Outside Forces Drive Cocoa Prices Up

Cocoa futures have picked up steam in recent sessions, driven by a weaker dollar and optimism that improving economic conditions could result in increased demand. After the International Cocoa Organization cut their expected deficit for the 2008-2009 growing season to 84,000 tonnes from 193,000 tonnes, sentiment turned extremely bearish. In fact, sentiment may have turned too bearish to the point where it actually became a bullish indicator. Industry buyers have seized the buying opportunity that was created after prices fell-off sharply from April highs and remained at relatively cheap levels.

There has also been some moderate spec buying due to inflation concerns. Other physical commodities have appreciated in value much more quickly than Cocoa, leading to spillover buying. The weaker US dollar has aided the rise in prices on two fronts. First, a weaker greenback is a sign that inflation may begin to speed-up, making physical commodities attractive to investors who wish to avoid the equity market. Secondly, a weak dollar and strong British pound creates an arbitrage opportunity between the London and New York Cocoa markets. The recent run-up in Cocoa prices, coupled with sharp moves in the currency markets, does make the market vulnerable to profit-taking pressure. Profit takers in both markets could cause prices to pull back in the near-term. The bullish economic sentiment is also rather fragile, as evidenced by the extreme volatility in the equity market. A string of negative economic data would likely put significant pressure on the Cocoa market.

Trading Ideas

The combined fundamental and technical picture for Cocoa seems to favor a neutral/positive outlook. The market is largely moving on outside market forces, rather than its own fundamentals, and the charts lack direction, which suggests that it may be wise for traders to take a cautious approach to this market. Traders who wish to be long the market may want to wait until the market posts several closes above near-term resistance at 2823, with stops near 2750. The 3000 mark could prove to be too great a psychological and technical barrier for the market to cross without fresh bullish fundamental developments. For this reason, traders possibly could choose to exit a long trade or tighten stops if and when prices approach 3000.

Technicals

September Cocoa remains range-bound on the daily chart, despite the recent rise in prices. Overbought conditions on the RSI, coupled with the market running into resistance at 2770, suggests a negative short-term outlook. Prices could come back to minor support around the 2600 level in the near-term. Failure to hold this support level suggests that prices may stay range-bound between 2300 and 2800. In order to break out of the sideways channel that has been in place since December, prices would have to close above 2832. Closes above 2900 could bring about a test of highs of 3385 made in July.