MRCI would like to welcome Don Dawson as a new guest contributor! Don is an independent commodity futures trader with 35-plus years of experience. He has authored hundreds of articles on commodity markets and trading education and previously instructed futures classes for an international trading school for 15 years, where he received multiple awards. Learn more as a professional futures trader shows how he has used Moore Research for 15+ years!
Cocoa Market: Break or Fake-Out?
The largest cocoa producer is the Ivory Coast of Africa, with annual production exceeding 2 million tons per year, representing 40% of the country's export revenue. The region employs over half of its citizens in agriculture. The environment is perfect, with 75% of the land suitable for growing cocoa.
Cocoa futures trade on the Intercontinental Exchange (ICE) US and the ICE Futures Europe Exchange. Our analysis will focus on the ICE Futures US Exchange.
2023 has been a bullish year for cocoa prices, up 15%. Support from a weaker US Dollar, up 1% YTD, has contributed to this rally. The Ivory Coast government recently reported that producers sent a cumulative 2.05 MMT of cocoa to ports for the 2022/23 marketing year, down 3.8% y/y. The market has found support in reports from the International Cocoa Organization (ICCO) that the global 2022/23 stockpiles would fall, reducing supply.
Source: Moore Research Center, Inc.
While the fundamentals sound overly bullish, the weekly continuous September Cocoa chart illustrates a conflicting view. Cocoa has been trading in a sideways market for approximately six years. Currently, cocoa is approaching the top of this channel for the fourth time, and prior attempts were rejected lower.
Will cocoa break out of this monotonous channel, or will it fake out the bulls and return to the lower end of the channel again?
The Commitment of Traders (COT) Report Analysis
Source: Barchart
This chart represents overhead resistance (red box) just above the 6-year channel the market has been trading in. The COT report is below the chart detailing the net position of managed money (blue line) trading in the cocoa market. When the blue line is under the 0 line, managed money is net short the market. When the blue line exceeds the 0 line, managed money is net long the market. During non-trending price periods, the blue line oscillates on both sides of the 0 line.
Managed money traders are the second largest category of participants in the futures markets behind the commercials. Their trading style is trend following, when there is one, and can be informative in our analysis.
During sideways markets identifying prior peaks in price with the position size of managed money can tell when managed money is near an extreme position size. Looking to the left of the chart, some consistent peaks in position size (red arrows) appear to be around 51K more longs than shorts, and then the market retraces from there as money managers are not buying as aggressively.
The price has rallied strongly since last year without any significant pause. Managed money has built a substantial long position, 49,725 net long, as the price approaches overhead resistance and a 6-year channel high.
The question now becomes, how many more long positions will managed money put on this trade?
MRCI Seasonal Analysis
MRCI released its special report on Historical Softs for 2023. While reviewing this report, I found a well-timed seasonal analysis of the cocoa market that supported my previous research discussed previously.
Due diligence and risk management are essential when trading futures. Mindlessly taking a seasonal pattern is not recommended and may lead to excessive losses. My experience in using MRCIs seasonal analysis is to have supporting information from other market data research (fundamental and technical.)
Through extensive computer testing of historical data as far back as 30 years, MRCI has found this particular seasonal trade. The above chart is the 15-year average price pattern of the September futures cocoa contract. With the unusual strength of the cocoa market this year, the seasonal pattern has been overridden by more powerful fundamental events, thereby distorting the prior patterns.
After I analyzed the COT report and the monthly chart revealing a 6-year trading channel, I felt the upcoming seasonal sell had an additional edge.
MRCI has found that the September cocoa futures contract closed lower on July 22 (green arrow) than on June 12 (red arrow), 80% of the time over the previous 15 years. They never had a daily close in the red for three of those years. With 12 wins and 3 losses, the average profit was $560 per contract. Yes, there were losses during this period, but each trader should use their risk management skills to avoid excessive account size losses.
Historical details here: https://www.mrci.com/client/futures/strat/f5974.php
In closing……
The current trend is up, and the seasonal pattern is a sell; this becomes an immediate red flag as it's a counter-trend setup. Wisdom would suggest that confirming a trend change before entering is the rational thing to do.
MRCI creates optimal entry and exit dates but is not necessarily carved-in-stone dates. Use these dates with some leeway, both pre and post-the-dates. We're building a window of opportunity, not a rocket launch date.
An over-extended bullish managed money sector is coming into the cocoa market's 6-year channel high with overhead resistance beyond that and could create the price action we need, more supply than demand, to support this year's seasonal pattern.
