Martin Kronicle

Bullish fundamentals and a “123 Trend Reversal” in cocoa means one thing: Chocolate Easter Bunnies are heading higher.

Bloomberg’s Elizabeth Campbell reported an excellent story on softs the other day called Cocoa Prices Rise on Supply Outlook; Cotton Falls, Coffee Gains.

Let’s forcus on the cocoa for now. I’ve annotated her story with some notes of my own (in blue) as I seem to trade the softs more frequently than other commodities. Information like this is can be considered Fundamental analysis.

March 30 (Bloomberg) — Cocoa rose to a five-week high on signs of reduced supply in Ivory Coast, the world’s largest producer, and on speculation that demand will increase as the economy improves.

Ivory Coast farmers delivered 8,464 metric tons of cocoa beans to Abidjan and San Pedro ports in the week ended March 21, 36 percent less than a year earlier, an industry official with access to the data said. Growers say low rainfall has hurt crops. Swollen shoot disease also has cut production, according to the state-run Bourse de Café et du Cacao.

“Swollen shoot” and “witches broom” are two known diseases that destroy cocoa crops. The best you can do is cut the trees down and burn them save the virus’ spread to other trees. Commodities Corporation founder Helmut Weymar wrote about them in his doctoral thesis (I’ve read it a dozen times) in 1965, so they are not new by any means, but are just as devastating to the cocoa crop.

“Supply may be somewhat reduced,” said Dennis Cajigas, a senior market strategist at Lind-Waldock in Chicago. Ivory Coast is “marginally below pace from last year,” he said. “Concerns over weather and disease suggest they may not keep pace.”

Cocoa for May delivery gained $39, or 1.3 percent, to $2,964 a metric ton at 9:51 a.m. on ICE Futures U.S. in New York, after earlier touching $2,980, the highest price since Feb. 23. Before today, the commodity declined 11 percent in the first quarter.

So now you have a bullish case for cocoa on the fundamental side as reported by Ms. Campbell. You can think of that as the Pilot, and the technical analysis as the navigator: How do you trade the cocoa? When do you get in? Is this a time for a spread trade?

First, what is the market telling us? Based upon the chart below, you can see that each successive month is higher in price than the previous month. As I mentioned in Sir Richard Branson’s 2015 market call on Crude oil, this is known as a carry-charge market and it’s said to be in contango. Markets in contango are saying “store me, we have enough for the time being.” (click to enlarge).

Second, I looked at the cocoa market charts and there’s a lot happening. As it turns out, there is what Victor Sperandeo calls his “123 Trend Reversal” in cocoa right now.

There are three defined stages of the 123 Reversal as delineated in his book Methods of A Wall Street Master (click images to enlarge):

1. The trendline is broken.

2. The trend stops making lower lows (or higher highs) and tests the lows, but fails to put in new lows. Support is held.

3a. Prices have risen above a near-term rally high.

3b. You can see in the red circle the breakout to the upside. A change in trend has occurred.

The great traders such as Paul Tudor Jones and Bruce Kovner utilize both fundamental and technical analysis. You can be a trend follower and utilize both, you don’t have to simply focus on mechanized trading systems based on technical indicators.

Keep in mind, cocoa has no daily price limits. Proceed at your own risk.

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I answered a question on LinkedIn the other day and I thought it might make sense to get a discussion going here or on Facebook.

Question:

Are contrarians and trend followers fundamentally different in how they view the market or do you think that a contrarian trader is simply a momentum trader thinking in terms of the 1st derivative of the market price time series?

My Answer:

Another way to look at the behavior of contrarian investors/traders is that they emphasize/discount a specific hueristic that the “crowd” is not and therefore seem that they are contrarian or going the other way.

For example, say the crowd is ultimately bullish on gold. One thing that a contrarian might focus on is the ability for a central bank to sell gold at today’s prices and act accordingly. The bulls know that central bank selling is possible, but the contrarian might have more focused or special insight on this potential phenomena…even if it’s only a gut feel.

It’s important to note that it’s not until AFTER the central bank sells that the msm will report that gold bulls/bugs got killed and contrarians made out well.

In my experience, contrarians are just men and women who can think for themselves and don’t necessarily think of themselves as contrarians, just unique in their thought processes.

Michael Mauboussin of Legg Mason is a great thinker and writer. I’ve read his newsletters for years and I’ve read all of his books. Here he is during an interview with the The New Yorker on the release of his most recent book, Think Twice.

I’ve said that emotional intelligence and self-awareness make up the majority of trading profitably. I think Mauboussin’s work speaks to that and you’d be well-advised to read as much of it as you can.

Hat tip to Barry Ritholtz.

Interesting article on Yahoo! Finance via Wall St. Journal by Brett Arends called The Turkey Principle. In it, he talks about buying stocks of your favorite places where you dump your disposable income:

For two decades, many private investors have been trying to get rich by blindly buying shares in their favorite stores, restaurant chains and the companies that make their favorite products. They were following Peter Lynch’s advice to invest where they shopped. Mr. Lynch, the former manager at Fidelity’s Magellan fund, made this notion the cornerstone of his 1989 best seller “One Up on Wall Street.”

During the bull market of the 1990s, investors did OK. But then, everything went up anyway. In the last decade the results of following this strategy have been mixed — or worse.

I agree with Mr. Arends. Immediately coming to my mind is the quote attributed to Paul Tudor Jones: Price moves first and the fundamentals follow.

- Many who invested in Fidelity Magellan (FMAGX) lost money while Lynch ran it. They decided to trade the fund’s shares.

- Investors who bought FMAGX the day before the crash in ’87 got the worst of it: they lost huge NAV and they got a tax bill on top of it for all the capital gains that Lynch took during the sell-off b/c he needed the cash to meet redemptions.

- People who buy AAPL b/c they think Steve Jobs is an incredible genius will lose money as investors.

- People who buy CSCO b/c it’s “the backbone of the internet” may need a chiropractor before they make any money.

If you are compelled to buy things that you know and love for whatever reason, you may be lucky and make money. But have an “uncle” point: a price where you’re out no matter what you think or read about the company. That’s in the best of times. You will really get hammered when all of your holding go south at the same time. In those times, cash is king.

Cisco Case in point

I owned CSCO for myself at the turn of the century (see chart above). I didn’t know a lot of the fundamentals, but I knew generally that Cisco was a major player in the internet space. However, despite what I thought I knew, or what the street thought, the price tells you everything that you need to know about a security. If everyone loves it, it will rise. If there is fear or people are scared about anything, they will sell.

I chose an uncle point at $75 for no other reasons that it was where I was willing to transfer the risk to someone else and take my small loss. I figured I could always get back in at a higher price.

Little did I know that it would never reach $75 ever again (and that’s 10 YEARS AGO!). Looking at the chart, I’m a lot happier being out at $75 than still in it (and my ego) hoping for it to come back. Hope is a wasted emotion in trading and investing. It doesn’t serve you unless you like the feeling of hoping all the time. Then I’d suggest you keep doing it until you figure out what the feeling is trying to tell you. (Like, learn how to better manage risk dude…)

During this time, Fortune magazine has named CSCO the #1 name it their industry several times. So when you hear some jackass MF manager say “we sell when the fundamentals change” don’t give them a nickel. Give them a grin, and firm handshake, and your other hand on their shoulder as you tell them “thanks for the wonderful insight.”

Remember what Paul Tudor Jones said: Price moves first, and the fundamentals follow. Always have a sell discipline, especially if you’re a long-only investor. True for stocks and mutual funds…and a way of life with commodity futures.

Staying in a losing position can mean several things, but 2 come to mind:

- You have a big ego and don’t like being wrong
- You don’t know how to manage risk at all

I have no positions in the securities mentioned in this blog post.