Hackett Advisors in the News

Why Armajaro Holdings' Attempt at Cornering the World Cocoa Market Is Destined to Fail

Justin Rohrlich July 19, 2010 1:55PM|

       Contrarian investors may want to take a look at Tootsie Roll or Hershey, one money manager says.   

English hedge fund manager Anthony Ward, of Armajaro Holdings, is attempting to corner the world cocoa market by buying 240,000 tonnes of cocoa beans -- the largest single cocoa trade on London’s NYSE Liffe Exchange (NYX) in 14 years and about 7% of annual global production.

Chris Skinner, chairman of the Financial Services Club, told the BBC that this represents "the whole of Europe's cocoa."

The beans themselves are expected to be warehoused in The Netherlands, Hamburg, London, Liverpool, or Humberside.
Skinner told a television interviewer that he believes Ward is thinking, "Well, I'd bet on the fact that, in the future, if I get control of the whole supply of cocoa, then I can corner the market and make a bit more money out of this.”

However, money manager Shawn Hackett, president and CEO of Hackett Financial Advisors, a firm with a specific focus on agricultural commodities, sees Ward’s attempt as a fool’s errand.

“Every once in a while someone attempts to do this. It’s always a huge failure and never works,” Hackett tells Minyanville. “I couldn’t be more bearish on cocoa, especially after this news.”

Hackett points to the attempt by the Hunt brothers of Texas to corner the silver market in the 1970s.

As described by

Bunker and Herbert [Hunt] had accumulated futures contracts for approximately 55 million ounces of silver -- 8% of the global supply at that time. But rather than selling the contracts to turn a profit, as most commodity traders do, the Hunt brothers had every intention of taking delivery of their silver.

Paul Volcker had been installed as the Chairman of the Federal Reserve, and Volcker was determined to get runaway inflation under control. He abruptly raised interest rates, thus soaking up the excess liquidity which had helped fuel the silver boom. The price of an ounce quickly dropped to $39 [from $50], and by March 14, it was down to just $21.

As the price of silver fell to $21, the brothers had futures contracts obligating them to buy at upwards of $50 per ounce. On March 25, 1980, the Hunts couldn’t make their $135 million margin call, and Bunker phoned his brother Herbert with three ominous words: ‘Shut it down.’ ”

Hackett continues:

The guy who tries to corner the market who thinks he’s smarter than everyone else gets taken to the cleaners. The concept is to try and take physical supply off the market, then end users panic and you sell to them. Problem is, the market never lets you get away with it. I don’t know of a single example of someone who tried to corner a market and it’s actually worked. Never seen anybody pull it off. Why would this be any different? Cocoa’s getting absolutely crushed today. It’s lost $212 in the US market just while we’ve been on the phone. That’s a shellacking. You don’t get a whole lot of 200 downs in a day very often. Why? Because this news is a bearish indicator. The real demand for cocoa isn’t what’s kept it here, it’s artificial. Now that the intent has been telegraphed, it’s not a surprise. Everyone knows what the game is. And besides, there’s no shortage of cocoa in the world; there are plenty of deliverable stocks in the ICE (ICE) cocoa warehouses.

Hackett notes that, “the market will force [Ward] out of that position and cocoa prices will likely fall substantially from here.”

“Who’s going to buy now that they know this guy has all this speculative cocoa?” he says. “I think we’re going straight down in the cocoa market. There are other speculators out there who can short the cocoa market and make a fortune. The hedge fund community doesn’t care about each other, they care about making money. They’re probably thinking, ‘Okay, now this guy is on an island, we can go short, hammer this thing down, and blow him out.’ Then that starts triggering stop losses, there’s a cascading effect, his equity is then falling and falling and falling…I can just see this guy getting totally ruined.”

In a fairly good-sized nutshell, Hackett says:

It’s kind of like saying, ‘I’m gonna try to get away with this even though everyone else who’s tried it has been taken to the cleaners in the past. There’s always some guy who thinks he’s smarter than everyone else, and it’s no different this time. This is a signal to get out, a classic topping kind of story. The fundamentals of a market always win out in the end. Those forces are more powerful than anything else in the world. You simply can’t overcome forces of supply and demand. History says this guy is in for one heck of a learning lesson. If it was that easy to corner a market and make money, everyone would be doing it. The reason no one does is that it doesn’t work.

Hackett explains how someone could even attempt to corner a market in the first place.

“In the US, you can only buy so much. Here, we appreciate, we don’t want someone coming in and distorting the market. In London, there are no position limits -- it’s the wild, wild West. This type of trade wouldn’t be allowed in America.”

Independent trader Sean Udall concurs.

“As far as cornering a market, shouldn't we have markets in this day and age that should not be able to be cornered?” he asks.

And Deborah Doane, director of the World Development Movement, headquartered in the UK, says:

Investment banks like Goldman Sachs (GS) are making huge profits by gambling on the price of everyday foods. But this is leaving people in the UK out of pocket and the poorest people in the world are starving. The EU must follow the example of America and crack down on banks' reckless gambling, and the UK government should take the lead in tackling this issue.

Just about all news reports would lead one to believe prices for cocoa-based products are about to skyrocket. Many say that if Amajaro sits on its cocoa stash and waits, the chocolate makers will be forced to come to it for their supplies, which would lead to a squeeze in September when confectioners buy raw cocoa for the holidays.

Hackett, on the other hand, thinks candy prices could actually be entering a downward period.

“If one wanted to be a true contrarian here, they might think about buying Tootsie Roll (TR) or Hershey (HSY). They were squeezed by sugar prices, which fell off a cliff. And now cocoa is about to fall off a cliff, the way I’m seeing it. They’ll have huge profit margins coming up. You want to buy when input prices are very, very high, because they rarely stay at those prices for long."

Seeing that cocoa prices have more than doubled since 2007, Anthony Ward’s likely loss could very well be the prudent investor’s gain.

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