Liffe cocoa, coffee prices need to rise to rebuild exchange stocks

* Futures need to rise for convergence with physical market

* Exchange oversight changes from September contracts onward

By Sarah McFarlane

LONDON, July 25 (Reuters) - A disconnect between the futures and cash prices for London coffee and cocoa, partly due to intervention by the exchange to keep markets orderly, has led to a depletion in Liffe stocks, which will only be rebuilt to healthy levels if futures rise.

Even with cocoa and coffee September contracts already trading at premiums and cocoa futures trading at around a three-year high, traders said prices are yet to reflect the strength of those on the physical (cash) markets.

"Certified stocks are pretty low in both cocoa and coffee and to replenish them you would need some degree of cash convergence (to futures) to attract fresh gradings to the board," a European analyst said.

"Maybe you just need this one-off cash convergence to get coffee and cocoa to the board to get a stock level that is reflective of the current balance sheet rather than one that's too low because people aren't prepared to deliver."

The Intercontinental Exchange, which owns the Liffe cocoa and coffee markets, is refining its approach to market oversight, to address concerns that exchange intervention had gone too far, ultimately preventing a strong enough link between the physical and futures markets.

Increased exchange intervention over the past couple of years in coffee and cocoa was partly driven by a desire to stamp out market manipulation. The exchange acts if it becomes concerned about a dominant position in nearby futures contracts.

The exchange's recent additional guidance, which applies to September contracts onward, has new procedures for monitoring cash prices along with any premium on a delivery month.

The exchange declined to comment more specifically on what the changes would entail including which cash prices it would use as benchmarks.

Last week good quality Ivory Coast cocoa beans were quoted at 75 pounds per tonne over the London September contract .

"If the physical market is paying you vastly above what the terminal market is paying you then there's no way people will put cocoa on the exchange, they'll sell it instead on the physical market," another analyst said.

SUPPLY OR SPECULATION

Markets normally trade with discounts on nearby positions but at times can become inverted either due to tight supplies or large speculative bets.

In the past, cocoa and coffee contracts have been squeezed, whereby premiums nearby can soar, which has led the exchange to intervene. In some cases, however, premiums have been driven by supply issues rather than market speculation.

"Over the past couple of years in the lead up to expiries, nearby cocoa contracts have consistently gone to premiums, indicating a shortage of available certified stock, although not to a level where there's convergence with the cash market to incentivise large volumes of fresh gradings," a European trader said.

"That implies the exchange is intervening at a point, preventing premiums widening, evidenced by the fact the certified stocks of robustas and cocoa have gone down when the role of an inversion is to do the opposite - to attract cocoa into exchange stocks."

The exchange declined to say whether it would allow premiums to trade wider than has been the case in the past few years.

Exchange stocks of both cocoa and coffee rose this week but quantities were close to the delivery position limits of 75,000 tonnes and traders expect the September premiums will need to widen from current levels to draw in fresh beans to further replenish stocks from their historically low levels.

The Liffe September cocoa futures contract closed at a 43 pound per tonne premium to December on Thursday (LCC-1=R), while September robusta coffee futures closed at a smaller $4 premium to November (LRC-2=R).

"Cash convergence today would require September to trade at around a 100 pound premium to December, although people might grade cocoa before it got to that level," the trader said.

There was also consensus on robusta coffee that the September premium would need to widen, with convergence between top grower Vietnam's beans and the Liffe futures estimated at between $40 and $60 per tonne above current futures prices.

"Coffee prices need to go up to get fresh coffee out of Vietnam, farmers don't have that much left to sell so they're not really in a hurry," a London-based broker said. (Reporting by Sarah McFarlane, editing by David Evans)