In a first, cocoa prices have doubled in three months to race past $10,000 per tonne, coinciding with the Easter demand peak. Cocoa, an essential ingredient for making chocolate, has been in short supply, with the deficit likely to rise to 374,000 tonnes in the 2023-24 season, up from 74,000 tonnes in the previous season, according to International Cocoa Organization (ICCO).
This marks the largest shortfall in over six decades, primarily due to the adverse effects of El Nino on cocoa crops in Ghana, the source of nearly 70% of the world’s total supplies, and the Ivory Coast. Additionally, the majority of the global cocoa supply now comes from aging trees, and new sustainability regulations in Europe intended to prevent deforestation-linked products from entering the market could further strain supplies. These rules require chocolate sellers to monitor cocoa beans through the supply chain from pod to port.
Supply disruptions have led to a mismatch between demand and supply, which has sent cocoa prices to the sky, with a year-to-date increase of 112%, outperforming notable stocks such as Nvidia, delivering a nearly 550% gain since the start of last year. The stock has become one of the largest in the world, gaining $2 trillion in value over the past 15 months before retail investors in countries like India even got a chance to hear of the AI chipmaker that saw its revenue double last year, as companies around the world rushed to stockpile computing power for running AI workloads.
The sudden surge in demand for Nvidia’s AI chips and cocoa in short supply are also playing out in financial markets, making them potential investment options for investors. The supply shortfalls have sent cocoa futures to historic highs this month.
While the cocoa price rise may be bad news for makers and consumers of chocolate, for Indian investors it is a lost opportunity, and a reminder that India needs to allow its commodity futures market to develop and grow.
More so at a time when retail investor inflows have surged towards small and midcap equity funds, driven by the limited availability of high-return investment classes. The Securities and Exchange Board of India (Sebi) has expressed concern over this trend, particularly the disproportionate inflows into small and midcap funds compared to large-cap funds, and the potential market frothiness signalled by a 33% increase in the Nifty Smallcap index over six months.
Sebi’s has responded by mandating stress tests for funds to ensure they can manage redemption pressures effectively, anticipating a correction in the prices of small cap stocks that is bound to come sooner or later.
Sebi also has mandated steps aimed at mitigating the significant influx of retail investments into mid and small caps. Mutual fund houses have stopped accepting lumpsum investments. Costs on redemptions are also likely.
This highlights concerns over the relative illiquidity of small caps, which can lead to sharp price declines under redemption pressure in the absence of a buying side.
If fund managers had the option of deploying the investible funds into a more diversified portfolios, across a range of assets, many of the issues Sebi has identified could be mitigated or even avoided with well-crafted regulations and safeguards in place. This approach would prevent the continuous pursuit of a limited number of illiquid asset classes by the ever-increasing pool of investable funds.
Agricultural commodity derivatives represent a viable alternative, as demonstrated by the rising cocoa futures contracts in global markets.
This year, the finance ministry has notified 13 new commodities for derivatives trading in India. These include apples, cashews, garlic, skimmed milk powder, white butter, timber and bamboo. It’ll be a while, though, before Indian investors will be able to benefit from the upside in prices of these farm products.
This is because although India launched derivatives trading in agricultural commodities more than two decades ago, the segment has seen frequent suspensions and bans imposed by governments, which have led to uncertainty and policy risk for investors.
In August 2021, derivatives trading in chana was suspended. In October 2021, trading was suspended for mustard, non-basmati paddy, wheat, soybean and its derivatives, crude palm oil, and moong dal. For the commodity derivatives market to flourish unimpeded in India, such disruptions must be avoided.
Enabling the market to develop unhindered is also crucial for fostering research and investment expertise in these derivatives. This will significantly contribute to expanding and deepening the market, attracting investors from various segments, enhancing the liquidity of contracts, and improving the mechanism for price discovery.
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