Macro Movements: Why is Halloween candy so expensive, and why it will be cheaper next year.

By: Aremorph 10/31/24

    In 2020 and 2021, the world was shocked by a plethora of circumstances that sent the production of the commodity cocoa into decline. To begin, COVID 19 decimated most trade routes and economic expansion of many nations, especially those in the West African region where over 60% of supply originates from. (Bloomberg) Following, adverse weather conditions from global warming and increased climate change caused excessive rain, leading to root rot, as well as droughts which ravaged crops. (Confectionery news) 

    This combination of events caused the price of cocoa to spike up from around $2,500 to just shy of $10,000. With roughly a 400% growth, there was global consensus that this growth was unsustainable, and the recovery of the supply chain would lead to the decrease in cocoa prices. Observing the CC1 Comdty graph on Bloomberg Terminal, we can clearly see how the price expectations in the following year shows a significant negative trend, suggesting that the supply of cocoa will recover. (Don't worry, next years chocolate will not cost a fortune)

 Fig 1. 2 year chart of cocoa futures, shows backwardation

    One key catalyst that pushes the price of cocoa in the future down is due to a report from the Ivory Coast on 10/18/24, stating that their expectation of cocoa production has increased by 10%, showing promising sign of a faster recovery of supply. In my personal opinion, I think other western African nations will begin to see positive expectations in supply of cocoa, that will push the futures price of cocoa lower, currently not being priced in. 

    Trade idea: Short Cocoa via futures contract, hedged with call options at spot price [1 year time horizon]

    Dec 2025 futures with a bid/ask of 5574/5591, Call Option with Exp date of Dec 2025

    Futures Strike Price: $5,580, Call Options Strike Price: @ spot price ($7,300)

    Explanation: Since there is market consensus that the price will decrease, and I am expecting more positive news that will drive the price of cocoa lower, I would enter a short futures contract on cocoa. To hedge against potential infinite losses on the rise of cocoa, I propose buying a call option at the spot price, which will give me the right but not the obligation to buy cocoa at a given spot/strike price. If the price of cocoa was to increase, my short futures contract (which makes me obligated to sell cocoa at a predetermined price, would incur losses of the difference between spot and strike price, multiplied by the amount of contracts I have bought.) The call option will limit my losses to the difference between the current spot price and the strike price of my futures contract.

    In short, the cocoa market went wild when COVID threw a wrench in trade, West African weather decided to be both too wet and too dry, and global demand for chocolate stayed as strong as ever. Prices shot up almost 400%, and it seemed like a world crisis: would chocolate bars cost more than rent?

    But don’t worry; it looks like prices are set to cool down. With Ivory Coast projecting a 10% bump in cocoa production, investors are eyeing short positions on cocoa futures—with a little call option on the side to keep things spicy but safe. So, good news: next year’s chocolate stash won’t break the bank!

Sources:

- Bloomberg Terminal

- https://www.confectionerynews.com/Article/2022/11/24/uncertain-supply-and-demand-undercuts-cocoa-prices

- https://www.bloomberg.com/news/articles/2024-03-31/why-cocoa-prices-spiked-and-what-it-means-for-chocolate-lovers

- https://www.sustainabilitybynumbers.com/p/cocoa-prices

- https://www.agmarkllc.com/news/story/29159172/cocoa-prices-retreat-on-ivory-coast-harvest-pressures