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I was viewing last week's Commitment of Traders (COT) report, released by the CFTC each Friday afternoon with the data from the previous Tuesday. The report divides traders up into large speculators, commercial hedgers, and the residual of non reportable positions are considered small speculators.

The commercial hedgers have traditionally been viewed as the smart money and strong hands; they know the supply and demand of the industry they operate in. Large speculators have been funds, using various methods but typically following some trend following algorithm. The small speculators are regarded as the weak hands, not well capitalized, and typically loosing over time.

Several years ago the CFTC started a supplement commodity index (CIT Report) for some agricultural commodities since speculators began using ETF's, instead of directly positioning in the futures markets. The banks that sponsored these ETFs would then classify themselves as commercial hedgers in order to receive better financing. This then lead to an upheaval in the report since the composition had drastically changed. The supplemental CIT report once again let speculators glean what the smart money and strong hands are doing. The ETF investors are classified as "Index Traders" and the commercials reported are again bona fide industry hedgers.

Recently, the "smart money" commercial became net long the Cocoa market as of October 4th, with this net position going about flat as of October 11th. Below is the data for just the commercial position from the CIT report at various times. One can see how the commercials had a large net short at the August high and became net long one day after the most recent October low, on October 3rd.

Date Long Short
8/23/2011 Contracts 89,459 111,742
% of Open Interest 47.7 59.6
Difference % -11.9
10/4/2011 Contracts 113,768 111,830
% of Open Interest 49.5 48.6
Difference % 0.9
10/11/2011 Contracts 116,141 116,977
% of Open Interest 49.1 49.5
Difference % -0.4

This leads me to begin to look for long entries. The traders who know the supply and demand fundamentals the best have begun to believe that the recent prices offer some buying value under current conditions. If Cocoa prices again sell off in a Macro "risk off" trade keep looking to see what the net commercial position is in the CIT report. The same report showed the small speculators having switched from a 2000+ contract long position at the August highs to a 2000+ contract short position as of October 11th.

click to enlarge

Speculators who do not have a futures account can use the iPath Dow Jones-AIG Cocoa Total Return Sub-Index ETN (NYSEARCA:NIB) to trade the Cocoa market. Since commercials are well capitalized they can withstand a larger drop and will keep averaging in their buying. Their time horizon is much longer than speculators, so this is by no means a slam dunk trade - manage the risk with stop losses. If one is short I would suggest tightening up those stops and booking profits on part of the position, since the smart money is not on the short side in the size it once was.

Looks like it is time to start enjoying a cup of Cocoa in the evening, along with anything else to "kick it up" a notch!

Source: Cocoa Commercial Hedgers Nibble On The Long Side

Additional disclosure: I might also buy Cocoa futures & options