The Market Corner: the month in review
By Filippo Lecchini
Chocolate? Yes, please..
One of the untold stories for 2018 so far is the rally in Cocoa prices. At the end of March prices were over 30% higher from the beginning of the year. Granted, this followed a multi years low in December but the volatility in this commodity remains quite remarkable.
As it often happens, the reason for these swings is mostly fundamental. Cocoa, unlike other agricultural commodities, needs a certain type of climate so production is localized in parts of the World that might present similar conditions, weather and shocks. That practically means that a shortage in a given country might not be offset by production in another country but rather compounded by both countries being in the same situation. Whenever we are discussing agricultural production, the single most unpredictable factor is commonly the weather, policy however matters too because pretty much all over the world Government intervention is very significant in this sector.
Roughly 70% of the world Cocoa production comes from West African Countries: Ghana, Nigeria, Cameroon and the bigger producer of all the Ivory Coast. While Asia and South America also participate, the African block is by far the bigger driver of market dynamics.
For the last several years crops have been plentiful or so were assumed. Several government programs pushed and supported production: much like in many other countries agriculture is subsidized, and cocoa beans are the main source of income for the majority of the farmers. In the first report of 2018 however, back in January, inventories that were believed to be plentiful turned out to be much smaller than expected and that triggered the rally. Fundamental reasons are commonly identified in some programs having been suspended and a less benign weather with warm winds blowing the land dryer.
As expected the financial markets quickly adjusted and a number of short futures positions were closed and replaced with long ones. It appears that after a protracted slump caused by oversupply, the cocoa market might now be heading toward healthier growth levels. Demand indicators seem strong but it might be too early to call for a full-fledged inversion of the trend. The biennial World Cocoa Conference is scheduled in Berlin, Germany for April 22-25 and will possibly help gain some more insights on where this market might be heading next.
The conversations around tariffs and renegotiation of NAFTA are in full swing at this point and are driving the volatility in the markets. The negotiations are ongoing and tense at times. There are legitimate issues of fairness but also concerns as possible solutions should not be enforced using instruments that have been dismissed long time ago. Distribution is certainly a concern within and among Countries, but seems pretty unequivocal that international trade and open markets, including the financial markets that allow capital circulation, were instrumental to the creation of wealth. There is room to make corrections without resorting to destructive and obsolete solutions.
Political skirmish aside, earnings season is upon us and that will be the real catalyst for the equities market. “The most hated bull market” has been called dead for quite sometimes now but there might be meaningful upside left behind the noise.
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