invest in Cocoa2015-06-24
The commodity cocoa refers to cocoa beans, the dried seeds from the Theobroma Cacao, or cocoa tree. The tree is native to the Americas, specifically the Southern Hemisphere, and has been a major part of the area’s history, though now the vast majority of the trees exist in West Africa.
In fact, cocoa beans were used as a common currency in many areas prior to the Spanish conquest. Now, cocoa is used all over the world to create chocolate and other products, such as cocoa butter. Many consume cocoa beans because of the benefits associated with them, for example, improved cardiovascular health. As an investment, cocoa has become a popular commodity for investors looking to cash in its sweet gains.
Physical Properties and Uses of Cocoa
Cocoa trees require a warm climate to thrive, specifically within 20 degrees north or south of the equator. There are two types of cocoa plants: Criollo and Forastero. Criollo is more sensitive to weather conditions than Forastero, making it more difficult to grow and harvest properly. Cocoa trees take approximately five years to reach maturity, and each tree can produce roughly 2.2 pounds of cocoa. The cocoa beans themselves are approximately three centimeters thick and their centers are filled with a sweet pulp called “mucilage”. The seeds are typically white, though they turn a reddish-brown color during the drying process [see also Commodity Investing: Physical vs. Futures].
The most visible use of cocoa beans are in candies and beverages, most often chocolate. But cocoa beans also make cocoa butter, which is used by pharmaceutical companies to encapsulate various substances. Cocoa beans are also present in cosmetics, including various kinds of makeup, lotions and soaps.
Cocoa Supply and Demand
Cocoa bean production is dominated by emerging and frontier markets, primarily countries in Africa. Côte d’Ivoire (The Ivory Coast), Ghana, and Indonesia are the top three producers worldwide, with Côte d’Ivoire nearly doubling the output of Ghana. Though Africa dominates cocoa production, holding roughly 70% of the market share collectively, Latin America also accounts for a substantial portion of output thanks to Brazil, Ecuador, Dominican Republic and Peru.
|Global Cocoa Bean Production in 2013|
|Country||Production (Tons)||Production (1000$)|
|Source: Food And Agriculture Organization Of The United Nations|
From a consumption standpoint, the country list is the polar opposite of the producing markets. The top five cocoa consumers are the U.S., the Netherlands, Germany, France and Brazil. Because the consumers and producers are in vastly different areas and economies, cocoa beans can see dramatic price changes [see also Why Commodities Belong In Your Portfolio].
Cocoa Price Drivers
As a global commodity, the price of cocoa is impacted by a number of factors, and is often subject to significant price swings in a relatively short period of time. The major price drivers of cocoa include:
- Weather Conditions: Like most agricultural commodities, cocoa is subject to adverse weather conditions. Any unforeseen extreme weather pattern can set off supply issues, sending cocoa prices soaring.
- Geopolitical Tensions: With the major cocoa-producing nations emerging and frontier markets, the supply of this crop can be easily bottlenecked by the combustible political situations that often afflict these nations.
- Climate Shifts: While most plants are pollinated by bees or butterflies, the cocoa flower is pollinated by midges, small flies, or by hand. Any kind of global climate shifts could drastically throw off the natural pollination of this plant. Also, as previously mentioned, cocoa trees require very specific environmental conditions for healthy growth; a subtle shift in an area’s climate could make a huge difference in the industry.
- Labor: Unfortunately, numerous cocoa plants are harvested by child labor. In fact, in 2005 it was estimated that over 200,000 children were working in sub-standard conditions in cocoa fields. As of 2011, active programs in almost 300 cocoa-cultivating communities in Ghana and Côte d’Ivoire have caused a migration to the region of adults looking for work. Because this crop relies heavily on cheap labor, these changes, as well as the new regulations on how the crop is produced, have pushed the price of cocoa to its highest level since its transition from delicacy to every day treat in the ’80s.
Investing in Cocoa
The investment thesis behind cocoa is that this global commodity can be used to hedge against inflation as well as numerous other factors. The majority of the world’s cocoa supply is dependent on international markets. As such, a cocoa investment can be a play on the political relationships of some of those volatile nations. Below, we outline numerous ways to add cocoa exposure to your portfolio.
Cocoa futures are traded on the Chicago Mercantile Exchange under the symbol CJ, with prices quoted in U.S. dollars and cents per pound. A single contract represents 10 metric tons of cocoa with a minimum fluctuation of $1.00 per ton. Trading is conducted in the March, May, July, September, and December cycle for the next 23 months. All contracts are subject to the rules and regulations of NYMEX. Trading terminates on the day immediately preceding the first notice day of the corresponding trading month of cocoa futures at ICE Futures U.S.
There are currently two ETFs that offer exposure to cocoa, both through Barclays iPath. The iPath Dow Jones-UBS Cocoa Total Return Sub-Index ETN (NIB) tracks a single-commodity, sub-index currently consisting of one futures contract on the commodity of cocoa, while the Pure Beta Cocoa ETN (CHOC) comprises a single exchange-traded future at a time but with contango-reducing technology [see also Which Cocoa ETF Is Right For You? NIB vs CHOC].
Another way to gain exposure to this commodity is to invest in countries that have high production levels.
- Market Vectors Indonesia Index ETF (IDX)
- iShares MSCI Brazil Index Fund (EWZ)
- Global X/InterBolsa FTSE Colombia 20 ETF (GXG)
- Market Vectors – Africa Index ETF (AFK)
Resources on Cocoa Investing:
Disclosure: No positions at time of writing.