Oil Isn't the Only Hot Commodity on the Rise

The world is consuming chocolate at an all-time high. The International Cocoa Organization expects demand to outstrip supply by more than 70,000 tons this year alone. Cocoa prices are rising and are expected to continue increasing for at least another decade. While I can't tell you to cut back on the candy bars, you can prepare your portfolio for the coming shortage.

Why no chocolate?
Cocoa production is a low-yield business. Bad weather and sociopolitical issues can crush cocoa harvests, as can happen with many commodities. But what separates cocoa from the others is its demand outweighs supply in the long run, not just the next few years. Analysts and experts agree that improving crop yields and creating new plants is absolutely necessary to meet the growing demand. Many private research organizations are working on this, but the finished products are a long way off.

Keep chocolate in your belly and out of your portfolio
The likes of Hershey (NYSE: HSY  ) and Archer Daniels Midland (NYSE: ADM  ) are bracing for what could be a 50% increase in cocoa prices over the next decade. In fact, some of the biggest bear arguments for Hershey come down to thinning gross margins -- a sign of rising raw-material costs. The company has been able to boost revenue over a five-year period, but a look at the declining year-over-year cash flows show where the margins are hurting the chocolate giant.

Archer Daniels is a similar story. The company has great revenue growth over the past few quarters, but the already low-margin business is cutting it even closer on gross margins, with net income hurting as a result.

These companies can hedge their bets by buying cocoa futures, but it's not as easy for you. If you were thinking about opening positions in these stable large caps, it might be better to wait and see how they handle the commodity issue.

How do I cash in on the sweets?
Unfortunately, the most direct players are buyers, not sellers. An ETF such as the iPath DowJones-UBS Cocoa SubIndex Total Return ETN (AMEX: NIB  ) is an option, but its historical price trends have not mimicked the rise in cocoa prices.

Snack companies with a more diversified portfolio, such as Kraft (NYSE: KFT  ) , would be a safer pick in the space. Kraft's cocoa-intensive businesses, including Cadbury and Toberlone, will no doubt feel the pain, but the 100-plus-strong brands under Kraft's reign should more than compensate for lackluster performance in any one segment. However, it is worthwhile to note that in the risk section of its latest 10-k, even Kraft mentions the cost of cocoa and its expected rise.

So should I just keep eating ice cream and not worry about it?
My advice would be to sit on the sidelines for this one. For any company with exposure to the cocoa crisis, keep a watchful eye on the situation and don't let your portfolio slip into a sugary sleep.

Think I'm wrong about the future of chocolate? Let me know in the comments. I'll make sure to respond, and in the meantime make sure to add any of these companies to our free My Watchlist service.

Fool contributor Michael Lewis owns none of the stocks mentioned in the story above. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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