Franc view: In October 2016, franctrade.com forecast a bearish cocoa market, with significant downside risks anticipated in the second half of the season (see article). While the collapse in cocoa market futures may now appear overdone, particularly given fledgling political risks in the West African region, we retain our base case that markets may have further room to fall should output continue to improve as we anticipate.
Cocoa prices under pressure
Cocoa prices have come under significant pressure with the generic front month futures market in New York currently trading near USD 2,233 per tonne and down nearly 20% compared with prices in October, the start of the main cocoa season in Cote d’Ivoire. Prices even reached a three-and-a-half year low in New York in December 2016 although technical buying and news of socio-political tensions related to mutinous soldiers in Cote d’Ivoire helped stem further losses.
Political risk premium: Still not enough to boost cocoa futures
Lingering agitation by a faction of the army in Cote d’Ivoire, as well as the risk of contagion in the West African region linked to heightened political tensions in Gambia (with implications for the entire ECOWAS region) will bring political risk in the region to the fore. However, we do not believe this will provide a significant buffer against bearish pressures on the cocoa market given the positive outlook for production in the current 2016/17 season. Additionally, political tensions have historically held little sway over cocoa trade operations in the region, although it should be noted that the profile of the industry has changed, especially in Cote d’Ivoire.
Speculative bear – CDI Cocoa Council to cancel and resell up to 300kt of contracts on the verge of default
The likelihood of significantly drier harmattan-induced weather is a phenomenon which could dent cocoa productivity in the region but we see this largely as a tail risk. Instead, markets remain glued to weak cocoa market fundamentals (and have been betting on further losses) exacerbated by a recent decision by Cote d’Ivoire’s Coffee and Cocoa Council to cancel and resell around 300,000 tonnes of cocoa contracts on the verge of default, thereby increasing exportable surpluses. Meanwhile the New York exchange has raised margins for cocoa speculators by a hefty 11.5% to USD 1,450 per contract – effective January 18 – to disincentivise excessive speculative activity, we believe.