Cocoa Outlook 2021: Time for a Choco-late Bull Run?
Over the past twelve months, many agri commodity prices have risen substantially, with the S&P GSCI Agriculture Index up almost 60% YOY. Cocoa, however, appears to have been left out of the bull run, with prices in New York only up 7% YOY and flat in London. The curve for both contracts also moved from steep backwardation to contango, suggesting a change in sentiment. So why has cocoa been left out and could it be due to its own late bull run?
Summary
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A Shifting Production Outlook
The unseasonably good weather in West Africa that boosted 2020/21 production may not continue ahead of the 2021/22 season. Recent rainfall across Ghana, in parts of Côte d’Ivore and elsewhere in West Africa has been below average, increasing stress on trees and reducing soil moisture levels in cocoa regions, this is due to the Africa Intertropical Front being well below its mean position. Furthermore, long range IRI forecasts suggest a higher probability of lower-than-normal rainfall continuing over the coming months and with a neutral ENSO outlook we may see inadequate soil moisture levels as we enter a more normal dry season toward the end of the year. The less than ideal weather and outlook has led us to reduce our global production estimates for 2021/22 by 60,000mt to 4,940tmt.
Cocoa Demand Gaining Ground
Recent cocoa grinding figures for the three main reporting regions were positive for Q1 2021 on a aggregated level and in our opinion still have the capacity for further growth. Asia region performed the best with the highest Q1 grinding figure on record and a 3.1% increase on last year. Overall grinding figures for the three regions were only down by 0.3% YOY but continue to show a strong recovery from Covid-19 lows.
Balancing on a Tight Rope
The current supply and demand balance suggests a large surplus in the market. This is backed up by increasing US merchant stocks which are the highest since 2018 and declining differentials at origin suggesting very good availability. Since December, reports suggest European differentials have declined as much as 60% for Nigeria and Cameroon and around 50% in the Côte d’Ivore and 30% in Ghana. In addition to the decline in differentials, futures prices also fell around 7.5% on average. Furthermore, the Counsel de Cacao recently reduced the farm gate price in Côte d’Ivore by 25% for the mid-crop. The decline in Côte d’Ivore also suggests a greater flexibility on price than previously expected. The current supply situation is bearish and coupled with uncertainty from Covid-19 and the living income differential (LID) has resulted in reduced futures market participation from both speculators and commercials and reduced forward cover. ICE NY cocoa open interest in futures and options is at around the lowest level in six years and forward sales for the 2021/22 crop in Côte d’Ivore and Ghana are reported to be lagging 2020/21 substantially.
A Preference for Powder
Powder prices have remained robust over the last year, compared to beans and butter, and will likely continue as demand growth remains strong post pandemic. Strong emerging market imports will likely keep prices elevated as powder demand appears to be more resilient. This trend was emerging pre-pandemic and will likely see post pandemic tailwinds. The continued strength in powder demand and prices should cause an improvement in processor margins to pre-pandemic levels, but this might take a bit of time, as out of home consumption and sales of beauty products in the US and Europe are make a slow recovery.
Outlook
In our opinion risks are skewed to the upside with global demand likely to continue to recover and increase while production for 2021/22 remains unclear with the potential for lower output than initially expected. Speculators also have the potential to build a sizeable long position in the coming months which could catch out short sellers and industry participants that aren’t hedged. Despite the recent shift in the shape of the futures curve, it may be that this is not maintained in the coming months as the July and September contracts come forward, the curve may shift back toward an inversion if the weather worsens. Those in possession of stocks in Europe may stand to benefit as the lower availability of stocks in the region compared to the US presents a greater risk of volatility and price spikes.
