HardAssetsInvestor

Written by Brad Zigler  |

December 06, 2010

Cocoa Getting Hot

Details

Where's a value-minded commodity trader supposed to go in a market like this? With the

CRB Index—technically, the Thomson Reuters/Jefferies Commodity Research Bureau Index—gaining 12 percent this year, virtually every commodity's been bid up.

Virtually, but not every. There are a handful of contracts that have escaped the notice of speculators. One of them is cocoa. Check that. One of them was cocoa. Enough traders have taken note of cocoa to send prices pounding on the cellar door that's confined rallies since late October. This time up, however, there's some powerful mojo behind the mocha.

The nearby December ICE (IntercontinentalExchange) contract, which had been treading water around the $2,800 level for two months, snapped $200/metric tonne higher over the last two trading sessions.

Weekly ICE Cocoa

So, what's the mojo?

Tightening supplies. ICE warehouse stocks have plummeted by 2.1 million bags, or 44 percent, since March. The rapid drawdown is attributable, in large part, to New York cocoa's discount to London Liffe beans. That discount—$116/metric tonne on Friday—attracts bargain-hunting end-users, and as long as it persists, State-side stocks are likely to be whittled further. When the market's equipoise is finally lost, prices will be sent aloft. Where that tipping point is exactly remains the big question, but jawboning among traders seems to be focused on the 2-million-bag level. At last look, ICE stocks stood at 2.6 million bags.

Monthly ICE Cocoa Warehouse Stocks

Add to this a sodden realization that crop prospects for Ivory Coast and Ghana now seem overly optimistic. They're being dialed back as the effect of aging trees and poor soil conditions are more fully reckoned and weather conditions, which have been uncommonly benign, have become less favorable.

On the technical side, the market turned positive with Friday's bullish MACD crossover. With decisive closes above the $2,944 resistance level on the nearby contract, the $3,052 retracement plateau—an artifact of cocoa's 2009 decline—will be within reach. Once there, if there, front-month contract buyers have a fairly unobstructed path to another retracement milestone at the $3,160 level.

For security investors, the cocoa market can be accessed through the iPath Dow Jones-UBS Cocoa Subindex Total Return ETN (NYSE Arca: NIB), which closed at $41.63 Friday. A breakout move in cocoa translates to a near-term price objective of $45 for the notes, a level last visited in August.

The NIB note is fairly active as far as single-commodity ETNs go, with an average daily turnover of 8,400 notes since inception. Volume's stepped up in the last three months, though, to 19,900.

As cocoa's volatility has increased, intraday pricing of the iPath notes sometimes can appear sluggish. That's more likely if only the last sale price is monitored. Because of the time gaps between trades, there's a difference between the note's printed price and its real-time indicative value. That difference—typically 3 cents—has widened to 20 cents over the last two weeks.