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Invest in Cocoa with These Top Ranked ETFs

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Thanks to emerging market weakness, a sturdy greenback, and towering stock markets, all-inclusive commodities finished the year 2013 on a sour note. However, the new year brought some respite for commodity investments, with some corners promising huge prospects.

Cocoa is among those high-potential commodities. Prices of cocoa are hovering around the three-year high level so far in 2014 on top of last year’s gain of about 25%, while the Dow Jones UBS commodity index fell 10% in 2013.

Behind the Bullishness in Cocoa

Surging Demand for Chocolate: Growing worldwide demand along with a supply crunch is pushing up cocoa prices and subsequently the funds focused on this soft commodity.  Since cocoa is the basis of chocolate, rapidly growing chocolate consumption is aiding the demand for Cocoa. Per the market researcher Euromonitor, global chocolate confectionery sales will likely rise 6.3% to a record $117 billion this year.

Increased Asian Demand: Global cocoa supplies are nearing the longest production deficit in more than five decades on increasing chocolate demand in Asia. While Cocoa processing in Europe – the biggest consuming region – has grown for three successive months to end the year 2013, the demand for chocolate is also constantly building up in Asia especially with China accounting for the extra demand in the sector.

In fact, the nation has recorded a twofold increase in sales over the past 10 years. The growing purchasing power of the middle-income population is driving Chinese consumption ahead of European use (read: China ETFs Jump on Government Reform Afterglow).

Supply Crunch: Political unrest and inclement weather in major producing regions – Ivory Coast and Ghana – are crippling cocoa supplies thus resulting in failure to meet global demand. The presidential election due in 2015 in Ivory Coast might also cause some short-term political uncertainty.

If these were not enough, farmers in West Africa – the region accounting for 70% of world output – are pushing hard to boost cocoa production as yield prospect can be restricted by old trees as per Bloomberg. Especially, in Ghana – the second largest grower in the world – aging trees that produce lesser beans account for 30% of total plantation and new trees generally take three years to be productive.

To add to the woes, the Ghana Cocoa board announced its plan (in August 2013) to curtail its subsidy program by half on pesticides next season to cut costs in the face of sagging cocoa prices. The plan took effect from October 1 pushing up the prices for fertilizers. This has compelled framers to lower the use of fertilizers which will likely damage as much as 40% of the global crop annually as per the ICCO.

Bullish Analyst Recommendation on Price: Rabobank – a research organization on agricultural commodities – gave its first forecast for the 2014/15 season in late December indicating a third consecutive year for deficit. Due to this supply-demand imbalance, prices of cocoa have been on a tear, with huge gains seen in the crop.

This uptrend in Cocoa prices make cocoa exchange traded products a lucrative destination for investors. And to do this, a look at the top-ranked cocoa ETF could be a great idea especially based on our Zacks ETF Ranking system (read: Cocoa ETFs: The Safe Haven In Agricultural Commodities? ).

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class (Read: Zacks ETF Rank Guide). Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of the three risk ratings, namely Low, Medium or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks ETF Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the soft commodity equities space, we have taken a closer look at the top ranked CHOC and NIB. Both members of the duo have Zacks ETF Rank of 1 or ‘Strong Buy’ (see the full list of top ranked ETFs) and both are detailed below:

iPath Pure Beta Cocoa ETN (CHOC)

This note looks to track 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.

This approach might result in less contango. This can be an important factor, as month-to-month shifts in contracts can eat away returns during an unfavorable market situation. The fund is a bit unpopular in the space as evident by its AUM of $8.0 million. The product charges 75 bps in fees.
The ETN gained 29.23% over the last one-year period – the highest among any other agriculture-based products.

iPath Dow Jones-UBS Cocoa Subindex Total Return ETN (NIB)

This ETN seeks to match the performance of 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. The product normally utilizes front month contracts in order to achieve exposure (read: all the agricultural ETFs here).

The fund is also unpopular and has attracted just $42.5 million in assets this year. The product charges 75 bps in fees per year and trades in a small volume of nearly 14,500 shares on average daily basis. This increases the trading cost in the form of a wide bid/ask spread.

The ETN added about 28% in the last one year.

Bottom Line

We expect Cocoa to be the clear winner in agricultural commodities space over the long haul. It is the only product in the soft-commodity ETF world exhibiting consistency. Though sugar ETFs also have a bullish outlook and favorable Zacks ETF Rank, the return is not as lofty as Cocoa at present.
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