WRFH/Radio Free Hillsdale 101.7 FM - Wall Street Weekly: Why Your Chocolate is So Expensive

Episode Date: April 21, 2024

In the penultimate episode of Wall Street Weekly, George takes a deep dive into the rising prices of cocoa, and Patrick talks about the largest asset manager in the world. Find all our episodes on X @wallstreetpod.

Welcome to Wall Street Weekly, a show where your host, George and Patrick, cut through the financial jargon to keep you educated and informed about the markets that affect our lives. Enjoy the show. This is the highly informing, overperforming radio show on Radio Free Hillsdale 101.7 FM. Coming back from a one-week hiatus going to the Pistons game, which Patrick Scott very much enjoyed watching Detroit's Finest on the Hardwood. Detroit's finest NBA's finest, you know. The worst in the NBA, but this isn't a sports show. This is a finance show. As we remind our audience every week, this show is for entertainment purposes.

Only anything we say on here does not constitute financial advice and, as always, talk to trusted financial representation before making any decisions. We also want to remind our audience or maybe announce for the first time to our audience that this is actually going to be our second to last episode, not only of this semester, but probably in the show's entirety. I'll be graduating this coming fall, and Patrick has quite the workload coming up next semester. As the great Warren Buffett once said,

all good things must come to an end, and we are nearing that point. So this will actually be our last real format episode, as next week we take a little time to indulge ourselves in our favorite past episodes. I'm looking forward to that one for sure. Should be a nice wrap up to the whole show. And if we're lucky, we will be in Omaha,

a few weeks down the road and maybe get some interviews there, maybe have a bonus episode airing after that, but we can't make any promises. What I can promise is that chocolate is going to be much more expensive in the near future. That wasn't a great segue, but it's an important topic and it's tough to break any hard news or difficult news in a light way. I did the best I could, but you heard me right. Chocolate has gone up about three times where it was at the beginning of the year, which is an insane shift in price in three, four months, especially because this isn't some high-flying tech stock or cryptocurrency. This is literally a commodity, which are generally pretty stable. But let's hear a CNBC host talking about some of the factors that might play

into this astronomic rise in price. Coco prices surge to all-time highs this week as bad weather conditions damage crop yields in West Africa, home to three-quarters of the world's production. Coco futures are up by more than $1,000 per metric tonne since the start of the year. Yesterday, Hershey's CEO, Michelle Buck, said earnings growth will be flat this year because of the historically high cocoa prices. And as you might have gathered from that new story, companies were already concerned when prices were at about $6,000 a ton for cocoa, what that might mean for the underlying profits. Right now, Coco is at $11,283 per ton, which represents an all-time high close. as of today, April 18th. And it's led many people to wonder what's actually driving these prices.

The major thing, as noted in the CNBC soundbite, is that agricultural conditions have been really rough. They have a dry season and a wet season, and the wet season had a lot of flooding. It was much too wet for the crop. And then this dry season has been one with a lot of droughts. If the plants were able to survive, they have smaller yields due to the unstable growing conditions. So are there some companies like in Africa that manage and sell all the cocoa? You have a lot of cooperatives where they try to bring farmers together and then they sell those to the major companies, Mondalese, which owns brands such as Cadbury, known for Easter fame, and obviously Hershey being a dominant player for all their different candies. Now, the bigger problem, in my opinion, some people will try to blame companies taking advantages of small farmers,

which definitely still occurs, or companies like Hershey's and Mondalas for taking advantage of those farmers by not looking into potential inequalities down the supply chain. In my opinion, one of the big problems is the governments that you have to operate in and the amount of corruption there. And this is why Coco is a long-term problem and concern for a lot of people, because the farmers who are at the core producing this crop often live on small farms without much capital investment or bargaining power, meaning that farmers are often being paid subsistence wages. But the governments that they're operating under, specifically I was looking at Ivory Coast,

which is the biggest producer of cocoa beans in the world. The property rights there rank very similarly to that of Venezuela for physical property. And when there's always a threat of your government or your neighbors taking over your property, you're not incentivized in any way to make investments to better your property. Here in the United States, you think that you really put a lot of effort into the intensive growth of your land, spreading fertilizer, putting chemicals on it, in a way that you don't necessarily want to do on the West Coast of Africa, where you have forces that could take you from your land. And so all this is to say that the poor yields, which are exceptionally bad this year, due to the poor weather conditions, are not likely a quick rebound insofar as there. And so far as there,

there will always be a major problem with underproduction until you have governments or institutions that can secure property rights. And it would be nice to think that the market has some self-correcting mechanism. And Hershey's has actually been trying to create the right incentive structure for the farmers that produce their cocoa. They say on their website that, quote, our pledge is to invest half a billion dollars in these communities by 2030, translating to meaningful results on the ground, helping to keep children in school, helping to diversify and increase income, giving farmers the support to build thriving businesses and protecting forests, unquote. And I think the idea there is, in business, we like to think of it being a very greed-driven, profit-motivated system.

But actually, Vernon Smith, he's a Nobel Prize laureate, he came onto campus recently, and he talks about the economics of beneficence, that you feel obligated to someone, if they do something nice for you and how that actually controls a lot of the interactions that we have in the world. And if Hershey's is able to slightly help a farmer out by lifting them out of day-to-day poverty, that they're going to feel indebted to Hershey's and that in the long run, their production is going to be much more efficient. And in the long run, Coco prices will hopefully be kept at a lower level. So that idea of beneficence, would you say that falls under more of, there's two different things that we've talked about that sounds to me to be similar to that idea. And that,

is Charlie Munger's ideas of human psychology misconceptions and the ESG, all that stuff that we talked about with our guest, Paul Tice. Do you see beneficence as falling into one of those categories, more or less? Yeah, for beneficence, I think specifically within the ESG movement, that's what a lot of people are arguing from more of the pro-free market perspective is that we don't need to push regulations on people because oftentimes business, it's in your best interest to treat. others well. You don't want to be known as the company that's constantly polluting or treating workers badly. So these things will come around naturally. And then I think when you talk about Munger, I think of the Buffett quote as those two are often associated that something along the

lines of we can lose a lot of money, but we can't lose one shred of our reputation. I horribly botched that quote. But the essence is that being known as a good and an upright and a beneficent company to work with is going to have some serious long-term dividends and hershies has obviously done well with that being around for over a century now there's a lot of political economic factors in this story but i think the most important one as we continue with our story about cocoa on a radio free hillsdale 101.7 fm has to do with the elasticity of demand and the basic economic concept goes like this and i'll get you involved patrick if you're dying of thirst in the desert what price would you be willing to pay if if someone drives by with a gallon of Gatorade and says they're willing to sell it to you.

At what price would you say, I'm not willing to pay that? I don't think there is a price there. I would be willing to pay anything if I'm, you know, dying of thirst. Yeah. Even if you had to borrow a million dollars from someone and work that off the rest of your life. To you, life is super important, so you're going to do that. And then you can think of a bunch of different scenarios where the max you would be willing to pay is $1,000, $100, maybe $10 if you're at a baseball game, and a dollar if you're at the

grocery store. So let's say I'm at a grocery store where there's a lot of different substitutes for Gatorade and urine, microin right now, what's a substitute? A substitute is, to my understanding, one good that does the same job as another good, but it's not the same thing. Yeah, it's a relatively good replacement. So for example, an orange is a substitute for an apple. It's not the same thing, but to you, it kind of does the same job. You know, it scratches the same itch. Yeah, so in this case, we might think of power rate as being a really close substitute, chocolate milk, but if Gatorade goes up by 10% in price and a group of people like me would decrease our consumption by more than 10%, that's a very elastic good, just meaning we're really

sensitive to price changes. Now, think about this in the case of Coco and why the price may have gotten so high. Hershey's is very limited in what they can do to reduce their dependency on cocoa. Maybe they can add a little more high fructose corn syrup or other additives, but for the most part, they're going to buy the same amount of cocoa. Because they don't have a substitute for it. There's not a great substitute for cocoa. And they have, as we talked about reputation, they have a brand to uphold a reputation to keep that they use cocoa in their chocolate bars. Right. And so to combat rising input prices, they either have to change their inputs or raise prices for customers. And that's what they have done and probably will continue to end up doing.

And let's think about customers. As the price of chocolate rises due to the rise of, of price and cocoa, they will substitute for other sweet treats. Like we said, it's not a perfect substitute, but they might buy Sour Patch Kids or Skittles or some other non-choclet candy. However, and I find this very interesting, if chocolate prices rise by 10%, candy expert Dan Sadler actually found that there's only a 4% decrease in the demand for chocolate, meaning that even at the consumer level, people are pretty unwilling to give up chocolate even among higher prices. So is that 10% increase all or partially from the rise in price of

cocoa or is that just from, you know, Hershey's wanting to make more money and so they increase the price? When the study was done, it probably wasn't the price of cocoa, but we could presumably see in the future raising prices because of an input cost. Okay, because I was thinking, you know, if there's only a 4% decrease in demand when you increase the price by 10%, then why wouldn't you just increase the price to, you know, exorbitant levels. Well, I was actually thinking the same thing, but it's because there's a competitive system. If you can make profit, if Hershey raises their price from a dollar to $1.10, maybe I'm a candy bar company that I can put my price up to $1.9 and try to undercut Hershey. But when you have an input cost that's going up, every comparable chocolate

brand is going to have to raise their prices. Every comparable brand that uses Coco. At a certain point, they're going to be losing money if they try to undercut Hershey because their input price has gone up. Right. Okay. So I know that I've covered a lot of ground in this story, but I just want to do a quick wrap-up in case anyone got lost along the way. Coco is the key input for chocolate and chocolate makers buy roughly the same amount of cocoa each year, and they often contract years in advance so they can lock in profitability. However, poor weather and uncertainty around future output has caused supply and expectations

of future supply to decrease, as we know from economics, less supply and even stable demand would cause prices to increase. You have the same amount of people chasing after fewer goods. But if you add to the fact that the uncertainty has led speculators and chocolatiers to buy more futures contracts than they normally would, prices have shifted dramatically. You have more people who are trying to buy less product. And that's why, as you go into the grocery store over the next few months and presumably years into the future, you're going to see higher prices for chocolate because people are unwilling

to substitute away from that beautiful bean that we all love and cherish. Coco. Now, let's move on to a company that has been a big buzzword on Wall Street that if you've watched any financial news recently, you've heard of them, and that is Black Rock. Patrick, what can you tell us about BlackRock? And is it really as scary as people make it out to be? Well, of course, it's a buzzword. It's the biggest asset manager in the world. So, yeah, I'll tell you a little bit about, um, BlackRock, some of their history, their founding, and how they do their business, how they make money. And so a little bit of a summary overview. BlackRock is an American multinational investment company, and they're based in New York City. They currently have around $10 trillion in

assets under management. And so that makes them, as they said, the largest asset managing company in the world. And in 2023, it was the 229th largest company in the world by revenue. And that's according to the Forbes 500 list. Its major competitors are Vanguard, State Street, Fidelity. These are companies that you've probably heard of before because you very well might have a retirement account with them. And one interesting thing about BlackRock is that it's positioned itself as a leader in ESG in the industry. And remember, ESG is environmental, social, and governance factors. And that's basically an activist investing, right? So you're purchasing shares of stock based on a mindset, a perspective of, you know, what can I do for the environment?

how is it affecting social issues, you know, social justice and all that stuff. And if you want to learn more about that, we would love for you to go back to our episode with our special guest, Paul Tice, to learn more about that. It was a great one. So a little bit about its founding. It was founded in 1988 by Larry Fink and others under the umbrella company Blackstone Financial. I know that's complicated.

Blackstone, Black Rock. It was actually kind of a joke when Black Rock was founded. Larry Fink and I think Andrew Schwartzman was the founder of Blackstone. and they kind of had a laugh by deciding it would be a good idea to call Blackstone's subsidiary Black Rock. Makes it very confusing in the investing world. Yep. And Larry Fink's whole goal was to create an asset management company that comes from a risk management perspective. And so a little bit about that.

This comes from an interesting story. This comes from October 19, 1987. We've talked about this day in one previous episode, I think two seasons, two semesters ago. But this is the Black Monday story. And so five years leading up to October 19, 1987, the Dow was on a roll, but growth began as low. In the 1987, you know, there's some fairly catastrophic things that happened, like Hong Kong's Hangseng Index crashed. And also, another political thing that happened, U.S. warships had attacked an Iranian oil platform

in response to a missile attack on an American ship, which doesn't seem related really to Wall Street, but basically huge political events like threats of war. They make people nervous and pessimistic pretty much about everything. And so you'll see that reflected in people's stock market activities. And then on Wednesday, October 14th of that year, the U.S. Committee of Ways and Means introduced a bill to reduce tax benefits for financing mergers and leverage buyouts. And so what's the leverage buyout really quickly?

Leverage basically means going into debt. And so this leverage buyout is barred. money to acquire another company. Did I get that right, George? Yeah, and then you're going to use the company you buy as collateral. So it's like if you found a really good deal on a house, they might say you only need to put 5% down on this house and then we'll use the rest of your house as collateral for the mortgage. And people would just do this with companies. Got it. Also, around this time, the Department of Commerce released some concerning trade deficit

figures and that ended up pushing interest rates up. And pushing interest rates up often means that stocks are going to go down. And so that week, that was a Wednesday on the 14th. And that Wednesday, Thursday, and Friday, the Dow Jones took a hit of a little bit under 5% each day. And so that growth that had been occurring the five years prior that was so strong that bull market that was starting to slow, all of a sudden on the 14th, that started to take a slow decline. And the thing to remember about the stock exchange is that they take weekends too. The stock exchange doesn't keep operating on Saturday.

Sunday. And so that meant that there was a lot of pent-up pressure building up from this decline that was happening three days prior. And so that meant that on Monday, it was like the Hoover Dam was completely fractured and cracked. And then all it took was markets to open and it just exploded. It's also important to remember that was the early onset of computers. And people speculate that computer algorithms were selling when a stock went down a certain amount. But because all the computers were programmed to do this, it caused a massive cascade of selling that couldn't be controlled. And companies have sense fixed that, so it doesn't happen and there can be more human interaction there, but that's part of what they think might have happened. Right. And one more thing to

remember is that the stock market is going to reflect expectations. And so when you see the stock market go down, you're probably going to want to pull your money out of it too. And that's going to push the stock market down even further when there's that pessimistic attitude surrounding it. And so ultimately the Dow dropped 22% in that one day, and that still today remains the largest one-day drop in the stock market's history. And so after that shock, people were mad with Wall Street, and so was Larry Fink. And that's where he comes in. So he decides he's going to build an investment bank centered around the identity of security, which was a pretty popular topic after the crash, understandably. People like the refreshing feeling of security and not wanting their assets to go down.

And so he loved the idea of risk management. And I say risk management in particular, this is not risk avoidance. There isn't really any risk avoidance with the stock market if anyone tells you, oh, I have an investment fund that is totally risk free. That's probably a scam. There's always going to be some sort of risk. Yeah. Most people would consider the only truly risk-free investment to be either holding cash or U.S. Treasury bonds, something backed by the U.S. government. Right, and with the treasury bonds, remember that Fitch, the crediting agency, they degraded the U.S.'s credit rating down from a AAA to a double A, which, you know, double A is still pretty good, but that does, you know, show a crack of vulnerability in the government's ability to pay off debt. Yeah, but at the end of the day, they're risk-free for us because if the government fails, it doesn't matter what we hold. We're kind of going to be really messed up badly. So the idea is that you can get a small rate of return no matter what unless the system comes crashing down. Yeah, if treasury bonds go bad, you know, the U.S. government defaults on its debts, then we probably have a lot of other bigger issues to think about rather than just losing our money,

which is hard to believe, but it's true. So about BlackRock's business, how do they make money? So they have a few main components. The first and the largest is investment advisory, administration fees. and securities landing. And that in 2021, their fourth quarter accounted for 78% of their total revenues. And so those are going to be fees that are related to their main business, which is managing people's money. And so what they do is they take all their investors' money, they pool it, and then they invest it into things like stocks, mutual funds, ETFs, those sorts of things. And they also

make their own ETFs and mutual funds and index funds. And those are going to earn them fees as well from whoever invests in them. 8% of their revenue from that quarter in 2021 comes from distribution fees, and so those are just going to be fees associated with distribution and service of their products. 7% is technology services, and so BlackRock offers lots of different technology systems to different insurance companies, banks, pension funds, and more. Those systems are often tools to do things like assess risk, for example. And then 6% is their investment advisory performance fees, and that applies to certain types of BlackRock accounts when performance is high, when they're doing well, sort of a commission-based thing. And so that's pretty much their business. It's pretty simple.

You know, there's nothing too complex. It's just very efficient. And one more thing that they've done well is mergers and acquisitions. So in recent decades, they've bought different segments from competitors. So for example, they bought Merrill Lynch's Investment Managers Division. They bought Barclay's Global Investor. And they also bought the Money Market Fund business of Bank of America. And all those acquisitions have been extremely successful, and Black Rock has just ballooned to this day. And so that was just a little bit of an overview about Black Rock. And we're going to have to conclude the episode there. But we thank you very much for listening to Wall Street Weekly. Once again, if you would like to listen to any of our past episodes, you can check on our

X page at Wall Street Pod. And we are looking forward to our next and last episode. Thank you for listening to Wall Street Weekly on Radio Free Hillsdale 101.7 FM.