UNBRIDLED CASHEW SPECULATION - HISTORY LESSON 102
June 20, 2008

By David Rosenthal

"Enhancing" contracts?

On May 28th members of the Association of Food Industries Nut and Agricultural Section met with diplomats at the Vietnamese Embassy in Washington DC to discuss the magnitude of cashew defaults from Vietnam over the past several months. It is reported that approximately 2000 container loads have been defaulted on by Vietnamese cashew shippers between November 2007 and April 2008. These actions by the Vietnamese shippers have had a major impact on cashew prices with some grades increasing by over $2.00 per pound.

Importers are being forced to pay 'enhancements' in order to have their contracted product shipped. This puts the importing community in a position to lose millions of dollars, depending on the volume of contractual obligations to roasters at lower market prices. Several importers who had agreed to these enhancements have been caught off guard when shippers again refused to ship already renegotiated containers unless they agreed to further increases to the enhancements as a result of higher market prices at the time of shipment.

Diplomats at the Vietnamese Embassy gave very little hope to the importers and roasters who attended the May meeting. They asked for the AFI members affected by the defaults to have sympathy for the suppliers who have suffered due to higher production costs, increases in raw material and high inflation rates. One roaster commented that he could understand the plight of the Vietnamese cashew suppliers if the enhancements were a one time event, but that asking for further enhancements to release shipments was unsustainable. Three weeks have passed since this meeting and in this short time the FOB price on 320's has moved up by almost $0.35 per pound.

Flashback to 1999

Industry wide defaults by cashew suppliers are not new to the industry. In 1999 Indian shippers defaulted in unprecedented numbers, resulting in tremendous market increases, and huge losses were absorbed by the importing and roasting community. Ironically, these actions by Indian shippers resulted in increased support of the Vietnamese cashew industry. Now that we have experienced this behavior from both major cashew producing countries we may have to reassess the way we conduct business, as taking forward positions has proven to be a very risky venture.

Understandably this is a difficult proposition since retailers continue to demand long term contractual agreements to lock in pricing, in some cases for more than one year. With a market certainty time frame of approximately 3 months, the speculative nature of the business has always presented a risk for the cashew commodity trader. Traditionally, if a trader called the market wrong he stood to lose a great deal of money. In today's environment, the trader runs the risk that, even if he calls the market right, his profitable forward position may turn out to be a worthless printout of uncollectible contracts. Speculative Trading Now Riskier The current conditions in the cashew market clearly indicate the high price paid for aggressive speculative trading practices from unreliable sources. The desire to get the lowest price sends many importers to small, poorly funded suppliers who not only have questionable manufacturing practices, but also have proven to be unreliable when markets go against them. The ripple effects of this behavior became so far reaching this year that even major Vietnamese suppliers that have been historically reliable caved in to the temptation to demand "price enhancements" in order to fulfill contractual obligations.

Hard Lessons

The cashew industry has experienced the same devastating events twice within one decade. Price increases of over $2.00 lb. are bound to have a negative impact on business with retailers - indeed cashew consumption is already down as consumers, faced with increased fuel and food expenses, cut back on snacks and luxury items. No one in the importing or roasting sectors is benefiting from the present conditions. The great American philosopher, George Santayana once said "Those who do not learn from history are doomed to repeat it". We've had two hard lessons - do we really want to continue on this path?

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PRICE HIKES AND DEFAULTS - MUST THEY GO HAND IN HAND?

By David Rosenthal

June 10, 2008

As if a staggering rise in cashew prices were not enough, reliable sources estimate that Vietnamese shippers have defaulted on over 2000 containers of cashews scheduled to arrive between November 2007 and February 2008. This presents a market differential in excess of 40 million dollars. The Vietnamese have protested that the discrepancies between current market prices and the lower prices contracted before the market overheated is so great that honoring the contracts would effectively put them out of business. Indian shippers (who so far have not defaulted) maintain that fulfilling the contracts would not result in substantial losses, because the Vietnamese raw seed, both domestic and imported, was bought at reasonable price levels and was sufficient to meet Vietnamese contractual obligations.

The problem is that much higher profits can be had by delaying shipments and causing supply disruptions. Historically, the default tolerance level is $0.20 lb. Once the market goes beyond this price differential, the temptation to default and sell to buyers willing to pay a higher price (and there appear to be plenty of these high bidders in China and Malaysia) is too much for some suppliers. And there is every possibility that even this traditional default tolerance threshold could decrease.

There is no question that these defaults are fueling the severe rise in cashew prices. It is by no means an isolated problem, but widespread – continuing from last year’s crop into the current one. The number of defaulted containers that need to be covered has triggered a wave of buying that is permeated with fear – both of shortages and of further price increases. The combination of fear and uncertainty is always a grim mix, and Indian shippers who know the extent of the defaults are not likely to allow prices to soften. There is a slim hope for price relief as the peak arrival period of raw seed in India and West Africa approaches, but the fear factor, delays and defaults seem to have created an environment in which the market firms almost as soon as it eases.

The problem is not unique to the United States. Our counterparts at CENTA have banded together and are working through their governments to resolve the situation through treaties and trade agreements with Vietnam. Although the United States does not have the same types of treaties, the AFI is also trying to safeguard the interests of American importers, who are caught in the vise of having to fulfill contracts to their customers while having to pay more for cashews purchased on an emergency basis in order to cover the defaults. Unfortunately American importers have the added handicap of the weakening dollar, making their bargaining position more problematic.

In order to recoup their losses and stabilize the situation, the importers need for these older, less expensive contracts to be shipped in full. This is not a question of “Force Majeure” from Vietnam, because they continue to offer containers of cashews for 5 – 6 months out (at high prices) which we must assume to be the very containers that they are not shipping for their contracts! By whatever means – arbitration, diplomacy, etc. the defaults need to be addressed, and resolved, because it is not only the short term that is at stake. The commodity trading and speculative market approach that has been the mainstay of the industry could be at risk if commodity traders (importers) are perceived to have no power to effectively enforce contracts.

The cashew industry has experienced these “perfect storms” in the past, and will weather this one also. It is worth mentioning that not all of the Vietnamese shippers have defaulted on their contracts – many are honoring their obligations. These tend to be the ‘best of the best’ – shippers who view long term relationships as more important than quick profits. These difficult situations are always learning opportunities – if nothing else, hopefully, the importing community will remember who the reliable suppliers are when the good times come around again. As if a staggering rise in cashew prices were not enough, reliable sources estimate that Vietnamese shippers have defaulted on over 2000 containers of cashews scheduled to arrive between November 2007 and February 2008. This presents a market differential in excess of 40 million dollars. The Vietnamese have protested that the discrepancies between current market prices and the lower prices contracted before the market overheated is so great that honoring the contracts would effectively put them out of business. Indian shippers (who so far have not defaulted) maintain that fulfilling the contracts would not result in substantial losses, because the Vietnamese raw seed, both domestic and imported, was bought at reasonable price levels and was sufficient to meet Vietnamese contractual obligations.

The problem is that much higher profits can be had by delaying shipments and causing supply disruptions. Historically, the default tolerance level is $0.20 lb. Once the market goes beyond this price differential, the temptation to default and sell to buyers willing to pay a higher price (and there appear to be plenty of these high bidders in China and Malaysia) is too much for some suppliers. And there is every possibility that even this traditional default tolerance threshold could decrease.

There is no question that these defaults are fueling the severe rise in cashew prices. It is by no means an isolated problem, but widespread – continuing from last year’s crop into the current one. The number of defaulted containers that need to be covered has triggered a wave of buying that is permeated with fear – both of shortages and of further price increases. The combination of fear and uncertainty is always a grim mix, and Indian shippers who know the extent of the defaults are not likely to allow prices to soften. There is a slim hope for price relief as the peak arrival period of raw seed in India and West Africa approaches, but the fear factor, delays and defaults seem to have created an environment in which the market firms almost as soon as it eases.

The problem is not unique to the United States. Our counterparts at CENTA have banded together and are working through their governments to resolve the situation through treaties and trade agreements with Vietnam. Although the United States does not have the same types of treaties, the AFI is also trying to safeguard the interests of American importers, who are caught in the vise of having to fulfill contracts to their customers while having to pay more for cashews purchased on an emergency basis in order to cover the defaults. Unfortunately American importers have the added handicap of the weakening dollar, making their bargaining position more problematic.

In order to recoup their losses and stabilize the situation, the importers need for these older, less expensive contracts to be shipped in full. This is not a question of “Force Majeure” from Vietnam, because they continue to offer containers of cashews for 5 – 6 months out (at high prices) which we must assume to be the very containers that they are not shipping for their contracts! By whatever means – arbitration, diplomacy, etc. the defaults need to be addressed, and resolved, because it is not only the short term that is at stake. The commodity trading and speculative market approach that has been the mainstay of the industry could be at risk if commodity traders (importers) are perceived to have no power to effectively enforce contracts.

The cashew industry has experienced these “perfect storms” in the past, and will weather this one also. It is worth mentioning that not all of the Vietnamese shippers have defaulted on their contracts – many are honoring their obligations. These tend to be the ‘best of the best’ – shippers who view long term relationships as more important than quick profits. These difficult situations are always learning opportunities – if nothing else, hopefully, the importing community will remember who the reliable suppliers are when the good times come around again.