Cocoa ETFs Surge On Supply Worries - Commodity ETFs

Thanks to weakness in emerging markets and dollar strength in the final part of 2011, a variety of commodities finished the tumultuous year on a sour note. While oil-heavy funds—such as DBC—managed to avoid the worst of this due to tensions with Iran, other products including those in the metals and softs sectors, plunged on the final four months of the year with many losing more than 10% of their value during the period. Soft commodities were especially hurt by the broad slowdown fears in global markets and particularly those tracking the often volatile cocoa market.

In this slice of the investing world, prices for the sweet commodity fell from just over $3,000/metric ton to just over 2,200/metric ton at the end of the year, representing a massive loss for the firm in just a fourth month time frame. While a strong dollar was part of the reason for the slide, another huge development was the return to some semblance of normalcy in Ivory Coast, the world's biggest grower of the crop. The country saw turmoil at the beginning of the year but rebounded in the fourth quarter, greatly increasing its exports of the crop and pushing prices far lower heading into 2012. Yet, although the recent performance has been weak—to say the least—other developments in West Africa could spell good news for those looking to make a play on the space.

West African Tensions

Nigeria, a nation in West Africa with a population approaching 170 million, is experiencing quite the rocky start to the year thanks to a variety of political problems. Workers are now on strike in protest of higher fuel costs-- which have doubled thanks to a repeal of subsides-- while farmers are refusing to sell crops thanks to a similar issue which has severely eaten into their profits. Meanwhile, attacks on various churches and mosques around the nation are being reported, with some even fearing a split of the country could come about from the resulting riots and tensions (read Forget WTI, Play Crude With This Oil ETF).  

Beyond the potential humanitarian issues and fears of a civil war, the country is also a major producer of both oil and cocoa. While the oil market has brushed off the tensions so far, the cocoa market has not, largely due to the country's outsized role in the production of the commodity. Currently, the nation is the fourth biggest producer of the product making nearly 370,000 metric tons out of the global supply of just over four million tons.

So although Nigeria isn't the biggest producer of the valuable crop, it does make up a sizable portion of supply and could be a wildcard this year, especially with already tight supplies for the in demand product. “Whenever you see a country being immobilized, you run the risk of exports not moving at all,” Hector Galvan, a senior commodities broker at RJO Futures in Chicago, said to Bloomberg. “Nigeria is not Ivory Coast, but when all is said and done, it's one of the top producers.”

As a result, prices of cocoa which trade on the NYMEX have been on a tear so far this week, adding nearly 17% in two days of trading with more than 8% gains in each session. This figure represents a huge reversal that could either be the start of an uptrend in the cocoa market, or if Nigeria gets things under control, an excellent entry point for shorts. Either way, the next few weeks look to be an extremely volatile period for this corner of the soft market and could produce big changes as we head into the second half of the month (read Three Micro Cap ETFs To Play The January Effect).

Cocoa ETNs

If investors are looking to make a play on the cocoa market, futures are one of the few choices available. Yet, for those who are looking to make an exchange-traded note play instead, there are two options that could be worth a closer look in this uncertain trading time in this soft commodity:

iPath Dow Jones-UBS Cocoa Total Return ETN (NIB)

The easiest way to achieve exposure to cocoa is with NIB which tracks the Dow Jones-UBS Cocoa Subindex Total Return. This benchmark tracks the performance of a single futures contract on the commodity of cocoa, generally the front month contract. The product is also collateralized with an investment in short-term Treasury bills which should help to offset the fund's 75 basis point yearly fee (Can You Fight Inflation With This Real Return ETF?).

In terms of volume, the fund trades just about 26,500 shares a day but the volume has spiked in recent days thanks to more investor interest. Obviously this isn't the highest level of volume for a commodity product, but it is by far the most for an ETF in the cocoa category. For performance, the fund has gained over 12.3% in the past five trading sessions, helping to cut into the significant losses from 2011 which came in at -33.8%.

iPath Pure Beta Cocoa ETN (CHOC)

For a new way to play the cocoa market, investors should take a look at CHOC instead. This product, also from iPath, seeks to use a different way to achieve exposure to its underlying futures which may help to cut down on contango. In this strategy, the fund doesn't just roll into the next month's contract but instead can roll into any number of contract expiration months in order to achieve exposure. Hopefully, this strategy can cut down on contango and push the fund to higher than expected returns (see Is USCI The Best Commodity ETF?).

The main downside for the product, however, is its tiny trading volume which some days barely registers past 1,000, if not outright zero. Thanks to this, investors may find it hard to get in and out of the product at the desired price. Nevertheless, the fund still charges investors a yearly fee of 75 basis points just like NIB so at least that part of the total cost picture is constant.

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