Is the Bullish Move in Cocoa Starting to Melt?
Fundamentals
After failing to hold above the $3000 per ton level, bullish traders ran for the exits in December Cocoa futures yesterday, as selling in equities and oil spilled over into the commodities markets including Cocoa. Cocoa prices have been in an uptrend for most of the year, as lower than expected production out of the Ivory Coast, the world's biggest producer of Cocoa, and a dearth of high quality supplies forced users to bid-up prices to obtain quality supplies. Arrivals at the ports in the Ivory Coast are running about 14% behind last year's totals, with a fair amount of the inventory not meeting quality standards. However, the next season's crop is believed to be off to a good start, as weather conditions have improved. This has led some traders to believe that Cocoa is now overpriced given current user demand and potential for improved production in the upcoming season. Although some weather forecasters are calling for the possible formation of an El Nino weather pattern later this year, it is too early to forecast any possible effects on West African Cocoa production should an El Nino pattern appear. Recent weakness in the British Pound vs. the U.S. Dollar also encouraged arbitrage selling in the New York market, as well as general commodity fund selling tied to weaker equities and oil prices. With large speculative accounts holding a net-long 20,968 contracts as of 8/18/2009, according to the most recent Commitment of Traders Report, it will take fresh bullish fundamental news to keep commodity funds from pairing their long positions now that strong resistance at $3000 has held.
Trading Ideas
Given the market's rejection to the $3000 level and solid support seen around the $2500 to $2600 area, some aggressive traders may wish to sell strangles in December Cocoa options just outside of this price band. An example of this trade would be selling the December 3200 calls as well as the December 2400 puts. With December Cocoa trading at 2800 as of this writing, this strangle could be sold for 120 points, or $1200 before commissions. The credit received would be the maximum potential gain in the trade and would occur should December Cocoa be trading above 2400 and below 3200 at the option expiration in November. Since a short strangle has unlimited loss potential, traders who choose to initiate such a trade should closely monitor their positions and possibly consider closing out the trade should December Cocoa trade at or above 3200 or at or below 2400 before the options expire.
Technicals
Looking at the daily chart for December Cocoa, we notice that yesterday's sell-off accelerated once the 20-day moving average was violated. This is viewed as a sell signal for short-term momentum traders and triggered sell stop orders below support at 2900. The 14-day RSI also displayed a bearish divergence, as Tuesday's recent highs of 3025 failed to produce a new high reading in the RSI. 2700 is seen as the next support point for December Cocoa, with 3025 as major resistance.
Mike Zarembski, Senior Commodity Analyst
