Inside the Surge in Cocoa ETFs: Can it Last? - ETF News And Commentary

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Commodity trading has been choppy this year on weak macro fundamentals and sluggish global trends in broad categories. Yet, one commodity in the soft commodities space - cocoa - is enjoying soaring prices and has been among the top performers this year based on supply concerns and growing global demand.

This is particularly true with the iPath Dow Jones-UBS Cocoa Subindex Total Return ETN (NIB) as well as the iPath Pure Beta Cocoa ETN (CHOC), as these have added nearly 20% in the year-to-date time frame (read: 2 Commodity ETFs Offering Investors Sweet Returns ).

Both of these are clearly outpacing the broad PowerShares DB Agriculture Fund ( DBA ) and PowerShares DB Commodity Index Tracking Fund ( DBC ), as these are seeing losses in mid single digits YTD. This is primarily attributable to recovering demand in the U.S. and Europe, as well as production problems in West Africa.

HolidaySeason Fueling Demand

Demand for cocoa is rising rapidly across the globe thanks to ever-increasing chocolate consumption. Cocoa grinding (indicator of chocolate demand) rose 4.7% in Europe and 8.25% in the U.S. in the third quarter, on an annual basis. This trend is expected to continue into the fourth quarter ahead of Christmas (read: Play a Resurgent Europe with These ETFs ).

Further, demand for chocolate is rising rapidly in India ahead of the country's major festival (Diwali). Chocolate demand is up nearly 40% despite growing concerns of contaminated sweets and abnormally high dry fruit prices, according to the Associated Chambers of Commerce and Industry of India.

Moreover, chocolate consumption is also growing in markets like Brazil, Mexico, Columbia and China. As a result, various industry experts predict global cocoa demand to rise nearly 30% by 2020, suggesting optimism and growth in the cocoa industry.

Supply Shortage

The global cocoa market looks to be in a production deficit for the next four consecutive years, according to the International Cocoa Organization (ICCO). The agency recently raised its cocoa deficit to 86,000 metric tons from 52,000 metric tons for the season 2012-2013. It also expects a deficit of 70,000 metric tons of cocoa for the current season 2013-2014, which started this month.

About two-thirds of global cocoa supply comes from West Africa with the Ivory Coast and Ghana being the two largest producing nations. Both nations are seeing bad weather conditions of late, raising prices of cocoa (also read Coffee ETFs: More Weakness Ahead? ).

Excessive rainfall, as much as 150% above the normal level, in the second half of October in the two countries is an added threat to cocoa harvest. This would lead to higher prices for cocoa at least for the near term, suggesting that investors may want to look to these exchange-traded options to play the commodity:

NIB in Focus

This ETN tracks the Dow Jones-UBS Cocoa Subindex Total Return. The index delivers returns through an unleveraged investment in the futures contracts on cocoa and currently consists of one futures contract on the commodity.

The product is a bit expensive as it charges 75 bps in fees per year. It trades in small volumes of nearly 36,000 shares a day on average, a level that could increase the trading cost in the form of a wide bid/ask spread.

The note is also unpopular and has attracted $45 million in assets this year. NIB currently has a Zacks ETF Rank of 3 or 'Hold' rating.

CHOC in Focus

This note seeks to match the performance of the Barclays Cocoa Pure Beta Total Return Index. Unlike many commodity indexes, this one can roll into one of a number of futures contracts with varying expiration dates, as selected, using the Barclays Pure Beta Series 2 Methodology (read all the agricultural ETFs here ).

This approach might result in less contango. This can be an important factor, as shifting from month to month in contracts can eat away at returns during an unfavorable market situation.

Further, investors should note that CHOC is illiquid with a paltry volume of less than 3,000 shares a day, suggesting a wide bid/ask spread. As such, investors may have to pay extra beyond the annual fee of 75 bps in fees per year. This ETN also has a Zacks ETF Rank of 3 or 'Hold' rating.

Bottom Line

Given bullish fundamentals at least for the near term, investors should consider these soft commodity ETNs in order to ride out the soaring cocoa prices. This could be especially true if holiday demand remains strong, or if supply issues remain in place, suggesting cocoa ETFs could offer some sweet returns to close out 2013.

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IPATH-PB COCOA (CHOC): ETF Research Reports

PWRSH-DB AGRIC (DBA): ETF Research Reports

PWRSH-DB COMDTY (DBC): ETF Research Reports

IPATH-DJ-A COCO (NIB): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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