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May cocoa fell to a fresh 6 1/2 month low yesterday. The market closed at the lowest settlement price since August leaving long-term downside price risk in place. With the fundamental outlook turning increasingly bearish, eventually we see May cocoa falling back towards the $2,600 price level. However, based purely on technical signals, May cocoa may be able to stage a bit of a recovery soon given the market’s extreme oversold condition. We don’t expect this to be much more than a dead cat bounce since a bearish long-term chart formation, a rising supply outlook and lack of investor interest will likely combine to keep the market’s downtrend in tact. May cocoa set a double top at the December and January highs and retracement targets of the contract low (November 2008) to high range are at $2,748 and then $2,567. The odds of the market continuing to trend lower seem to have improved yesterday after the ICCO forecasted a bearish shift in the market’s fundamental setup for next season. The ICCO’s executive director is forecasting a global cocoa surplus of as much as 90,000 tonnes for the 2010/11 season compared to an 18,000 tonne cocoa deficit predicted for 2009/10. The ICCO sees global cocoa output rising by 5% next season and at twice the growth rate of global grindings citing the likelihood that high cocoa prices, which hit a 32 year high in the NY market in January, will promote higher production under normal weather conditions. It is interesting to note that the cocoa market’s dip to a new low for the move yesterday apparently didn’t attract any fresh industry buying. Perhaps after the ICCO predicted a much higher forecast for the Ivory Coast mid-crop of between 310,000 and 320,000 tonnes, chocolate manufacturers may decide to stay on the sidelines in anticipation of lower prices into the April harvest which could leave the cocoa market without a strong price floor. ICE cocoa warehouse stocks stand at 4.540 million bags, down 7,499 bags.

TODAY’S GUIDANCE: The cocoa market remains highly influenced by the currency trade and with the Pound under pressure in the early overnight action it leaves May cocoa at risk of retesting yesterday’s low. Currency influences may need to turn more supportive before any significant technical bounce in cocoa is seen.

TODAY’S MARKET IDEAS: While we see the trend continuing down, traders also need to be mindful that cocoa is overdue for a technical bounce and short position holders may want to have trailing profit stops in place.

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May cocoa’s chart remains weak and after yesterday’s downside breakout the market looks to be on track for an eventually slide to test the $2,750 price level. A good portion of yesterday’s selling in cocoa looked to be currency connected. Cocoa fell on arbitrage related selling tied to the Pound which slid to a 10 month low and was under pressure after a political poll suggested no UK party would win a majority in parliament in the upcoming general election. May cocoa may have some ability to bounce this session depending on the currency action, but in the early overnight action the Dollar has continued to gain against the Pound and Euro and that could keep cocoa under pressure. We still see the upside for cocoa limited by the market’s fundamental and technical setup which will leave downside price risk in place. May cocoa has fallen back from 30 year highs reached in January as it is becoming increasingly apparent that this season’s Ivory Coast crop will be larger than last year. The main Ivory Coast harvest is winding down and arrivals to ports are running 4.6% ahead of last season. While the Ivory Coast’s cocoa marketing body reported that the main crop cocoa harvest would likely end up below the 5 year average of 885,000 tonnes, traders seemed to be focusing on the fact that supplies will be bigger than last year given the improved prospects for the upcoming mid crop. After seeing a good mix of rain and sun over the last month some industry forecasters are significantly raising the outlook for mid-crop production and part of the liquidation selling seen in cocoa yesterday was certainly tied to the supply side news. Even the political situation in the Ivory Coast is calming down and that will remove a geopolitical threat from the cocoa market. While the supply outlook for cocoa has improved, sentiment in cocoa has been damaged by ongoing concerns that high sovereign debt levels in Europe and the UK will hinder the economic recovery in major chocolate consuming regions. ICE cocoa warehouse stocks stand at 4.363 million bags, up 32,751 bags.

TODAY’S GUIDANCE: Yesterday’s price action in May cocoa was technically bearish. Based on the contract low (November 2008) to high (January 2010) range, a 50% retracement comes in at $2,747 while a 61.8% retracement comes in at $2,566. With funds still holding nearly 28,000 contracts net long as of early last week, cocoa would seem to have ample selling capacity and that may push the market toward $2,750 before a significant technical bounce is seen. The May contract could trade as low as $2,566 if there is a bumper Ivory Coast mid-crop.

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While May cocoa continues to trade within a well defined range, yesterday’s price action also shows a lack of strong speculative buying interest in this market. Cocoa fell despite a weaker trade in the dollar yesterday and it couldn’t attract strong enough buying interest to even lift the market back to resistance at $3,188. The latest COT report with options for cocoa shows speculators continuing to reduce their net long position, particularly managed money and trend following funds. May cocoa lacks upside traction even though there continues to be reports of more widespread and violent political protests in the Ivory Coast and that clearly shows the government upheaval isn’t thought to be a supply threat yet. Since the main harvest in the Ivory Coast is nearly complete and production continues to outpace last year’s levels, the political turmoil in the Ivory Coast has not become a bullish catalyst, especially since good growing conditions for the mid-crop leave the supply outlook favorable. It must have also been disappointing for the bull camp yesterday to see cocoa slump despite a major cash trading company predicting world cocoa demand to rise marginally this year. The London cocoa market is looking a bit shaky and overbought at these higher price levels following a sizable rally from the February low. If the London market starts to back peddle, it will likely end up being a factor that drags the NY cocoa market lower. ICE cocoa warehouse stocks stand at 4.227 million bags, up 84,887 bags.

TODAY’S GUIDANCE: The weaker trade in the Dollar overnight seems to be providing cocoa with some early price support. But so far the currency action hasn’t been enough of an influence to push May cocoa out of the $2,988 to $3,200 price range. Unless the political situation in the Ivory Coast begins to impact cocoa business, May cocoa appears to lack a bullish catalyst to support a significant move higher.

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With the market still trading off technical signals, price action hints that a short covering bounce may be imminent. Daily technical indicators have fallen to an oversold extreme and seeing May cocoa hold another test of support near the $3,000 price level, which is also around the 200 day moving average, suggests the aggressive selling seen last week may be drying up for now. Trading in cocoa has been dominated by spread and rollover activity ahead of the March contract’s first notice day on Friday. Outside markets haven’t had much impact on cocoa trading recently and that also reflects a decline in speculative interest in this market. Cocoa was able to close a bit higher yesterday despite a firmer Dollar/weaker Pound trade. This usually has a tendency to pressure the cocoa market. But a recovery bounce in the London cocoa market may have provided some spillover support to NY cocoa on Wednesday. While we suspect the odds are growing for a recovery bounce in cocoa, the upside potential seems limited and gains may be short lived since the fundamentals aren’t particularly supportive. In fact, the industry news out yesterday was generally bearish. Asian cocoa butter ratios traded at the lowest level since 2002 and dealers only expect hand-to-mouth buying despite the upcoming Easter holiday. Ivory Coast domestic cocoa prices paid to farmers have also dropped as exporters have become less concerned about a supply shortfall this season. A London bank is predicting a 5,000 tonne global cocoa surplus for the 2010/11 season.

TODAY’S GUIDANCE: With short-term technical indicators falling to oversold extremes it raises the odds for a recovery bounce. The first retracement of the January high/February low range is at $3,188. But the lack of speculative interest in cocoa recently suggests a technical bounce could end up being short lived and provide a fresh selling opportunity unless a new bullish supply side catalyst surfaces.

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Cocoa has edged lower in the early overnight trade with a weak Pound adding to the selling bias that was firmly in place last week. May cocoa has been swept sharply lower from the January high by heavy liquidation pressure tied to a shift in the fundamental outlook, bearish currency influences and a harsh political regulatory environment which could keep the bear camp in control a bit longer. With May cocoa closing under the December low and below the 100 day moving average for the first time since June 2009, downside price risk remains in place. A retreat back to $3,143 can’t be ruled out if May cocoa fails to hold support at $3,200. With the highs in December and January looking more like a quasi double top, May cocoa’s close under the 100 day moving average may be pointing to a broader bearish technical setup. Cocoa fell last Friday despite 4th quarter US GDP growing at the fastest pace in over six years which could have raised optimism for a recovery in chocolate demand. Instead, cocoa still looks to be under pressure from the weak North American grind which fell 1.5% last quarter and is a clear indication that general US economic strength didn’t provide a demand boost in the US cocoa sector. Heavy selling in cocoa has also been inspired by the bearish currency action with the Dollar Index rising to a 5 month high last week. A stronger dollar diminishes the appeal of cocoa as an alternative investment. Macro economic uncertainty following China’s steps to tighten bank credit and the slide in US equities also has investors scaling back risk and this has been sharply felt in the cocoa market. The January 26th COT report with options for cocoa showed the combined fund and spec net long position at 48,460 contracts as of early last week, but this reading is certainly overstated since the market has fallen by nearly $180 per tonne since the report was measured. We still suspect part of the selling in cocoa has been tied to the sovereign debt problems facing Europe and the UK which could undermine growth prospects and demand in key chocolate consuming markets. Although Ivory Coast cocoa bean arrivals to ports are expected to trail off this month, supply side issues so far haven’t provided any price support.

TODAY’S GUIDANCE: It’s clear from the price action that traders are recalculating a weaker demand outlook in the fundamental setup for cocoa and that could pull May cocoa back to the November low unless macro economic optimism can be revived or a bullish supply side catalyst surfaces.

TODAY’S MARKET IDEAS: The price action in May cocoa continues to favor the bear camp and the close under the 100 day moving average (the first time since June 2009) may be signaling a more significant change in the market’s technical pattern. Overhead resistance is at $3,283 then $3,330. If May cocoa fails to hold support at $3,200 the next target will be $3,143.

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Cocoa made impressive upside move yesterday on strong speculative buying tied to positive chart signals and bullish expectations ahead of the North American grind data. While the chart pattern remains positive as the market closes in on the December high, the market has become a bit overbought leaving futures vulnerable to selling. Yesterday’s market action suggests traders were likely pricing in expectations for the North American grind to show a small gain. With the National Confectioners Association reporting the 4th quarter North American grind fell a slight 0.02% from the 4th quarter in 2008, the news may inspire some profit taking. While it was impressive to see the cocoa market trade higher yesterday despite the bearish currency and equity action, it was also clear that the market was being pulled higher by the strength in the London trade, which lifted that market to a fresh 32 year high. And we suspect upside leadership from London will continue to be a key driver for higher trade in the NY market. Gains in both NY and London yesterday may have been partly based on reports of rising domestic Ivory Coast prices as buyers scramble to secure tightening supplies amid ongoing concerns that bean supplies will be scarce next month due to dry conditions. Expectations for another global production deficit to be seen this year has been a driving force lifting the market to 30 year highs last month. Still, seeing March cocoa close with only modest gains yesterday also suggests the market isn’t completely immune to outside market influences. In fact, we are a bit concerned that the price action in cocoa could become more volatile and two sided up at these price levels leaving March cocoa at risk if general commodity sentiment continues to sour. We also suspect the bull camp’s resolve will be tested today since we suspect some traders will see the North American grind as being a bit disappointing.

TODAY’S GUIDANCE: Strong fundamental optimism gives March cocoa the potential to eventually trade above the December high. But in the short run, we are concerned that a somewhat disappointing North American grind along with macro economic issues may give traders a fresh incentive to take profits. However, if the weak price action in the Dollar gains traction, it could provide an offset to the grind news.

TODAY’S MARKET IDEAS: The slight drop in the North American grind may be enough of a disappointment in a market that has also become short-term overbought to trigger profit taking in March cocoa, especially since general commodity market sentiment has turned a bit negative this week.

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While yesterday’s higher close in March cocoa would seem to give a technical signal of an upside breakout of the consolidation range, the market continues to have difficulty gaining upside traction. In fact, the weak price action overnight suggests price gains will continue to be hard fought. Part of yesterday’s move in cocoa looked to be currency connected and with the dollar trading a bit firmer in the early overnight action, it will be a challenge for cocoa to follow through higher unless outside market influences turn more supportive. Cocoa rallied yesterday as the Dollar slid on expectations for US interest rates to stay low for a considerable length of time and if that attitude holds, rising investor risk appetite for alternative investments could funnel fresh fund money back into the cocoa market. The January 5th COT report with options for cocoa showed managed money funds further reducing their net long position. But with the market’s technical setup turning positive, trend following funds could become active buyers again if the market can take out overhead resistance. A firm London cocoa trade may be just as important to providing a further lift to NY cocoa since the price action in two markets have been closely tied. It was impressive to see the London cocoa market gain yesterday despite the strength in the Pound since this type of currency action can at times weigh on London market. A bullish environment for commodities is also being cultivated by signs of improving macro economic conditions being reflected in the latest trade news from China which could also benefit cocoa if the outlook for chocolate demand starts to improve. Simmering concerns over Ivory Coast harvest supplies is another factor that continues to underpin cocoa which may soon be pushed to the front burner. A report estimating the weekly cocoa arrival rate to Ivory Coast ports showed a week to week decline in cocoa arrivals and news of dry conditions in certain growing regions may also spark some additional fundamental buying interest in cocoa. Concerns of another Ivory Coast election delay following reports that the ruling party has accused the election director of fraud and asked him to resign may have added some political premium to cocoa prices in yesterday’s trade.

TODAY’S GUIDANCE: March cocoa’s upside move yesterday and close above last week’s high is a positive technical signal, but the early price retreat will certainly frustrate the bull camp. Based purely on the market’s technical setup, the next upside target for March cocoa is at $3,400. But a lack of currency support in the overnight trade puts March cocoa at risk for a retreat back to support levels. Overhead resistance for March cocoa comes in at $3,350 then $3,366 with support near $3,298 then near $3,269.

TODAY’S MARKET IDEAS: Yesterday’s upside breakout suggests March cocoa has the potential to eventually trade back to at $3,400 level perhaps higher. But since trading in NY cocoa has been choppy as the market follows the ebb and flow of the Dollar and the London cocoa, we don’t get the sense NY cocoa is set to make a swift return to the upside, so with the market pulling back in the early overnight action, there will clearly be opportunity to buy March NY cocoa on dips closer to support levels.

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March cocoa settled higher yesterday but within the previous day’s range as the market continues to consolidate following a steep drop from 30 year highs reached earlier in the month. With low market participation ahead of year end, the trade likely lacks the incentive to push March cocoa outside the recent range between $3,300 and $3,220. While there has been some industry news including forecasts of higher Indonesian production and good weather improving the development of the Ivory Coast cocoa crop that would seem to dent the bull case, it doesn’t appear that market sentiment has completely shifted away from the bull camp, even though a lot of weak handed longs were shaken from the market on the sharp technical break seen this month. There still seems to be a general view that Ivory Coast harvest supply flows will begin to trail off in the New Year. And in fact, the pace of cocoa bean deliveries to ports which started the season at 93% above year ago has fallen to an estimate of only 13% above year ago as of December 27th. With March cocoa falling by as much as $287 from the December high, seeing any clear evidence that Ivory Coast supplies are starting to tighten could quickly shift control back to the bull camp.

TODAY’S GUIDANCE: Some of the strength in March cocoa yesterday may have been currency related given the strength in the Pound. But with trading conditions thin and a lack of industry news available, the market is easily being pushed around. With the Dollar trading weaker overnight, the currency action could provide some price support to cocoa this session. The price action in March cocoa still looks as if the market is attempting to form a bottom. But so far the market lacks upside traction and may remain in a holing pattern until more traders return to the market in the New Year. Critical overhead resistance comes in at the 40 day moving average at $3,288 today.

TODAY’S MARKET IDEAS: With the cocoa market likely lacking a fresh fundamental incentive to trade higher but with selling interest also likely limited by the market’s oversold technical condition, a sideways trade in March cocoa between $3,288 and $3,220 seems possible on the last trading day of the year.

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In retrospect, 2009 was a very impressive year for the commodity markets. For most of the year commodities were seen as “the” place to be, with many analysts touting them as a new and potentially sustainable investment class. Indeed, certain commodities forged very impressive rallies in the face of highly uncertain economic conditions, with the Continuous Commodity Index forging a gain of more than 30% from the end of 2008 to the October 2009 highs. If one also takes into consideration the low to high rally in crude oil prices of 74% and the 94% run-up in sugar prices, it would seem like certain commodities are well on their way to pricing in a recovery.

With the sharp, surprising run-up in equity prices of 67% off of the March 2009 low, there are a number of analysts who view the equity markets as pricing in positive growth for 2010. While the outlook for the economy remains very suspect as of this writing (and many traders might consider the commodity markets as overstating the recovery potential), a bit of historical perspective will lead one to conclude that many commodity markets still have significant upward potential.

In our opinion, a large portion of the commodity price gains that were forged in 2009 were simply a rejection of severely deflated pricing. In some cases markets fell to (and even below) the cost of production and did so off of sentiment that suggested demand was going to fall to depression type levels and not recover for years.

But as the situation was so extreme (interest rates approaching zero, widely accepted expectations for a continuous deflationary spiral and, for a while, little or no hope of an end to the crisis) the conditions that had sent prices to extreme lows in 2008 and early 2009 may not be repeated very soon. It could be very difficult for markets like natural gas, crude oil, sugar, cotton orange juice, copper, coffee and corn to return to the lows they have forged over the last 18 months. And while markets like cocoa, soybeans, soybean oil and wheat may seem to lack the fundamentals that would allow for strong upside price extensions again in 2010, against a backdrop of a falling Dollar, fairly consistent global demand growth and ongoing investment flows toward commodities, even those “weak horses” could catch some spillover support.

One could say that 2009 was a year to “close your eyes and buy everything physical.” In contrast, 2010 looks like a year to be more selective. To be sure the direction of most commodity prices will still be largely a function of the direction of the economy, but while we have to assume that the US will slowly claw its way out of the sub-prime disaster, we have to be aware that there will likely be periodic setbacks.

However, never in history has the US Federal Reserve been so forced into a position of erring to the side of inflation. Adding into the equation what appears to be a long term devaluation of the Dollar and unprecedented quantitative easing by the most of the world’s central banks, one is presented with a spectacular, classic inflationary setup for commodities.

Picking up Where We Left off Ahead of Sub-Prime

Certain players maintain that steep commodity price gains in the 2000 to 2008 time frame were artificial, or they maintain that many of the highs made during that time were irrational and not really a reflection of fundamental conditions. But even before the new millennium arrived The Hightower Report often warned of an impending wave of “Boom and Bust” pricing in commodities, as we realized that decades of disinvestment would expose the world to periodic instances where demand would overrun supply.

On the other side of the coin, we also recognized that old ways and opinions die slowly and that many commodity producers, traders and even analysts would attempt to apply old, historical pricing to the new commodity era, which in turn would foster a movement to attempt to limit investment in commodities. Those in favor of regulation to limit such investment in commodities suggest that fund buying is exaggerating price levels in many commodities and must be stopped. If we could call an end to globalization, rising global standards of living and improved diets, it would make sense to limit investment toward commodities, but as it stands the markets need more investment and more supply.

Some players point to the late 2009 rally in soybeans as a rally that was unjustified by “the fundamentals” of the soybean market. Perhaps it should be said that soybeans were not following the old soybean market fundamentals but instead soybeans were following the new fundamentals of rampant Chinese demand, probably the biggest inflationary threat seen in the modern era. While soybean prices might be expensive relative to expectations for a big crop from South America, they might not be as expensive in the context of tight world corn supplies and in terms of the deflated Dollar.

Some players now want to call an end to the globalization wave despite, the fact that hundreds of millions of individuals in the developing world are poised to move into the middle class. The sub-prime disaster may have temporarily derailed the stellar growth in developed countries, but the rapid acceleration in standards of living in the rest of the world will not be easily denied. And while the recent price gains have come a long way towards repairing the lack of investment in mining and oil exploration and production, global commodity demand looks to continue to grow, right along with the biggest explosion of capitalism in the history of mankind.

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The higher close in March cocoa yesterday leaves it on an upward track which still gives the edge to the bull camp. In fact, cocoa prices have firmed in the early overnight action as the market seems to be benefiting from general bullish commodity market sentiment tied to robust industrial and trade data from China improving the global demand outlook. Cocoa seems to be getting spill over support from the early gains in gold, equities and oil. A weaker Dollar may also be raising investor’s risk appetite and the appeal of physical commodities such as cocoa as an alternative asset. Although the overnight gains put March cocoa within striking distance of the October high, short term technical indicators at overbought extremes also raises the risk to long position holders since it leaves the market vulnerable to heavy profit taking once the buying begins to ebb. The NY cocoa trade seems to be most closely connected to the action in London, where prices were pushed to a new contract and 25 year high in yesterday’s trade. A bullish psychology has taken hold on the idea that the strong harvest flow from the Ivory Coast will start to fade in the second half of the main season in January leaving overall supplies tight. A report showing Ivory Coast cocoa export declaration were down 6% for the season through early December may have contributed to the tightening view. The cocoa market may have also been supported in yesterday’s trade by the US government weather agency predicting the El Nino weather pattern will extend into the spring. Cocoa prices were supported earlier this year on El Nino weather concerns and if this weather condition intensifies, it could start to boost speculation again that dry conditions could damage Indonesia’s bean crop. With the London market providing upward price leadership, NY cocoa seemed to easily shrug off a report from Nigerian cocoa farmers saying that mid-crop development has been very good.

TODAY’S GUIDANCE: March cocoa looks poised to make an upward extension above the October high. But the London market, more so than the Dollar right now, appears to be the main influence on NY cocoa market direction. Therefore, the extent of the rally in NY March cocoa may depend on the continued strength in the London market. On a break above the October high at $3,439, buy stops are likely to propel March cocoa higher and pave the way from an eventual rally to $3,500. But with funds increasing their net long positions in cocoa recently, a failure at this key level or if profit taking in the London market surfaces, it could also trigger an extensive profit taking break in March NY cocoa. It will be critical for March cocoa to hold above uptrend channel support, which comes in at $3,375 today otherwise, more chart based selling is likely to be seen.

TODAY’S MARKET IDEAS: While the bulls have a clear stronghold, we still believe there is a growing risk to long position holders given the market’s technical condition. Therefore, traders may want to have some type of option profit protection strategy in place.