The Approach To The Cocoa Market Has Changed
Summary
- The bearish plunge took cocoa to the lowest price in a decade.
- Every rally was a sale.
- Supplies have been abundant, but demand is strong too.
- A correction since August 2017.
- Every dip could now be a buy.
Cocoa beans are the primary ingredient in chocolate confectionery products enjoyed by people all over the world. On the demand side of the equation for cocoa, the growth of the market China and the rest of Asia over recent years had supported the price. The price of the commodity that trades on the Intercontinental Exchange reached a low of $1898 per ton in 2011. While many other raw material prices declined from 2012 through late 2015 and early 2016, the price of cocoa went the other way and reached a high of $3422 per ton in December 2015.
As many people in China began to enjoy the pleasures of a chocolate treat, the rally during a challenging time for the commodities asset class was demand-based. Meanwhile, on the supply side of the market, over 60% of annual supplies each year come from the West African countries of the Ivory Coast and Ghana. Cocoa beans tend to thrive in equatorial climates and in these two nations; it is the cocoa business that employs a large percentage of the workforce.
Like all agricultural commodities, the weather and crop diseases each year determine the total crop. However, the politics and economies of West Africa present unique issues at times when it comes to political stability. It is one thing to grow and produce a crop, but often another to transport cocoa beans to ports for export around the world. During periods of political instability such as military uprisings, coups, and other events, even a bountiful crop can rot in the hot African sun.
Corruption in these nations can also cause problems for the cocoa business at times as it is often rampant in West Africa. Over recent years, lots of investment from around the world has improved technology when it comes to cocoa production, but as an agricultural commodity, the primary ingredient in chocolate often suffers from additional concerns because of the region of the world where production occurs.
From 2011 through late 2015, a demand-based bull market took the price of cocoa beans higher and while the price experienced periods of volatility, almost every price dip and selloff was a buying opportunity. Starting in 2016, the price of cocoa went the other way as cocoa moved to its lowest price since 2007.
The bearish plunge took cocoa to the lowest price in a decade
The price of ICE cocoa futures reached a high of $3422 per ton in December 2015. 
Source: CQG
As the monthly chart highlights, cocoa plunged from highs to lows of $1769 per ton in June 2017. Cocoa moved to the downside because of two critical factors. First, supplies from West Africa and other producing regions of the world rose as technological advances in production combined with excellent and disease-free growing conditions to create abundant crops. While demand from Asia continues to rise, supplies overwhelmed the demand side of the fundamental equation sending prices lower.
Second, the Brexit referendum in June 2016 caused the British pound to plunge from the $1.50 level to lows of around $1.20. The hub of the international cocoa market is in London, and many physical transactions use the British currency as a pricing mechanism. As the pound plunged, the price of cocoa in sterling terms caused additional selling pressure on the market.
Every rally was a sale
Cocoa went through a period where every price dip was a buying opportunity from 2011 through late 2016, to a time when every rally was another chance to sell as the soft commodity not only trended lower from June 2016 through June 2017, it fell off the side of a bearish cliff. Selling cocoa short for the year-long period was a winning strategy for any market participants with the patience to wait for small rallies to jump in on the short side of the market.
Cocoa finally hit a low in June at $1769 per ton and retested close to that level in July when the price made a higher low at $1780. All the while, the fundamentals of the market pointed to price weakness.
Supplies have been abundant, but demand is strong too
Bumper cocoa crops and only marginally increasing demand data from grindings led the price to continue to test lows over this past summer. However, commodities prices are cyclical and at prices that were close to half the level seen in late 2015; producers have lost a lot of their profitable mojo at the lows and even at current levels. Over recent months, the Ivorian government ran into problems with the military as declining cocoa revenues caused the inability to make payments to soldiers.
In some cases, logistical issues in the nation occurred as soldiers blocked critical logistical routes that carry crops to port causing short-term price corrections to the upside. However, in the world of commodities, when prices decline to levels where production slows and becomes less economic, inventories tend to decrease, demand increases and prices turn higher. Since the middle of August, we have seen many signs that cocoa found a bottom at the $1769 per ton level.
A correction since August 2017
The correction in cocoa began in mid-August, and since then it appears that selling every rally has become a losing proposition for market participants. 
Source: CQG
As the weekly chart shows, ICE cocoa futures have been making higher lows and higher highs since the middle of August. The most recent price peak came on October 20 when December futures traded to a high of $2160. Cocoa is now coming close to an area of technical resistance at the highs from the weeks of March 20 at $2187 per ton.
Cocoa futures had already broken the pattern of lower highs when the price moved above the June highs at $2083 in late July, and since then the highs have been getting higher with marginal new peaks on each rally. December ICE cocoa futures were trading at the $2138 level on Wednesday, November 1, 2017.
Every dip could now be a buy
When it comes to trading or investing in commodities using the futures or ETF/ETN markets, timing is everything. In markets like cocoa, which tend to back and fill during bullish and bearish trends, buying highs or selling lows tends to be a strategy that leads to aggravation and stress at the best or losses at the worst.
The price action in the cocoa futures market now looks like we have entered a period where the market is set to continue to make higher lows and higher highs. The trend has once again shifted to the advantage of the bulls, but it will not likely go higher in a straight line unless a supply problem develops. Buying rallies in cocoa these days is a low-odds strategy. To optimize results, buying on dips when the price action looks lousy and taking profits on rallies could yield the best and most profitable opportunities.
Cocoa has a long history of backing and filling within a price trend on the upside. The NIB ETN product does a reasonable job replicating price action in the cocoa futures market for those who do not venture into the rough and tumble, leveraged world of ICE cocoa futures and options. The optimal approach to the cocoa market appears to have changed once again to buying on dips rather than selling on rallies.
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This article was written by
Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup.
Over the past two decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities.Andy understands the market in a way many traders can’t imagine. He’s booked vessels, armored cars, and trains to transport and store a broad range of commodities. And he’s worked directly with The United Nations and the legendary trading group Phibro.
Today, Andy remains in close contact with sources around the world and his network of traders.
“I have a vast Rolodex of information in my head… so many bull and bear markets. When something happens, I don’t have to think. I just react. History does tend to repeat itself over and over.”
His friends and mentors include highly regarded energy and precious metals traders, supply line specialists and international shipping companies that give him vast insight into the market.
Andy’s writing and analysis are on many market-based websites including CQG. Andy lectures at colleges and Universities. He also contributes to Traders Magazine. He consults for companies involved in producing and consuming commodities. Andy’s first book How to Make Money with Commodities, published by McGraw-Hill was released in 2013 and has received excellent reviews. Andy held a Series 3 and Series 30 license from the National Futures Association and a collaborator and strategist with hedge funds. Andy is the commodity expert for the website about.com and blogs on his own site dynamiccommodities.com. He is a frequent contributor on Stock News- https://stocknews.com/authors/?author=andrew-hecht
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