Supply Worries Slam Cocoa

Gold falls $6.70 at $686.60 an ounce.
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Cocoa prices were tumbling more than 5% Thursday amid speculation by investors that supplies might be greater than previously expected.

Prices of futures contracts for the beans were off $103 at $1,853 a ton in recent action on the New York Board of Trade.

"The trigger for the selloff was that the West African midcrop might be revised higher," says Brandon DiTullio, an options trader at Next Source Trading in Orange County, Calif.

The midcrop from Ivory Coast and Ghana is harvested and sold starting in May and continuing through August. It accounts for about 60% of world supply.

Another factor is likely high net short positions by producers who are hedging their cocoa output, which historically augers a pullback in prices, he says. Producers sometimes manage their price risk by selling futures contracts to cover a portion of their expected output.

"When commercials are heavy shorts relative to what they normally are, it's just a matter of time before the markets follows," DiTullio says.

Rohit Savant, an analyst at specialty consulting firm CPM Group in New York, cautions that a free fall for prices probably won't occur in the near term because the market is still relatively robust and a significant global cocoa deficit is forecast for the year.

Cocoa is used together with sugar and other ingredients to manufacture chocolate.

Chocolate makers

Cadbury Schweppes

(CSG)

and

Hershey

(HSY) - Get Report

were both dipping recently, off 1.7% and 1.1%, respectively.

Worse-than-expected first-quarter results for Hershey were weighing on the shares. Still, the company is remaining optimistic for new dark chocolate and luxury products to "make meaningful contributions in 2007."

Turning to the metals, gold futures were selling off as news of weakness in Asian stock markets sparked a flight to liquidity.

June-dated gold bullion contracts were off $6.70 at $686.60 an ounce on the Comex division of the New York Mercantile Exchange. The bullion exchange-traded funds that hold inventories of the metal,

streetTracks Gold Shares

(GLD) - Get Report

and

iShares Comex Gold Trust

(IAU) - Get Report

, were each down about 1% in recent action.

The Shanghai Composite Index fell 4.5% overnight after the Chinese government indicated it felt its economy was in danger of overheating.

Other economic news showed a drop in new claims for unemployment insurance last week in the U.S., indicating continued tightness in the labor market and evidence of a solidly growing economy.

"The major economies can now tolerate some form of tightening more than they could if the economy was weak," says Doug Roberts, chief investment strategist at Channel Capital Research in Shrewsbury, N.J.

The strength means that policymakers at the

Federal Reserve

and foreign central banks will worry less about higher interest rates pushing the economy into recession and instead focus on fighting the war on inflation, he adds.

"This is not very good for gold, since gold is an inflation-relative index," Roberts says.