On November 30, 2017, the International Cocoa Organization (ICCO) released its latest 2016/17 cocoa year estimates. Given the prevalence of production in Côte d'Ivoire, Ghana and Brazil, timeline of the cocoa year mainly corresponds to production seasonality in these three countries, and runs from October through September.
Throughout 2017, agency’s production estimates for the 2016/17 season year have been continuously revised higher to reflect better crop conditions in the African region. Upped by another 33 thousand tonnes in November update, latest forecast – at 4.733 million tonnes – is slightly higher than that of the previous periods:
- Feb 2017 forecast: 4.552 mln tonnes, up 14.8% year-over-year;
- May 2017 forecast: 4.692 mln tonnes, up 18.1% year-over-year;
- Aug 2017 forecast: 4.7 mln tonnes, up 18.1% year-over-year;
- Nov 2017 estimate: 4.733 mln tonnes, up 18.5% year-over-year.
Having rallied since mid-August, cocoa futures took note of an improving crop outlook and broke the upward price channel in November. Delivering a strong blow to large trader sentiment, recent sell-off ended the bullish accumulation in non-commercial positioning.
The cocoa prices’ 2015 run-up and the subsequent plunge in 2016 were mainly a function of a strong supply balance shakedown. Having suffered two consecutive production decreases during the 2014/15 and 2015/16 season years, global production demonstrated a colossal annual reversal of 18.1 percent in 2016/17. A sudden switch from a deficit to a multi-year record in production surplus fueled a substantial uptick in stocks-to-grindings ratio and a notable build-up in ending stocks.
With the ratio at a 5-year high, one may draw a parallel between the current and the 2010/11 cocoa market situation. For reasons mainly associated with weather seasonality and decreased fertilizer spending and acreage, historical trends indicate that a second consecutive production increase is much less probable after the 2016/17 season record.
The situation is different for the stocks-to-grinding ratio, however. Following an increase to 41.6 vs. a multi-year low of 34.2 percent a year earlier, it might take at least another season year for the ratio to signal a cocoa market tightening given the high ending stock levels. In contrast with the annual production decrease during the 2011/12 season year, the ratio – signaling modest demand growth – demonstrated a 1.7 percentage point increase to 46 percent. Incapable of keeping up with production growth, softer demand dynamics resulted in a significant cocoa supply glut.
Fundamental perspective offers limited clarity on the future cocoa price direction at this point, with an immediate rebound appearing increasingly unlikely. Although the low price levels may persist in the coming months, latest positioning data is crucial as the market is starting to digest next season’s weather and crop data.After experiencing an all-time peak in non-commercial short positions in mid-July, cocoa futures closely followed the turnaround in non-commercial exposure before correcting in November. One should note that a shift to a net-short large trader positioning has been a rare occurrence over the last 10 years. It is also important to note that cocoa prices have a tendency to plateau after a supply glut occurs, sometimes fueling a multi-year consolidation in a certain price channel.
While it remains unclear whether the 1800-2200 trading range is set to become a new home for cocoa prices over the next couple of quarters or not, downside risks appear to be gradually diminishing.
The following catalysts are likely to go into play over the next couple of quarters:
- Cocoa harvest area in Ghana and Cote d'Ivoire, which collectively account for 62.5 percent of the world supply, might be set for a minor decrease following the recent government crackdown on production in prohibited areas. Deforestation – an old-time byproduct of cocoa production in the key producing regions – is increasingly being targeted by the media and continues to drive government and corporate attention. Announced at the recent UN Climate Change Conference, the two countries’ initiative to tackle the issue and focus on sustainable production is likely to result in lower volumes and higher crop quality. Companies supporting the initiative include such leading confectionery industry players as Hershey, Mondelez and Blommer Chocolate Company.
- Being provided a certain price floor, local farmers of Ghana have recently been reassured that the government-set prices will remain unchanged at $1,914 per tonne. In contrast, farmers of Cote d'Ivoire experienced a significant cut to approximately $1.23 per kilogram, or a 36 percent decrease in CFA francs. With lower prices continuing to hurt the local farmers, it’s being increasingly argued that the country should put additional emphasis on its cocoa business given its export significance (44% in 2015). According to a Reuters article, the head of Coffee and Cocoa Council was quoted as saying the following: “Ivory Coast must be involved in the marketing of cocoa like it’s done in Ghana. Ivory Coast and Ghana are going to get together very soon to find solutions to the drastic price drop.”
- Being motivated to drive the prices higher, Ghana and Cote d'Ivoire also expressed their plans to increase their warehouse capacity to combat further price pressure. In an interview with Reuters in September 2017, Narcisse Sepy Yessoh, chief of staff to Ivory Coast Trade Minister Souleymane Diarrassouba, said the following: “The countries agreed that we needed specialised warehouses to allow us to conserve cocoa so that we can regulate supply and push up prices.” According to Reuters, Cote d'Ivoire plans to build six new warehouses with a total capacity of 250 thousand tonnes. Its other plans include setting an output limit and putting additional emphasis on crop quality in the coming years.
- Despite the recent correction, leading players might be starting to reconsider the bull case for cocoa in 2018. Commerzbank’s forecast for end-2018 prices in New York was lifted by $200 to $2,300 per tonne, Agrimoney wrote December 8. Bank’s forecast incorporated a positive demand outlook and a skeptical view on the recent crop strength optimism.
- ICCO isn’t too bullish on the 2017/18 season crop, highlighting the risks of excess rainfall and crop disease in Cote d’Ivoire. Per Agrimoney, the agency noted that most Cote d’Ivoire farmers are not able to afford fertilizers and insecticides at current government-set farmgate prices, while also mentioning the possibility of supply disruption due to political unrest in Ghana.
Despite creating an uncertain 2017/18 crop outlook, current cocoa market situation might create attractive option writing opportunities. Taking advantage of the recent correction, one may choose to sell longer-dated out-of-money puts to capitalize on the possibility that cocoa prices are nearing a bottom.
There were no material changes to wheat market outlook in November. According to the latest USDA forecasts, global inventories are set to reach record 267.5 million tons by the mid-2018. With CFTC data indicating a notable build-up in non-commercials short positions, wheat futures entered December on a quite downbeat note.
Despite a decrease in net-short non-commercial exposure in the second half on November, corn futures continue to trade at lower levels of 3.5-3.65 US dollars per bushel.
Per USDA, global soybean demand for 2017/18 is currently seen at 302 million tons. While a record, ending stocks are still forecast at 98 million tons due to upbeat crop data. In parallel with a significant build-up in net-long non-commercial positions, soybean futures have been in an uptrend since mid-August.
Despite mainly tracking soybeans on a medium-term basis, soybean meal futures tend to demonstrate higher price volatility in the short term.
USDA rice consumption forecasts remained nearly unchanged in November. Global production levels are expected to demonstrate a minor decrease and reduce ending stock levels to approximately 139.9 million tons. In parallel with an outflow in non-commercial short positions, raw rice futures demonstrated a sharp reversal in mid-November.
Global sugar production in the 2017/18 season year is currently seen at 185 vs. 171.5 million tons in 2016/17. With a modest consumption level increase to 174.2 million tons, ending global stocks are forecast to reach 40.8 million tons. Oversupply outlook continues to weigh on the sugar market, with futures demonstrating a strong correction in the first half of December.
There was only a minor change to USDA’s cotton outlook in November, except for a minor global ending stocks revision to 90.9 million tons. Following a strong reversal in later October, large traders increased their net-long exposure to cotton futures to levels last seen in June.