Commodity ETF Alert July 2010 Issue

| July 12, 2010 | 0 Comments



The last few months have been filled with uncertainty for commodity investors.

First we had the European debt crisis.  These worries shook the market hard…

Now fears of a global slowdown are giving investors pause.  They’re thinking twice about putting money back into risk assets like stocks and commodities.

The fears have driven commodity prices down over the past few months.  Fear and uncertainty are a commodity investor’s worst nightmare.

But here’s a secret to investing in commodities…

Sometimes it’s best to buy when others don’t want to.  When fear is in the air, prices come down.  And when prices come down, we often get bargains too good to pass up.

And that’s exactly what’s happening in cocoa right now…

Not only has cocoa come down in recent months, but a number of bullish scenarios are developing for the beloved bean.

So let’s jump in to this month’s trade.  It has the potential to be a big winner even in these uncertain economic times…

The food of the gods…

Cocoa, as it’s commonly known, comes for the “Cacao Tree”.  The tree is native to the American continent but is now grown in locations around the world where conditions are favorable.

Carl Linnaeus, a Swedish natural scientist, named the cacao plant in 1735.  He called it Theobroma cacao, or “food of the gods”.

The cacao tree produces a fruit called a “cocoa pod”.  Inside the pod are the cocoa beans.  It’s these beans that are the basis for a sweet delicacy enjoyed around the world… chocolate.

Cacao trees are grown only in areas approximately 20 degrees north or south of the equator. It seems the cacao tree is rather finicky about where it grows…

Countries such as Indonesia, Nigeria, and Brazil are all producers of cocoa.  According to the International Cocoa Organization (ICCO), an estimated 3.5 million tons of cocoa were produced in 2009 worldwide.

But the number one producer in the world is the Ivory Coast…

This West African country produced nearly 1.2 million metric tons in 2009.  Their neighbor to the east, Ghana, is the second largest producer.

Over 50% of the world’s cocoa supplies come from these two countries.  And over 70% of world production comes from West Africa.

These two countries are absolutely critical to cocoa production.  If anything goes wrong with their crops, cocoa prices will react harshly.

The cocoa crops in the Ivory Coast are growing as we speak.  And growing conditions are essential to a robust cocoa crop.

But this year the weather is not cooperating…

Excessive rains in the region are worrying cocoa farmers.  Cacao is a finicky tree requiring a certain amount of sunshine each day.  If it doesn’t get the right amount of sunshine, the quality of the bean suffers.

Four hours of sunshine a day is needed for the best quality bean.  Over the past month, the trees have been receiving nowhere near enough sunlight.  In fact, it has been raining cats and dogs.

Too much rain is bad for the cocoa crop.  Excess rain not only lowers the bean quality, it also opens up the possibility of “black pod” disease…

Black pod disease is the last thing farmers want to see.  The disease comes with excess moisture and can cut down on crop yields.  With the two largest cocoa producers in the world having weather problems, you can bet traders are watching closely.

The harvest season begins in October and farmers are worried.  If the weather doesn’t improve, cocoa yields could come in lighter the expected.

But here’s where it gets really interesting…

The ICCO is already forecasting a global shortfall of nearly 1% for the 2009-10 harvest.

Read that again… production for this year’s cocoa crop will fall short of demand.At the same time, demand for cocoa from confectioners (chocolate makers) is expected to rise by 4% over last year.

This is called a “supply crunch”.  And a supply crunch works out only one way… prices go higher.  And usually a lot higher…

But this supply crunch has nothing to do with the weather.  It has to do with cocoa production not increasing along with global demand.

You see, the Ivory Coast is politically unstable.  Remember, this is the largest producer of cocoa in the world.

The country is in dire need of investment to raise cocoa production.  But investors steer clear of putting money to work in this country because of the political instability. With growing global demand for cocoa, the number one producer in the world can’t keep up.

If this scenario pans out like the ICCO predicts, cocoa prices could be headed much higher.  And if the wet weather persists, the cocoa shortage could be even worse. This double shock could send prices soaring!

The time to buy cocoa is now…

Trading in cocoa is light through the summer as the growing season progresses.  This lack of interest has prices trading at levels we can’t afford to miss.

But once fall comes around, expect trading and volatility to pick back up.

The fall is when the main crop in the Ivory Coast is harvested.  It’s also when confectioners start buying for the holiday season.  This is a pivotal time for the cocoa market.  Any sign of a poor harvest and prices will shoot higher.

The bottom line is this…

We have two catalysts potentially driving cocoa prices higher.

First we have the ICCO forecast of a supply crunch for this harvest season.  This is due to cocoa production not keeping up with global demand.  I expect cocoa prices to move up on this forecast alone.

We also have the wet weather in the prime cocoa growing region of West Africa.  The heavy rains may crimp the quality of the beans.  And more importantly, the wet weather may hurt the total yield of the cocoa crop for this harvest season.

With the recent pullback in prices, we can get into cocoa at a discount.  If the expected supply crunch occurs, we should see cocoa prices retest the late 2009 highs… or higher.

Remember, trading may remain light throughout the summer.  Patience will be required as this trade progresses over the coming months.


The iPath DJ-UBS Cocoa ETN (NIB) is an ETN reflecting the price of cocoa.  NIB tracks the Dow Jones-UBS Cocoa Total Return Sub-Index.  This index reflects the returns potentially available through an unleveraged investment in the futures contracts on cocoa futures contracts.


Take a look at the chart…


As you can see, NIB has come down since the beginning of the year.  Let’s get in below $45.50 for the best prices.  Further (but limited) downside in the near term is possible due to light summer trading.


The iPath DJ-UBS Cocoa ETN (NIB) is trading at $43.33.
Buy NIB up to $45.50 per share.
Our profit target is $52.00.
Don’t forget your position sizing.

Commodity Review

Energy JJE $21.90 $22.20   -1.4%
Grains JJG $36.11 $32.33    11.7%
Industrial Metals JJM $34.54 $32.10   7.6%
Precious Metals JJP $62.67 $63.14   -0.7%
Softs JJS $46.05 $41.16    11.9%
Livestock COW $28.67 $28.18   1.7%
All Commodities DJP $37.83 $36.67    3.2%


Oil has been all over the map in recent trading.  After trading up to nearly $80 a barrel a couple of weeks ago, crude fell down to $72 in short order.  But then it built another head of steam and shot back up to the $76 area, where we’re trading today.

Crude may be establishing a range at these levels.  It looks to be forming between $70 on the low end and $80 on the high end of the range.  Look for these areas to hold in further trading.

Recent inventory reports came in lighter than expected.  There was a steep drop of five million barrels in last week’s EIA Petroleum status report.  Demand side numbers came in stronger as well.

This points to crude oil holding these levels and heading higher.  And I think it will as long as we don’t get more frightening news from Europe.

Keep holding our position in OIL.  We want to stay exposed to further upside in crude prices.

But just in case, let’s keep the line in the sand at $20 in our position in OIL.  If OIL closes below that level, exit the trade to conserve capital.
Our position in UGA is now closed.

We recommended exiting this position if UGA closed below $33, which it did last week. The summer driving season is going strong but gas prices are holding steady. Obviously, this is a good thing for anybody going on a summer road trip!

As you know, the global economic uncertainty over the past few months hurt a few of our positions.  But don’t worry!  Along with all our big winners from the past year, the occasional loser was bound to happen.

In this uncertain environment, it’s best to conserve capital in certain situations.  We want you to be around to catch the next big winner!


The recent action in grains just goes to prove how quickly demand/supply fundamentals can change.

The spring planting season was uneventful and grain markets slid lower for months. Investors were waiting for a catalyst to move grains higher.  But it never developed… Weather was perfect and USDA reports showed plantings were abundant.

Then a report at the end of June changed everything…

The USDA corn stocks report came in around 300 million bushels light.  After some boring trading action in the spring, this report caught traders off guard.  You can see from the recent explosion in corn prices, traders weren’t expecting this news.

Wheat and soybeans prices are along for the ride as well.  I expect a bit of a pullback in coming weeks for grains.  But it looks as though a bottom may have been put in for the year for grains.


Concerns about the global economic recovery sent a number of industrial metals reeling.  Aluminum, copper, nickel, and lead are all substantially lower from just two months ago.

At some point, these metals will be good buys again… but not quite yet.

Industrial metals will likely remain volatile with no real direction in coming months. These metals are all economically sensitive and will react to global economic news.  It’s best to steer clear of them for now…


Gold is pulling back slightly in recent trading action.  Prices fell to the $1,200 range over the past week.  We mentioned in the last update that gold might see some extra volatility in coming weeks.  This recent pullback may be the start of it.

Whatever you do, don’t get shaken out of your position in IAU.  It may be tempting for you to sell and take a nice profit at these levels.  Please don’t!  The fundamentals for gold are just too strong.  Gold should be going higher in coming months.  But we may have to withstand some volatile price action along the way.

Remember, IAU had a 10 for 1 split recently.  We sent out a special update explaining how it works.  For every share of IAU you owned before, you should now own 10.  The price of IAU is now around $11.80 due to the split.

Silver is the same story as gold…

After reaching highs of $19.50 in May, prices have inched back down to the $18 area. There’s good technical support for silver at $17.50 as well as the $15 area.  Remember, the prospects for higher silver prices are huge.  Once silver can break higher through the $19 area, we could really see it take off.

Both of these precious metals have huge potential upside.  Keep holding them…


Coffee exploded to the upside over the past month.  Even with a recent bumper crop from Brazil, prices rocketed higher.  Shortfalls in harvests for Vietnam and other countries are tightening the supply/demand picture for coffee.

This is a classic short covering rally in coffee…

Many traders were expecting robust coffee supplies would keep a lid on coffee prices. The sudden explosion in price caught these traders on the wrong side of the trade.  By covering their short positions in coffee, they drove prices even higher.

I suspect some coffee traders had a really bad month in June…

Our position in sugar is doing well.  After we bought SGG last month, sugar prices are rising nicely.  We got a great entry in SGG and see sugar prices gradually heading higher in coming months.  Keep holding this position for further upside…


We just don’t see anything exciting about hogs and cattle right now.  After a brief surge in March and April, prices have come back down.  Rising corn prices will limit the upside potential of cattle in coming months.

Portfolio Changes

  • This month we’re adding cocoa (NIB) to the portfolio.
  • Gasoline (UGA) is now closed.

Category: Commodity Trading

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.