The world can be divided into chocoholics and those who should be; I proudly include myself in the former category. Small wonder, then, that we celebrate Valentine's Day with boxes of bonbons and other cocoa-crammed confections.
The cocoa tree is native to the Americas. The Aztecs made a bitter drink from unsweetened cocoa, water, cornmeal and chili peppers. Cocoa-based drinks laced with sugar became popular among the upper classes in Europe, and to feed the demand, cocoa trees were transplanted to colonial plantations from the West Indies to Africa to Sumatra.
Chocolate took off as a mass-market item during the Industrial Revolution, when new processing methods allowed for the creation of solid forms like the chocolate bar. By the mid-19th century, the ever-enterprising Swiss softened the taste and the consistency by adding milk, sugar and extra cocoa butter. There you go -- history in a heart-shaped box.
It's worth noting that cocoa plantations haven't been exemplars of enlightened labor relations: African slaves were used from the beginning, and even today, slavery, child abuse and forced labor have been alleged. The chocolate and cocoa industry have formed the
to improve working conditions.
Cocoa and Sugar
A recurring theme in these parts is that there is no single entity called "commodities," the best efforts of latecomers to the party notwithstanding. Just because a commodity is both tangible and exchange-traded does not put it on a bullish track. Perhaps no commodity illustrates this better than cocoa.
Its constant-dollar price is only 47.1% of its January 1961 level. The constant-dollar price of sugar, cocoa's confectionary soul mate and recent favorite of the biofuels crowd, is 93.5% of the level when John F. Kennedy took the oath of office. Ask not what commodities can do for you; ask what you can do for commodities.
By the way, cocoa and sugar do not benefit as much as other commodities from long-only index funds. Their weights in the Goldman Sachs Commodity Index are 0.19% and 2.29%, respectively. In the Dow Jones-AIG Commodity Index, they account for 0% and 2.967351% -- I don't make this up, I just report it -- respectively. In other words, if they are going to go higher in price, they are going to have to do it on their own fundamental power. All's fair in love and war; no one said a thing about commodities.
Candy Is Dandy. And Cheaper
Source: CRB Infotech
Biofuels Won't Boost Sugar
The huge price spikes for both of these "soft" commodities in the 1970s and the long periods of torpor thereafter illustrate once again why in the grand scheme of things, you don't want to be a primary commodity producer. Someone else can come along and plant more cocoa trees or sugar cane or sugar beets, use improved fertilizers, pesticides and herbicides and toss in a little genetic modification here and there, and supply will come out of the woodwork, literally and figuratively.
Even with all the hoopla about sugar being an energy commodity, this will remain true. It is hard to conjure an industry more ripe for technological improvements than the conversion of sunlight into ethanol. The simple thermodynamics of photosynthesis mandate significant net energy losses every step of the way.
Crops such as corn and rice manage to convert 1% to 2% of the energy received in sunlight into biomass; sugar cane is a major outlier, able to convert nearly 8% of sunlight into biomass. But then this sugar has to go to feed the yeast that produce ethanol and carbon dioxide (think beer) as waste products. The theoretical maximum conversion of sugar into ethanol is 51.4%; practical conversion rates are around 35%.
Once you start accounting for all the energy and capital inputs into farming, harvesting, producing, fermenting and distilling, transporting and distributing ethanol, you may be at a net energy loss. It doesn't take much of a leap of imagination to say there is vast room for technological improvement in converting sunlight into usable fuel. And when that happens, the real price of sugar will plunge.
Here's some advice to save you a few bucks: If you hadn't heard of switch grass prior to last week's State of the Union address, don't invest in it now.
How Sweet It Isn't
The Producer Price Index for sugar and confectioneries reflects the inability of sugar and confectionery suppliers to gain any sort of pricing advantage over time. It has captured only 94% of the total PPI gain since 1947; the huge disruptions of the 1970s are easy to spot on the chart.
One Brief Shining Moment
How have individual firms' performances relative to their benchmarks fared as a function of cocoa and sugar prices?
First, let's keep in mind that sugar and cocoa constitute only a small portion of the cost mix for most integrated food firms such as
Second, the production side of the world sugar and cocoa industries are dominated by either state marketing boards or privately held firms such as the Fanjul family's Florida Crystals Corp. Some of the largest confectioners, such as M&M/Mars, are privately held.
The dominance of private firms, state firms and widely diversified food firms should not surprise you. This industry structure is one way of managing commodity price risk.
Finally, sugar is one of those commodities politicians of all stripes can't resist. We protect beet growers in the Dakotas and cane growers in Florida and Louisiana, and we almost let their opposition derail passage of the Central American Free Trade Agreement.
The European Union's technocrats in Brussels have a similar soft spot for sugar beets.
As a result of our protections, sugar prices to the consumer have been kept well above the world price for sugar for years.
The recent rally in world sugar prices, or No. 11 sugar, still has kept prices lower than the domestic, or No. 14 sugar, contracts traded on the New York Board of Trade.
Don't tell the "hot commodities" crowd, but you have been paying the high domestic price for years.
The rest of the world is just catching up to our prices.
You Have Been Paying the High Price for Years
Given this insulation from world sugar reality, how do the performances of three confectioners --
relative to the Russell 3000 index change with world sugar prices? We shouldn't expect a negative impact at all, and indeed the trend curves of all three confirm they simply don't care about higher world sugar prices.
Higher World Sugar Prices Do Not Affect Confectioners
However, we should expect higher cocoa prices to affect confectioners' margins, and this does seem to be the case. The relative performance of all three confectioners declines as cocoa prices rise.
Higher Cocoa Prices Do Affect Confectioners
So when you present your sweet offerings to that special someone next week, rest assured the confectioner cares not a whit about No. 11 sugar. Cocoa, well, that's another story. Buy the bonbons, sell the stock.
Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of
The Dynamic Option Selection System
. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback;
to send him an email.
TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.