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Cocoa investing: Sweet taste of profits for your portfolio

Tony D'Altorio, Investment U
0 Comments| June 10, 2010

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While the investment world spins out of control, cocoa somehow stands out from the rest.

Instead of tanking or vacillating like everything else, it continues upward. Cocoa futures have even hit their highest price since November 1977. And they’ve jumped 15% in the past three weeks alone.

With good reason too. Demand for the sweet commodity is outstripping supply again this season. This marks the fourth year in a row that this has happened. The last time a shortage lasted so long was from 1965 to 1969.

U.S. cocoa processing, a measure of demand for the beans used in chocolate, rose 16% this first quarter compared to the previous year. Meanwhile, in Europe, cocoa grindings rose 8.1%, their biggest first-quarter gain in four years.

Most in the industry expect demand to outstrip supplies yet again in the 2010-11 season. That has never happened in the 50 years traders have kept record. Naturally, that kind of talk alone puts further upward pressure on prices, not to mention if it actually happens.

But it’s the supply side that really has the market rising. Cocoa inventories at exchange-registered warehouses have fallen to very low levels… for unfortunate reasons…

Cocoa supplies dwindle ever downward

About 70% of cocoa is grown in the Ivory Coast, Ghana, Cameroon and Nigeria. The remainder mainly comes from Brazil and Indonesia.

Traditionally, though, the Ivory Coast produces the vast majority, totaling about 40% of the world’s 3.5 million ton crop every year. Its output of 1.3 million tons is more than double what it was in the 1980s. And it’s 26 times larger than the harvest count in 1960.

Clearly, as the numbers of chocoholics grew, so did the Ivory Coast’s yield.

At least it did until recently. In the past five years, its yield has fallen over 15%. For that matter, so has the quality of its crops.

Companies such as Nestle ADR, Hershey (NYSE: HSY, Stock Forum) and Kraft Foods (NYSE: KFT, Stock Forum) depend on reliable, cheap supplies of cocoa. So this decline has them worried. They’re even beginning to talk about a potential “chocolate crisis.”

They care much less about their sales at this point than they do about what they’re buying. They seek out good quality cocoa, and that is becoming more and more difficult to obtain.

Cocoa traders don’t expect anything better from the 2010-11 crop season either, which starts in October. And some traders even foresee much worse numbers.

Ivory Coast’s continuing cocoa problems

The Ivory Coast currently features largely old cocoa trees. Their aging limbs make them more fragile and prone to disease.

As I detailed back in November, that isn’t the commodity’s only problem. The farmers who tend cocoa crops are largely very poor. And though local politicians ignore them in every other way, they still tax them heavily. About 40% of the international price of Ivorian cocoa finds its way into government coffers.

Who can blame the farmers for then abandoning the crop altogether? Many have switched to growing rubber instead, which is also trading at all-time highs. Unfortunately, that has led to severely depleted output. The Ivory Coast’s yield is now less than that of Indonesia, the third-largest producer.

The Ivory Coast’s remaining cocoa farmers have made repeated appeals. They have contacted the global chocolate industry. They have gotten in touch with non-governmental organizations. And they have reached out to the World Bank.

The chocolate companies, at least, want to help. They believe everybody would benefit from replanting new, higher yielding, pest-resistant trees.

Unfortunately, it’s usually easier said than done. And with two billion cocoa trees to account for, the Ivory Coast is no exception to the rule.

Nestle currently has the most advanced plans. It aims to spend nearly $100 million over the next decade, replanting 12 million trees. But even so, that accounts for merely 0.6% of the total population.

Who doesn’t like cocoa?

Clearly, companies that rely on the cocoa industry have a long-term problem on its hands.

But on the sweet side of the deal, that gives investors a long-term chance to profit. Until other countries increase their production, cocoa prices will continue to climb upward.

The simplest way to have your chocolate and eat it too is through the iPath Dow Jones-UBS Cocoa Sub index Total Return ETN (NYSE: NIB, Stock Forum). The ETN was created to mirror the performance of cocoa futures.

Investors who take a bite of NIB should enjoy some tasty returns.



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