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)
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!