Cuckoo for Cocoa Prices

What do chocolate and chipmaker Nvidia have in common?

The price of cocoa, a key ingredient in chocolate, and share prices for recent Wall Street darling Nvidia have risen in roughly the same trajectory since late 2023.

Few prices have shot up as quickly as cocoa in recent months. Cocoa prices are up 330% over the last 18 months and 140% year-to-date through April. Cocoa's peak price was $11,064 per metric ton on April 22.¹ Prices dropped in May, mainly owing to speculators backing off their earlier positions on cocoa price increases as the year's first harvest approached. But, as Figure 1 shows, prices have started rising again.

Cocoa price movements illustrate how often overlooked external factors can significantly affect commodity prices and stock fundamentals. Climate change, regulation, geopolitical risks and inflation cycles can unexpectedly influence market dynamics. Considering these factors may help investors better prepare for potential market shifts.

We’re focusing on candy and confectionery companies that can manage cocoa’s extreme price fluctuations due to their strong brands, liquidity and financial flexibility.

Why Did Cocoa Prices Skyrocket?

Cocoa, a crucial input for chocolate from dried beans, has historically been subject to volatile prices, primarily because most of the world’s cocoa is cultivated only in a few countries in West Africa.

Many West African governments set the prices at which farmers can sell cocoa to cooperatives before the commodity reaches the market. The idea is that it protects the farmers if prices get too low. However, it also limits the farmers’ income even if prices are high, making it an increasingly unattractive crop, particularly for smaller farmers.

Cocoa enjoyed a period of abnormally low and stable prices from 2017 to 2022. During much of this time, West African governments, chiefly Ghana and Cote d’Ivoire, set prices well below the market price. This decision exacerbated the already tenuous economics of cocoa farming because controlled prices led farmers to use their land to plant other, more profitable crops. By the time governments raised prices, it was too late because new cocoa trees take three to five years to produce pods that can be cultivated.

How Weather, Higher Production Costs and Regulation Have Limited Cocoa Supply

Cocoa farmers faced challenges from inflation and the impact of Russia’s invasion of Ukraine, which nearly quadrupled the cost of fertilizer and pesticides in 2022. They have also had to cope with extreme weather events:

• Significant rain and flooding in 2022 contributed to crop diseases that damaged the cocoa yield during the September harvest.
  

• Heavy rain before the September 2023 harvest caused mold in harvested cocoa pods, compromising yield.
  

• Drought during the 2023-24 growing seasons has led the International Cocoa Organization to forecast the most significant cocoa supply shortfall in more than 40 years.²

Finally, a forthcoming EU regulation prohibits importing and selling products derived from deforested land. These new rules on deforestation-free products have unintended consequences, as some beleaguered farmers decided to mine their farmland for metals rather than deal with the headaches of growing and selling cocoa beans.

This combination of regulatory factors, geopolitical risks, inflation cycles and climate change has led to an unprecedented global cocoa shortage and attendant spike in cocoa prices.

Cocoa Prices Likely to Stay High as EU Regulation Spurs Stockpiling

We expect European cocoa buyers to stockpile cocoa before the EU deforestation regulation’s implementation in December. This will likely cause demand to exceed the already limited supply. Making matters worse is the likelihood of another disappointing September harvest.

We think this means that while cocoa prices may retreat from their peaks, they will remain well above historical norms for at least the next two quarters. And while a solid growing season could help restore the crop yield, we think cocoa prices could remain elevated even longer.

Rising Cocoa Prices Impact Consumers and Investors

To adapt to rising cocoa prices and the global cocoa shortage, companies that sell products with high cocoa content — Hershey, Mondelez, and Nestle, for example — have raised prices even though consumers are already weary of seeing higher totals on their sales receipts.

These companies may also charge roughly the same price for smaller package sizes and face potential complaints of shrinkflation. Consumers should also expect to see these companies push brands and products containing less or no chocolate at all.

High cocoa prices could lead to lower profit margins in the near term and increased volatility in these companies’ share prices.

However, we believe that Hershey, Mondelez and Nestle are businesses with well-established brands and substantial market shares. In our view, these businesses should be able to manage through commodity price volatility without outsized impacts on their return profiles, the sustainability of these returns or risk to their dividends.

In our view, stock price fluctuations related to spikes in commodity prices may create attractive investment opportunities for long-term investors.