Longs Washed out of Cocoa

November 14, 2014

As posted on CQG.

Longs Washed out of Cocoa

Cocoa has been in a sustained long-term uptrend since July 2013 that has taken prices from $2170 per ton to a high of $3399 on September 22, 2014. A rush of buying in late September as fears of Ebola took hold of the cocoa futures market caused the recent high. Those highs brought many speculative longs to cocoa. The buyers were looking for a challenge of all-time highs established in March 2011 at $3,826. Unfortunately, for the longs, the cocoa market reversed in late September and prices fell like a stone, closing last Friday at $2875- over 15% lower than those recent highs.

Cocoa Technicals

The recent sell-off in cocoa futures was sharp and painful for the longs.

20141114 Cocoa Daily

As the daily chart illustrates cocoa fell over 15% over a 5-6 week period. This has washed out some of the speculative longs as open interest dropped 14% over the same period. The price swoon left a gap on the daily chart between $3274 and $3283. Last week cocoa stabilized around the $2875 level. Historical volatility has dropped momentum indicators seem to be turning, as does the relative strength index.  The weekly chart also tells a story.

20141114 Cocoa Weekly

The weekly cocoa chart is clearly oversold. The decrease in open interest, the total number of open long and short positions, indicates that the move lower has been the result of long liquidation. Open interest is now at the lowest level since August 2013 when the rally commenced. Moreover, at current prices support for cocoa is very close to current market levels. There is a double bottom on the weekly chart at $2,853 which should be firm support considering the fundamentals in cocoa.

 

Cocoa Fundamentals

The over yearlong rally was the result of increasing Asian demand for chocolate confectionary products. Particularly in China, chocolate has become more popular in recent years and a new generation of chocoholics has been consuming more and more of the delicious treat increasing demand for cocoa beans. Considering 1.3 billion Chinese (not to mention increasing demand in other Asian nations) the potential for demand is huge.

The largest producers of cocoa beans in the world are the West African nations of Ghana and the Ivory Coast.
Together these countries produce more than 50% of world cocoa supplies. The spread of the Ebola virus across West Africa caused a great deal of speculative buying in September. Prices rose quickly from $3,019 per ton on September 11 to 3,399 on September 25 due to reports of increasing Ebola cases in Sierra Leone, the Republic of Guinea and Liberia. Guinea and Liberia both border on the Ivory Coast, the world’s largest producer of cocoa beans. Fears that Ebola would cross the porous borders and make its way into the two cocoa producing nations caused a speculative buying rush. An Ebola outbreak in the Ivory Coast and/or Ghana would affect production and logistics as the economies of these two countries depend on the cocoa growing and transportation business.

Cocoa demand has continued to be strong from Asia and Ebola is still prevalent in West Africa. The fundamentals for cocoa remain strong.

The bottom line…

Cocoa sold off from recent highs as speculative longs rushed to buy on Ebola fears. When the market ran out of buying it reversed and washed those longs out of their positions. The decrease in open interest validates the long liquidation. An oversold condition in cocoa, turning momentum indicators and a double bottom very close to current trading levels creates an interesting opportunity in the commodity. Demand for cocoa beans continues to be strong in Asia and the Chinese traditionally love to buy price dips in commodity markets. Look for the Chinese and other Asian nations to use today’s lower prices as a buying opportunity. Moreover, Ebola continues to plague West Africa and cases in the Ivory Coast and Ghana are not only possible, they are probable due to porous borders with affected nations.  Historical volatility has dropped in recent weeks making cocoa option prices cheaper. Consider buying some cheap call options at current levels. Look for a continuation of the long-term rally that began over a year ago. Cocoa is now in the buy zone. Given the double bottom formation on the weekly chart at $2853 cocoa is a low-risk high-reward opportunity at current price levels in terms of futures or options. The case for higher cocoa prices and perhaps an eventual challenge of all-time highs over $3,800 per ton is compelling.

Article: Longs Washed out of Cocoa


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