Chocolate: A Smart Move On A Sweet Commodity?

To hell with the health kick.

And while I, like many of you, are consuming more leafy greens, organic tomatoes, free-range chickens and beef that hasn’t been given booster shots, the fact is there is one guilty pleasure that we can’t live without. In fact, we are indulging in it now more than ever before.

Chocolate.

After my grilled chicken salad this weekend, I treated myself to some delicious dark chocolate. (Dark chocolate is my weakness!)

But that dark chunk of goodness is growing more expensive and the cost is going to continue to rise due to two key factors…

Global consumption of chocolate is rising while harvests have shrunk as the Indonesian drought worsened. West African harvests are also smaller due to dry weather. However, weather is only a small factor in what’s driving up cocoa prices.

The fact is people are eating more chocolate. Demand currently outstrips the supply and analysts don’t see a change in the trend for at least the next five years.

You can expect to pay even more for your favorite piece of chocolate for as long as the world’s taste for chocolate remains insatiable, and I know a great way to take advantage of the coming rally in cocoa prices.

Demand and Drought

Asia’s demand for cocoa continues to increase. In fact, Hershey expects overall chocolate sales to grow 60% in the Chinese market over the next four years to $4.3 billion. The region’s middle class has developed a taste for chocolate and, as the ranks of the middle class expand, chocolate’s popularity is increasing. The same thing is happening in Africa, particularly in Kenya and Nigeria.

India alone has experienced 20% annual growth in chocolate consumption. Just last month Mars Inc., the privately-owned company that makes Snickers and Galaxy, announced it will open a $160 million plant there.

Not surprisingly, sales in the U.S. and Europe remain strong. In the U.S., chocolate sales swelled by 24% between 2009 and 2014 to $21 billion and are continuing their upward trajectory.

Meanwhile, weather conditions in the key cocoa growing areas of West Africa and Indonesia have not been ideal, cutting into the bean harvest. Indonesia is the third-largest cocoa grower, but they saw drier than normal weather last year as El Niño grew stronger. Rainfall is gradually returning to normal and the Indonesian Cocoa Industry Association says their harvest will be stable at about 400,000 to 450,000 tons for each of the next five years.

That’s not enough to meet demand. As a result, the country switched from being an exporter of cocoa to an importer. Imports increased by 60% to 120,000 tons in the last year just to keep the cocoa butter flowing into the Asian market.

On the other side of the globe — the home of the world’s leading growers Ghana and the Ivory Coast — things have gone from bad to worse.

The countries combine to produce 50% of the world’s cocoa. Heavy rain, lack of sunshine and a fungal disease called black pod hurt the crop last year. Then in February and March of this year, dry winds blowing off the Sahara sapped the moisture away from cocoa trees. The one-two punch will reduce the harvest, although we won’t know by how much for another month.

Still, the total profit for the world’s cocoa producers was $13 billion for the 2013-2014 season. The profit for chocolate — the end product — was $130 billion.

Mars sees the possibility of cocoa prices doubling by 2020 as cocoa supplies fall a million tons behind demand.

A Sweet Play

You might think you can make good money off climbing cocoa prices. But it isn’t as easy as it might seem. Let’s unwrap the choices:

Hershey Co. (NYSE: HSY) is up about 125% since 2010 while the S&P 500 has climbed 79%. Hershey, however, is susceptible to the price of sugar and, to a lesser degree, soybeans. Both are affected by the weather but not the same way and not necessarily at the same time. So, Hershey’s stock has too many non-cocoa variables that it must contend with.

Nestle SA (VTX: NESN) is traded on the Swiss exchange, which isn’t very convenient for most of us, unless you have an account with a brokerage firm that offers access to many of the major overseas stock exchanges. Besides, Nestle is diversified and chocolate is only a portion of their business.

Rocky Mountain Chocolate Factory (NASDAQ: RMCF) does, as its name implies, a lot of business in chocolate. However, the stock is thinly traded and the Nasdaq Composite has outperformed Rocky Mountain by 60% and I’m not looking for this laggard to make a breakout any time soon.

The best way to play cocoa prices is the exchange-traded fund iPath Pure Beta Cocoa ETN (NYSEARCA: CHOC). The price mirrors the actual cocoa futures trade. If the industry is correct that cocoa prices will continue to rise, you’ll be able to benefit over the long haul as the lingering effects of El Niño continue to negatively impact harvests and demand for the sweet commodity rises.

There’s a silver lining in every cloud,

Chris Orr
Certified Consulting Meteorologist