#$nib

Cocoa tends to begin a seasonal decline in early to mid-March through the end of May (shaded in yellow below), instituting a short position in our seasonal best-trade category. Selling on or about March 14, right before St. Patrick’s Day and holding until on or about April 17, for an average holding period of 23 trading days, has been a winner in 34 of the past 45 years. Even in the face of the 2008 great commodity bull-run, this seasonal trade worked with a potential profit of $1,730 per contract. Since 1997, this trade has only posted three losses.

Cocoa has two main crop seasons. The main crop from the Ivory Coast and Ghana in Africa accounts for approximately 70% of the world production and runs from January through March. As inventories are placed on the market, this has a tendency to depress prices, especially when demand starts to fall for hot chocolate drinks and chocolate candy in the spring and summer time. For most of last year, cocoa was essentially stuck in a trading range from around $1800 to $2200.

Cocoa tends to begin a seasonal decline in early to mid-March through the end of May (shaded in yellow below), instituting a short position in our seasonal best-trade category. Selling on or about March 13, right before St. Patrick’s Day and holding until on or about April 16, for an average holding period of 23 trading days, has been a winner in 33 of the past 44 years. Even in the face of the 2008 great commodity bull-run, this seasonal trade worked with a potential profit of $1,730 per contract. Since 1997, this trade has only posted three losses. 

Speculators have turned net-short on cocoa futures for the first time in years -- just as prices are testing major long-term support.

If you’re still looking for last minute gift ideas for that trader on your list, a few shares or contracts in cocoa may do the trick. That’s because the sweet commodity may be well-positioned for a bounce following a 12-month rout. First, let’s look at prices as determined by the iPath Bloomberg Cocoa Subindex Total Return SM Index ETN, ticker, NIB. NIB is presently testing the 27-28 level that represents the fund’s all-time lows set in 2011-2013.

Even if this 27-28 level eventually gives way, one would expect it to hold at least temporarily given that this is the first test of the level in almost 4 years.

Another thing cocoa has going for it, especially if prices are able to hold here and begin to bounce, is the current positioning among cocoa futures traders. From the CFTC’s Commitment Of Traders report, you can see on the bottom half of the chart that for the first time in four and a half years, Non-Commercial Speculators have moved to a net-short position.

These Speculators, who are made up mainly of commodity and hedge funds, are primarily trend-followers meaning the more prices trend in one direction, the bigger the position that they will adopt. That’s all fine and well as long as the trend continues. However, these Speculators are also notoriously wrong-footed at major turning points, especially when positioned to an extreme. And while they have had larger net-short positions in the past, since this is their first net-short in 4 and 1/2 years, it certainly represents an extreme in recent years.

Furthermore, net-short positions have not worked out well for Speculators in the past. Net-short positions in 2008, 2010 and 2012 preceded rallies in the NIB of 37%, 67% and 35%, respectively, though the 2010 version did take a few months before a rally kicked in. If prices are able to hold the support level mentioned and begin to tick higher, it will put pressure on the Speculators to cover their shorts and begin adding to the long side. This should serve to perpetuate any budding rally in cocoa prices.

So if you need any last minute gift ideas for your trader friend with a mean-reversion bent, the setup in cocoa looks potentially pretty sweet right now.

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More from Dana Lyons, JLFMI and My401kPro.

Cocoa tends to begin a seasonal decline in early to mid-March through the end of May (shaded in yellow below), instituting a short position in our seasonal best-trade category. Selling on or about March 13, right before St. Patrick’s Day and holding until on or about April 16, for an average holding period of 23 trading days, has been a winner in 32 of the past 42 years. Even in the face of the 2008 great commodity bull-run, this seasonal trade worked with a potential profit of $1,730 per contract. Since 1997, this trade has only posted two losses.

Unlike many commodities that have been getting crushed lately, Cocoa has been able to avoid the meltdown (so to speak). Through September, the iPath Cocoa ETN (NIB) was up a 22% for the year. And while its uptrend remains intact -- and we are not about to fight it too forcefully -- there are 3 reasons why a bittersweet counter-trend pullback may be in store for the commodity.

First, from 2011 to 2013, NIB dropped by almost 50%. Its recent rally has now reached the 61.8% Fibonacci Retracement level of that decline in the past few days. This can present a major hurdle for even the strongest of trends.

Secondly, looking at the Commitment of Traders report in Cocoa futures, we note that dealers' net position is now close to a record short level (set earlier this year). And while dealers have been on the wrong side of the trade so far for much of the year, they are typically positioned correctly at major turning points.

Lastly, looking at seasonality we note that October is historically the weakest month for Cocoa. And it isn't close as the following chart from sentimentrader.com shows. Cocoa is down roughly 30% of the time in October, to the tune of about 2.5%, on average.

While we would not stick a fork in the Cocoa rally without some price evidence first, considering the three points made above, we wouldn't exactly call this a sweet spot of a long entry either.

And a bonus -- this was one cocoa post without the word "ebola" in it...almost.

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"Raw Cocoa Nibs" photo by Joana Petrova.