Cashing in on Commodities: Life’s Little Luxuries are Costing More than Ever Before

Editor's Note: This is the fifth installment of a new Money Morning series highlighting investment opportunities in the global bull market in commodities.

By Jennifer Yousfi
Managing Editor

Soaring prices of grains, dairy and meat have been grabbing global headlines. But other commodities have been on the rise as well. I'm not talking about the increases in daily staples that make the front page, but those little extras that make daily life just a little bit sweeter - coffee, cocoa and sugar.

We might not need them, but we definitely want them. And inflation is putting upward pressure on the price of these soft commodities just as it is on oil and grains such as wheat and rice.

Coffee is Big Business

It doesn't take an investment expert to realize Americans love their coffee. It's no longer a drink just to wake you up in the morning. Starbucks Corp. (SBUX) helped create a cultural coffee phenomenon, introducing consumers to espresso drinks. Now it seems like every city street corner has its own gourmet coffee shop selling specialty coffee beverages, often for upwards of $4 a cup.

But it's not just the extra foam on top that is making that cup of coffee cost more. The price of coffee beans has more than doubled in the past few years.

According to U.S. Department of Agriculture (USDA) data, the New York spot price for Brazil's Arabica coffee is up 20% over last year's annual average of 110.72 cents per pound. Just five years ago in 2003, the annual average was only 50.82 cents per pound.

The USDA said in its recent Tropical Products: World Markets and Trade report that U.S. imports of coffee and coffee products increased 14% in 2007 to $3.8 billion. Meanwhile, exports were at a record $513 million, but that's still a huge trade imbalance.

But there's hope for those who are looking for a cheap cup of joe before year-end. Brazil's 2008 coffee crop is just starting to be harvested and is already forecast to be one of the best ever, producing almost 50 million bags of coffee.

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"With Brazil's larger production this year, world coffee output is expected to reach 133.25 million bags while consumption is seen at 126.0 million. If these figures are realized, it will result in an 8.25 million-bag surplus for the 2008 crop year," wrote James Cordier & Michael Gross, "This is not a record surplus, but it should be enough to knock prices down into a new trading range for the second half of the year."

If coffee prices head lower this year, then the buyers of the raw beans are going to be the ones to benefit. You might want to consider:

  • Green Mountain Coffee Roasters Inc. (GMCR): The bulk of U.S. coffee exports are of the roasted variety and this company is getting its share of that export action. It recently announced expected sales growth of 42% to 47% for its fiscal third quarter and reaffirmed its positive outlook for the full-year. Year-to-date, shares are up just a little over 1%, but are up 35% over the past five years. Green Mountain also owns the popular Keurig single-cup brewing system and sells many varieties of coffee to fit it.
  • Starbucks Corp. (SBUX) and McDonald's Corp. (MCD): Starbucks will likely benefit from any dip in coffee prices. Meanwhile, McDonald's has been aggressively entering the specialty coffee arena and is set to give Starbucks a run for its money when it comes to lattes and espressos served on the go.

The Cost of Cocoa

You may have noticed that your candy fix, much like your caffeine fix, has cost you more lately. On average, the cost of high-quality chocolate, which has a higher cocoa content, has increased over 6% in the last year, according to Nielsen data.

That's because the cost of cocoa has more than doubled since the beginning of 2007. It can be shipped in powder, paste or liquid form and commands $2,600 per metric ton on New York's Intercontinental Exchange, up from $1,700 at the start of 2007.

And while cocoa is certainly subject to the same conditions that can affect other crops such as poor weather conditions, the huge increase in price, at least for this commodity, doesn't seem to be a simple function of supply and demand.

For the year ending in September, the International Cocoa Organization only expects a 51,000-metric-ton shortfall, which can be made up with existing stock, The Wall Street Journal reported.

"The fundamentals do not justify this price, and I haven't heard of any other explanation other than [investment] funds," said Hagen Streichert, a German government official and the spokesman for cocoa-buying countries on the International Cocoa Council.

Many analysts and management from some of the leading global chocolate manufacturing firms including Cadbury PLC (ADR: CBY) and the Swiss firm Chocoladefabriken Lindt & Spruengli AG are pointing the finger at hedge fund investments. Volatile equity markets and tight global credit markets have led funds to seek out alternative investments in commodities.

"In my lifetime, it's an entirely new phenomenon," Stephanie Garner, a cocoa trader for Sucden, a broker owned by Sucres & Denrees SA, on the London International Financial Futures and Options Exchange told The Journal, speaking of the sudden increase in cocoa futures contracts. "It's to a large extent a fallout of the credit crunch."

It's hard for the average investor to find a pure cocoa play. There are some exchange-traded funds that focus on the price movements of cocoa, but they trade in London and aren't open to most U.S. investors. However, Africa produces most of the world's cocoa supply, so an ETF focused on that region could be a good choice:

  • SPDR S&P Emerging Middle East & Africa ETF (GAF): This ETF seeks to replicate the movement of an equity index based on the Middle East and African equity markets. The fund uses a passive management strategy to track the total return of the S&P/Citigroup BMI Middle East & Africa index.

Sugar High

Most people take sugar on the table for granted, but soon it might be used for more than just sweetening your tea.

The USDA recently released its World Sugar Situation report for May 2008. The expected raw sugar production for the 2008-09 marketing year of 161.7 million tons will just barely meet estimated global usage of 160.8 million tons. Production is down 3.8 million tons, while consumption is up 4.6 million tons from the prior year.

But due to trade imbalances, the USDA estimates a 1.1 million ton shortfall in the 2008-09 marketing year.

"World sugar raw prices dramatically increased during the last six months reaching over 15 cents [per pound] in March before declining to present levels of under 11 cents [per pound]," the report read.

On its own, Brazil accounts for 20% of global sugar production. Asian countries account for 40%. Brazil, India, Thailand, and China, together, account for half of world production and 56% of world exports.

But if demand for ethanol continues to increase, as it likely will given current government production mandates, sugar could become even scarcer. Brazil uses sugar cane, rather than corn, which is favored in the United States, to produce the popular alternative fuel.

Imperial Sugar Co. (IPSU), one of the largest U.S. sugar refiners is currently planning the first ethanol plant that would run on a mix of corn and low-grade sugar. If approved, the plant could be up and running as soon as 2011.

If Imperial can find a way around government caps that currently limit how much sugar can be imported for non-food use, it could be very cost effective.

"It makes all the sense in the world," State Representative Nick Lampson told The Houston Chronicle. "If you look at the world price of sugar, it's less than 3 cents a pound. Our sugar price is about 19 cents a pound. That means we could produce energy for significantly less than what is presently being used to make ethanol from corn."

With oil at record highs, cheaper ethanol could be set to become a very valuable commodity of its own. That could put upward pressure on the cost of sugar, especially if sugar becomes a cost-effective alternative to corn.

If you're looking for some sweet profit plays, consider:

  • iShares MSCI Brazil Index (EWZ): The largest South American country is one of the leading exporters of both coffee and sugar. This exchange-traded fund seeks to provide investment results that correspond generally to the price and yield performance of publicly traded securities in the Brazilian market as a whole, as measured by the MSCI Brazil Index.
  • Imperial Sugar Co. (IPSU): Sometimes it pays to be first. And if Imperial can pull off its proposed hybrid ethanol plant, its profits could be set to take off. The stock is currently trading near its 52-week low of $13.83, but the firm has maintained its 7-cent quarterly dividend.

[Editor's Notes: In Money Morning's "Cashing in on Commodities" series we have written about uranium and coal, crude oil, timber and frontier markets. Next up: Look for our story on gold this Friday. While oil and other commodities have dominated the headlines, they're far from the only investment opportunities available. And some of the other profit plays are more lucrative, and less risky. If the economic uncertainty - or the volatile markets - of recent months have you at a loss over the best moves to make next, check out Money Morning's first book, "The Essential Investor's Playbook for the Next 12 Months." At 118 pages, our just-published global-investing guide provides an insider's look at the Top 16 global trends you're likely to face over the next year or more, and contains a special chart that details more than 50 profit opportunities. And it really is a playbook: No matter what the market throws at you, you'll find a play you can call to maximize profits.]

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