European Cocoa Companies Distrust Markets

LIFFE Traders (BBC Image)

A number of large European Cocoa companies have threatened to move their hedging business from LIFFE (London International Financial Futures and Options Exchange) to ICE (The former New York Board of Trade) unless LIFFE implements controls to limit speculative trades.

According to a letter sent by sixteen European cocoa organizations, “the cocoa industry cannot continue to trade on a futures market that is not offering a minimum of hedge transparency.”

In plain English, the companies are complaining about the speculative behavior of banks and funds that are driving up cocoa prices in London. Cocoa reached a 32 year high last week.

By way of explanation, cocoa importers, processors, etc., routinely purchase cocoa futures and options when the buy real cocoa to protect against price risk. For example, a company agrees to buy cocoa for December delivery. To make sure that it did not pay too much, the company also purchases an equivalent futures contract. Should the price of real cocoa go down, the sale of the futures contract can offset the loss incurred.

To assure that all this works as planned, there have to be speculators. Every pamphlet put out by the futures exchanges lauds the importance of speculators. Their role is to provide the opposing positions so that that all positions can be squared by the final trading day.

Apparently, the number of speculators has increased so much and they are not taking the proper positions so that, for example, there were open positions for 50,000 lots for July cocoa only two weeks before the final trading day for those contracts.

A representative of the German Cocoa Trade Association demanded that LIFFE amend its rules to reveal how many of the open positions are held by speculators. Alternatively, these companies will move their business to New York City or trade at the Deutsche Termin Börse.

So a little speculation is good, just not too much. I wonder who will determine the right amount.

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