Will a Rising Dollar Cause the Cocoa Bull Market to Melt?
Fundamentals
Speculators have been going cuckoo for Cocoa futures lately, as the most active March futures are approaching 30-year highs. Tight global Cocoa stocks have been the main catalyst behind the price surge, as supplies out of the Ivory Coast, the world's largest Cocoa producer, have been disappointing. Domestic cash Cocoa prices in Nigeria and the Ivory Coast are starting to rise, as exporters try to obtain supplies before stocks become even tighter later in the season. With signs of an improvement in the global economic outlook, many traders believe that chocolate demand could improve going into 2010, which would increase Cocoa demand. However, the recent resurgence in the U.S. Dollar could take a bite out of speculative demand for Cocoa, as a higher Dollar makes commodity prices more expensive for non-Dollar buyers. Speculators are holding net-long positions in Cocoa futures according to the most recent Commitment of traders report, with non-commercial (large speculators) and non-reportable (small speculators) holding a combined net-long position of 44,368 contracts as of December 8th. Although the speculative position is rather large, it is still well off the record highs set in 2008 at over 73,000 contracts. As long as the greenback continued to be bid, the potential for long liquidation selling to occur in Cocoa and other commodities looks to be increasing. However, should the greenback start to falter, there appears to be plenty of room for additional speculative buying to occur in Cocoa, especially given its current bullish fundamentals.
Trading Ideas
Even though the fundamentals still point to potentially higher Cocoa prices, the market might be overdue for a correction. A quick look at the daily chart for March Cocoa shows that the 3100 level appears to be an area of solid support. A trader looking to take advantage of a potential downside move in Cocoa who believes that the 3100 area will hold may want to explore buying a put ratio spread in March Cocoa options. An example of this trade would be buying the March Cocoa 3250 put and selling 2 March Cocoa 3000 puts. With March Cocoa trading at 3250 as of this writing, the trade could be done for a debit of 65 points, or $650 per spread. Given the fact that this trade involves selling more puts than are being purchased, solid risk management is essential. Traders may want to consider closing out the trade early should March Cocoa close below 3000.
Technicals
Looking at the daily chart for March Cocoa, we notice that the long-awaited correction is underway. The continued rise in the U.S. Dollar has hurt commodity bulls, and a market like Cocoa, which is trading at historically high levels, can be particularly vulnerable to bouts of long liquidation. Friday's sell-off took the March futures below the 20-day moving average, which triggered a sell signal for short-term momentum traders. The strong selling moved the 14-day RSI below the 50 level, with a current trading of 44.60. 3100 appears to be strong support for March Cocoa, with resistance found at the 20-day moving average currently near the 3355 area.
Mike Zarembski, Senior Commodity Analyst
