Cocoa Demand Reports Preview: Buy the Rumor Sell the Fact?

Last week I laid out the bullish case for cocoa in light of an impressive 21 percent run up last year thanks to supply issues and robust demand. Today and tomorrow, data from North America and Europe will help clear up the demand questions from the last quarter of 2013.

The deluge of data begins with the European Cocoa Association releasing measurements on the amount of cocoa beans processed in the fourth quarter 7 a.m. GMT Wednesday. Washington-based National Confectioners Association will follow suit and release its own data at 4 p.m. EST on Thursday for North America.

Analysts across the globe are in agreement that cocoa grindings increased year-over-year last quarter. According to Reuters, analysts polled believe North America cocoa grindings will increase five-to-7.4 percent compared to 2012. Bloomberg conducted its own poll with analysts for the European data and they expect grindings to increase 4.1 percent during the same time period.

The bullish sentiment is justified. Recent headlines from Reuters point to increasing demand. U.S. chocolate sales in October (Halloween candy sales) notched a five percent increase year-over-year versus expectations of one percent. Across the pond, Swiss chocolate maker Lindt & Spruengli published a Q4 sales increase of 8.6 percent thanks to strong North American numbers.

The futures market has taken notice. Today the ICE Cocoa March contract closed up $40 a ton, settling at $2,752, three ticks below the intraday high, after buying picked up just a few hours before the close.

Looking at the cocoa futures chart below, we see a breakout from the ascending wedge pattern (white lines) after the failed bear move to end the year. This move coupled with strong bullish sentiment should keep bears on edge.

The daily front-month ICE cocoa contract

The daily front-month ICE cocoa contract

However, that can all change with some bearish demand data. This might be a “buy the rumor, sell the fact” situation. The cynic in me thinks the run up Tuesday may be part of an insider pump-and-dump scheme, praying upon bullish headlines to lock in prices before an impending crash. The bullish data is probably already priced in. Furthermore, I keep hearing about how cocoa arrivals from the west African harvest are stronger than expected. Once we get through the data this week traders will return their attention to Africa.

Momentum Favors Higher Prices

Regardless of what may happen, I’m taking my chances from the long side. As I described earlier, I examine three main criteria before entering a trade: a technical breakout, fundamental basis and matching sentiment. Thus far we have the bullish technical breakout and the matching bullish sentiment. Now we need confirmation of the bullish fundamental basis.

Should the market sell off following the data release, this may mark a top and I’ll instead be looking to reverse my position and go short. Until then, I remain bullish eyeing a break above the 2013 high set last month.

P.S., if you don’t feel comfortable trading futures contracts, take a look at the iPath cocoa ETFs, including (CHOC) and (NIB) for opportunities to gain exposure.

Please Note: I am currently long ICE Cocoa.

Cocoa Futures to Star Again in 2014…But Will Demand Strength Continue?

Overall, 2013 was an up-and-down year for most futures markets as raw materials from corn to gold to sugar took a dive while natural gas and stock market futures took off. Attain capital pointed out a near 50/50 split between gains and losses for the 39 futures markets it tracks. Meanwhile, agriculture-specific commodities fell by 7.7 percent based on data compiled by Agrimoney.com.

Of the top agriculture performers, cocoa presents an interesting bullish opportunity. Despite an already impressive 21 percent price increase in both New York and London trading in 2013, the supply and demand scenarios remain bullish. Analysts across the globe unanimously see cocoa repeating as a star performer.

Laurent Pipitone, head of statistics at the International Cocoa Organization in London, told Bloomberg in a story dated December 30 that, “Consumption will top output by about 70,000 tons in the 12 months started October 1. Deficits will persist through 2018, a six-year stretch that would be the longest since the data began in 1960.”

On the supply side, analysts cite aging cocoa trees in West Africa, the world’s top producing region, and farmers switching to palm oil and rubber as major culprits for waning supply. Furthermore, weather has not cooperated this growing season. Despite a strong start to “port arrivals” for the early West African harvest in December, major trading houses expect a drop off thanks to the persistent hot and dry weather that plagued the growing season. In the short term, however, this same hot and dry weather has helped increase the pace of harvest and the size of warehouse inventory, providing traders the perfect excuse to take year-end profits.

The demand picture is somewhat less clear. The two big questions (as is often the case with commodity demand) is China’s growing appetite for chocolate and the global economy. Overall, global economic growth has revived the demand for confectionaries. Will the growing Chinese middle class take to chocolate like their European and North American counterparts? Data provided by Euromonitor states that demand for cocoa increased 6.9 percent in Asia, primarily driven by China. The firm expects a 6.6 percent increase this year.

As the supply issues are structural and probably won’t change significantly at least for a few years, demand will drive the fundamental trader’s decisions. Should global economic growth continue and the Asia chocolate binge expand, prices have nowhere to go but up.

But How Many Bulls Are Left?

Despite the year-end selloff, the market remains quite long. Cocoa’s supply issues and strong demand are no secrets to anyone who has passively watched the market for at least the past few months.  A story in Seeking Alpha noted money managers continue to add to long positions and were net long 81,600 contracts in December compared with net long 63,700 contracts in September.

To keep this market humming higher, we will need a steady stream of bullish news from Africa and a strong looking chart.

Cocoa At An Inflection Point

Front Month Daily Cocoa Chart (March 2014)

Front Month Daily Cocoa Chart (March 2014)

Looking at the daily chart of the front-month New York cocoa contract, 2013 ended with consolidation near the year’s high and then a four-day breakout to the downside. On Friday, the market retraced some of those losses but it closed below near-term resistance around $2,730—the former support level during the market’s recent consolidation.

I’ll be looking to establish a long position if the market can return to the consolidation zone early this week, which will prove a false breakout. If harvest reports coming out of West Africa get worse, as analysts expect, they just may reignite bullish fever and help push cocoa above its 2013 highs. Keep in mind that the margin of error is small for the bulls with so much bullish news already priced in.

Of course, markets seem to top when bullishness sentiment is strongest and it has maintained a strong six-month uptrend, so I will remain wary for the time being until we can make new highs. What looks initially like a correction can quickly become a change in trend, often before most realize it. I may switch course and get short if the recent downtrend is confirmed.

Good luck out there!