How To Marry Fundamental & Technical Analysis in Cocoa

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.