Cocoa prices 'bearish' after slump, with traders relying on algorithms to predict futures

Cocoa’s wild run this year means traders have had to come up with more money to pay margin calls, forcing them to close out positions. According to the exchange data compiled by Bloomberg, the aggregate open interest in New York cocoa, or the number of outstanding contracts, has fallen to the lowest since 2011.

Before the recent market downturn, cocoa futures, which serve as a global benchmark for bean pricing, had surged in value this year. This was largely due to adverse weather conditions and disease outbreaks in key cocoa producers Cote d’Ivoire and Ghana, as reported by Reuters.

"Nigeria, another major producer, reported a rise in cocoa exports, further adding to overall supply. These factors led to a price correction, with cocoa futures dropping over 25% in just two days, said Bernard Kidioh Anchang, ofi cocoa sourcing officer.

In April, Futures almost hit an eye-watering $12,000 a ton, but they have since slid to near $7,500, offering some relief to buyers.

'Tulip craze'​

Jim Roemer, a respected meteorologist, and commodity trading advisor warned a few weeks ago that investing in cocoa during a 400% rally would be a grave error. He predicted prices could mirror the infamous 'Tulip Craze' of the 1600s.

He explained in his newsletter that Dutch Tulip trading is the first well-documented speculative commodity bubble.

“The same thing has just happened to cocoa prices,” he said. “For cocoa, this is the time of the year that the smaller West African Mid-crop hits the market. This often results in hedge fund selling occurring ahead of and during harvest.”

Bullishness

He argued that most of the bullishness in cocoa was already built into prices. “This is something I have been preaching to my newsletter clients for a couple of months. That the 'seasonals'would ultimately become bearish [believing that a market, asset or financial instrument is going to experience a downward trajectory] for cocoa.”

Reuters reported that cocoa’s ascent left many physical market players out of pocket and has even driven hedge funds away, dealers said, leaving the futures market in the hands of algorithmic funds programmed to follow similar technical signals.”

Without liquidity, these funds exaggerate price swings on both the upside and downside. Buying more physical cocoa would require traders to hedge their purchases in the futures market, just as the spike in volatility forces them to put up more money to cover margin calls, Bloomberg reported.

"Is there a concrete bit of news that drove the market here? No," Jonathan Parkman, head of agricultural sales at Marex, told Reuters.

The current cash crunch is now forcing traders to delay purchases from the top producing countries such as Ghana and Cote d’Ivoire, which means already struggling farmers won’t be paid.

The good news is that recent rains in West Africa could boost the mid-crop harvest, and both countries have reportedly raised the price paid to farmers in a bid for them to grow more increasing the supply of beans  back to the market.

• Additional sources: Reuters, Bloomberg, Barchart.​