Cocoa: A Breakout In The Works?

December 14, 2010

Cote d'Ivoire's presidential election has pushed cocoa prices higher. So what's the best way to play the move?


It is the holiday season and that can only mean one thing: Everyone cheats on their diets and sneaks an extra piece of chocolate.

Unfortunately, that piece of chocolate may be costing you more in the near future.

Last week, cocoa prices hit their highest level in over four months, as supply worries centering on Cote d'Ivoire's presidential election sent the ingredient in chocolate higher. A metric ton of cocoa got as high as $3,140 on Dec. 7, the highest price since Aug. 6. Prices have since ebbed, but the 8 percent rally in just one week has catapulted the little-discussed commodity to above-the-fold headlines.

Why does Cote d'Ivoire matter so much? The small West African nation produces approximately 35 percent of all the cocoa in the world and a recent election can be blamed for the breakout in the price of the commodity.

Cote d'Ivoire is not the most stable country politically; the recent election, which resulted in two main contenders claiming victory as leader of the country, was enough to send buyers into a frenzy. The worry is that an unstable Cote d'Ivoire would lead to a slowdown in exports and decrease the supply of cocoa available around the world. As you know, when demand remains steady and supply drops, prices will rise as a result.

But cocoa demand isn't holding steady; increased usage from emerging markets has also been a factor behind the recent run-up in prices. Even though the United States and other developed nations make up the largest portion of cocoa demand, growing consumption in markets like China and Brazil look poised to shift the overall demand balance for the sweet stuff.


Investing In Cocoa

Investors who want to play the breakout in cocoa and the potentially higher prices have two options.

First, you can buy cocoa futures through a futures trading account. But individual futures can be expensive and hard to access; luckily, an easier option exists: the iPath Dow Jones-UBS Cocoa ETN (NYSE Arca: NIB). This ETN tracks the price of the cocoa futures, minus a small management fee of 0.75 percent.

Now, cocoa has not followed the path of the overall commodity sector this year, especially not its peers in the soft commodities category. As the coffee and cotton futures have reached new multiyear highs, cocoa struggled through the first nine months of the year. But in early September, the price of the commodity stopped its downtrend and began to form a bullish base. Over the next three months, the base turned into a slow developing uptrend channel that set the stage for the early December breakout.


NIB Performance: 12/31/09 - 12/14/10


NIB's year-to-date chart shows this early December breakout, which sent the ETN above its resistance level at the $41-$42 area. But news that the Cote d'Ivoire situation has improved pushed the ETN back to its support levels.

Still, as long as NIB can hold in the $41 area, it will be considered a buying opportunity for a continued rally into 2011.

Clearly I would not suggest buying NIB or cocoa futures simply on the basis of a presidential election alone. But I do like the chart of NIB and believe it offers a fundamental story as well. And considering cocoa exports from Cote d'Ivoire fell in October by 17 percent, more long-term supply issues could arise in the future.


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