Is the Long-Term Bull Market in Cocoa Coming to an End?
Fundamentals
Since the end of 2006, Cocoa futures have been in bullish hands, with prices more than doubling during the past 4 years, due to increasing global demand and lower than expected production especially the past 2 years. However, there are some signs this historic bull trend might be starting to wane. For starters, production is expected to increase this year due to improved growing conditions seen on the Ivory Coast, which is the world's largest Cocoa producer. Higher production combined with an expected decline in demand, particularly from Europe, is expected to move the market into a surplus this year, with some estimates calling for a nearly 100,000 ton surplus for the 2010-11 season. While fundamentals seem to be pointing to potentially lower cocoa prices this year, it is the technical picture where Cocoa bears are starting to flex their muscles. Lead month December Cocoa is now trading well below the key 200-day moving average; a barometer used by many technical analysts to determine whether a market is in a bullish or bearish phase. In addition, prices have fallen below the key 2800 level in the December contract, which was the bottom of a 400-point consolidation range formed since mid-May. Speculators have been in a long liquidation mode in Cocoa recently, with the most recent Commitment of Traders report showing that large non-commercials (large commodity and hedge funds) liquidated nearly 6,000 contracts the week ending August 24th. This lowered their net-long position to only 4,925 contracts. Commercial traders, on the other hand, added to their net short positions, as short-hedgers attempted to lock in current prices ahead of the start of the main harvest in September. So until we start to see real improvement in the world economy or end users need to enter the market to meet their needs, Cocoa prices may continue to slump, as "liquidation" mentality remains in speculators' minds.
Trading Ideas
Some traders looking for continued weakness in the Cocoa market who wish to collect income by selling options may wish to investigate selling a bear call spread in Cocoa options. An example of this trade would be selling the December Cocoa 3000 calls and buying the December Cocoa 3200 calls. With December Cocoa trading at 2762 as of this writing, this spread could be sold for about 30 points, or $300 per spread, not including commissions. The premium received would be the maximum potential gain on the trade, which would be realized if December Cocoa is trading below 3000 at option expiration in November. Given the potential risk in this trade, some traders may wish to close out the trade before expiration should December Cocoa close above 3000.
Technicals
Looking at the daily continuation chart for Cocoa going back 5 years, we notice prices have fallen below the 200-day moving average and are now trading at 13-month lows for the lead-month contract. The 14-day RSI looks weak, with a current reading of 27.20. Longer-term, there is an area of support that comes in around the 2250 area, but that is still over 500 points lower than current price levels. Resistance is found at the 200-day moving average currently near the 3050 area.
Mike Zarembski. Senior Commodity Analyst
