(ETN) How To Profit From The Chocoholic’s Worst Nightmare

December 1st, 2009

by Tony Daltorio, Investment U Research

In the volatile world of commodity investing, they’re called “softs.”

But we know them as commodities like coffee, sugar, orange juice and cocoa. And when it comes to investing, the latter represents an excellent opportunity right now.

Cocoa grows predominantly in the West African nations of the Ivory Coast and Ghana, which churn out 40% and 20% of the world’s production respectively.

Because of the particular growing conditions for soft commodities, prices tend to fluctuate due to weather issues, political conflicts, credit shortages and the inability to respond to rising prices.

When any of those happen – as they frequently do, companies have to cope by charging more. And that means investors can do quite well…

A Sour Mix

Right now, things aren’t so sweet for chocolate lovers.

While analysts expect cocoa demand to recover quickly from the global economic downturn – growing anywhere between 1.5% and 3% between 2009 and 2010 – the market cannot sustain that kind of pressure.

The increase in cocoa-craving consumers will create a growing market deficit for the fourth year in a row, rising from 62,000 metric tons in 2008 to 73,000 this year according to the International Cocoa Organization.

And with the industry forecasting that consumption will outpace supply yet again next year, the cocoa market could very well enter its worst period of shortage in 40 years.

To make it worse, El Nino weather patterns could affect production in Indonesia, the world’s third-largest producer, and Ecuador, the seventh-largest. Meanwhile, in Nigeria – the fourth-largest producer – political problems lowered exports by 22% earlier this year and could affect the crop at any point again.

But even with all of that, the real reason cocoa prices should soar is down to the Ivory Coast…

The Ivory Coast’s Lagging Production

Thanks to too much rain and the Black Pod Disease – a fungal infection that can ruin entire crops – the Ivory Coast reported a poor cocoa harvest this year. And even if it gets perfectly favorable weather in the months ahead, the country could deliver a still smaller crop due to too many aging trees.

And it’s not simply a question of planting new trees. That endeavor requires time and money, the latter of which small farmers in that region – already among the world’s most heavily taxed growers – simply don’t have.

Under that kind of stress, Ivory Coast output could decline as much as 15% in 2010 – some 100,000 metric tons. And that’s on top of a 200,000 metric ton drop in the 2008-2009 season.

This has cocoa buyers such as Cadbury (NYSE: CBY) and Nestle (OTC: NSRGY) worried. Both firms have launched programs aimed at replanting trees, in a desperate effort to avoid a long-term decline in output.

The problem is, no one is certain whether those efforts will succeed, especially with the region’s largest cocoa workers’ union threatening to strike if its demands for government subsidies and farmers’ co-operatives aren’t met.

And finally, we have the fact that many chocolate manufacturers have yet to cover their needs for next year…

Enrich Your Portfolio

Not good news for chocoholics. But if you’re an investor, it could be a sweet ride, as prices move to their highest levels since February 1980.

With the problems in the Ivory Coast looking like they could take a while to resolve, investors still have plenty of time to get on board this upward trend in cocoa prices.

Experienced commodities traders could take advantage through the cocoa futures or futures options market directly. But a simpler way is to invest through an exchange-traded note (ETN).

Trading on the New York Stock Exchange just like a stock, the unleveraged Dow Jones-UBS Cocoa Subindex Total Return ETN (NYSE: NIB) is based on cocoa futures and will mirror the performance of cocoa, minus the fees.

Good investing,

Tony Daltorio

View original at: Investment U