Food for thought, fodder for investment

I am no rabid chocoholic. 
But I am inexplicitly drawn to the price of cocoa (which, in case you were unaware, is an ingredient that goes into the making of chocolate). 

I guess Armajaro's antics are what got me hooked. 

This firm has a reputation for its audacious gamble on the humble cocoa bean. The last “heist” (if it can be called that) was in July 2010 when the firm reportedly purchased around 240,100 tonnes of cocoa beans, worth more than $1 billion, sending the spot price of cocoa skyrocketing to a 32-year high. Co-founder Anthony Ward probably bought it on the presumption that the next cocoa bean harvest would be a poor one, driving up the price of the commodity and catapulting him to chocolate heaven. 

In most transactions, traders exchange contracts to buy and sell the commodity at various prices but do not take physical possession. This time, actual delivery took place and the mountain of beans was most likely stored in warehouses across England and The Netherlands. 

To drive home the magnitude of the trade, the media had intriguing parallels to ignite someone’s imagination. That investment could have materialized into more than 5 billion small chocolate bars. Or, try this: It was sufficient to fill 5 Titanics (credit for that goes to the then-chairman of the Financial Services Club, Chris Skinner, in an interaction with BBC).

Armajaro did not confirm nor deny the reports, but the street knew it. In 2002, Ward pulled the same stunt when he purchased 204,000 tonnes of cocoa at a time when supply was limited because of poor harvests and political instability in West Africa. The Daily Mail reported that he made more than £40 million in just two months after the price of the commodity rose steeply from £1,400 to £1,600/tonne. Traders at that time nicknamed him Chocfinger after the Bond villain Goldfinger.  

Such speculation (and stockpiling) in the notoriously fickle and famously unpredictable commodity markets stifles supply and forces the price even higher.
So why am I reminiscing about him now? 

Because prices of commodities are going through the roof. Bloomberg has reported that money managers recently raised bets on higher prices for cocoa which has hit a 9-month high at the start of the month on the back of poor weather conditions. Incidentally, the last I heard of Chocfinger was when I read that the price of cocoa dropped by 26% resulting in a huge loss on his position. Not the first time he would have lost. Ward had dabbled in another cocoa bet in 1996 which backfired when the firm had to unwind the trade after a slump in cocoa bean prices.

Speculation is a dangerous game. Mark Twain would know. He was an avid speculator who went bankrupt before the age of 60. His words of wisdom stemmed from painful experience: "There are two times in a man's life when he should not speculate: when he can't afford it and when he can". Touché!

But I doubt Twain speculated in agricultural commodities which has taken on a moral dimension. According to the United Nations Food & Agriculture Organisation (FAO), excessive food price volatility and the speed at which price swings have been occurring over the past few years has resulted in a "human impact" driving home the point that food commodities cannot be used as pure financial instruments. In the past few years, there have actually been food riots across the globe caused by rising prices. 

A report by the Institute for Agriculture & Trade Policy states that food and energy prices have become linked and unstable over the last decade largely due to speculative investments. 
The Independent has stated that investments in food commodities by banks and hedge funds has risen from $65 billion to $126 billion over the past five years. This has pushed prices to 30-year highs causing sharp price fluctuations that have little to do with actual supply of food. The likes of Goldman Sachs, Morgan Stanley and Barclays Capital dominate the food commodities market. 
Commerzbank has restricted investments in agricultural products after accusations that speculation has pushed up food prices and fuelled unrest in some poor countries. 

While there are ethical implications to commodity speculation, I am not saying I subscribe to the unvarnished view that speculation is the sole cause of price volatility. I believe it does exacerbate swings in prices already vulnerable to climate shocks, lack of investment in agriculture, rise in global food demand, decrease in per capita arable land and the loss of agricultural land to grow biofuels. And it is because of such factors, I doggedly believe that an investment in agricultural stocks would be a shrewd diversification in an investor's portfolio over the long term. Don't speculate. But profit from volatility and invest in an opportunity.