What’s Killing The Cocoa ETF?

by on August 27, 2010 | ETFs Mentioned:

Many of the most popular commodity products offer exposure to a diversified basket of natural resources, including industrial and precious metals, agricultural commodities, and energy. Among single-commodity products, the most popular are–not surprisingly–those focusing on physical gold and futures contracts on natural gas and crude oil. But the impressive expansion of the commodity ETF space allows investors to establish exposure to more obscure commodities such as lead, cotton, and nickel.

There’s also an exchange-traded option for cocoa, a commodity that few consider as an investment option despite its ubiquitous presence in everyday life. Some investors, like Anthony Ward, have made a fortune in the cocoa business, capitalizing on favorable demographic and demand trends to turn a profit on the commodity used in many food products. But recent months have been challenging for cocoa investors, particularly those who recently made a huge bet on the commodity by purchasing about 7% of the global supply.

Ward, a trader who made large, profitable bets on cocoa in 1996 and 2002, bought up about $1 billion in cocoa in July, enough to make about 15 billion Hershey’s bars. But that investment has so far left him with a bitter taste in his mouth; cocoa prices have plummeted since he took delivery of about 240,000 metric tons, declining by about 25% [see Three Reasons Why The Cocoa ETF (NIB) Is Leaving Investors Bitter].

Behind The Freefall

Cocoa prices had recently rallied to their highest levels in more than 30 years, thanks in large part to concerns about extreme weather in the Ivory Coast, which supplies about 40% of the world’s cocoa. But concerns about a wetter-than-normal season there have eased considerably in recent weeks, and indications now are that the Ivory Coast crop won’t be significantly impacted by the weather [also read Sugar ETF: Due For A Comeback?].

In some sense, an investment in cocoa is a bet on weather patterns halfway around the world. The amount of rainfall in a small African country can send prices around the globe higher or lower, highlighting the inherent volatility in the commodity’s price. Not surprisingly, investors who are active in cocoa markets pay close attention to the Doppler. “We invest hugely” in weather data said Ward in an interview earlier this year. “”We even have our own weather stations, our very own, that no one else has, in some parts of the world.”

Even if the weather cooperates, other developments in the Ivory Coast can impact cocoa production. “Political tension has been roiling Ivory Coast for years, and elections are to be held at the end of October, introducing the potential for short-term disruptions,” writes Gregory Zuckerman.

Also weighing on cocoa prices in recent sessions is a report from the NYSE Liffe Exchange indicating that beans from the Ivory Coast, Ghana, Ecuador, and Nigeria passed quality tests. Some analysts predict that European stockpiles of cocoa could quickly triple, depressing prices even further.

Cocoa ETN In Focus

Few investors have the resources to to buy cocoa from farmers in the Ivory Coast and Ghana, but there are alternatives for establishing exposure to the commodity. The iPath Dow Jones-UBS Cocoa ETN (NIB) is linked to an index that consists of futures contracts on cocoa. Futures trade on the ICE, with contract listings five times per year (March, May, July, September, and December). Cocoa futures also trade on the NYSE Liffe Exchange, where prices recently stood at about $3,100 per metric ton.

This year has been a rough one for NIB, at the note is now down about 20% in 2010. It has lost more than 12% over the last month, including a steep drop approaching 10% in just the last week of trading [see more fundamentals of NIB here].

Disclosure: No positions at time of writing. Photo from David Monniaux.