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Market selloff Cocoa prices off to a bad start in 2016.... Brokers say selling is driven by algorithmic traders

The bean behind chocolate joined this week’s global market selloff as algorithmic traders jumped on a shift in the supply outlook, brokers say.

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Cocoa, one of a few bright spots in the commodities world in 2015, is having a bad start to this year.

The bean behind chocolate joined this week’s global market selloff as algorithmic traders jumped on a shift in the supply outlook, brokers say.

In 2015, cocoa was one of only two commodities tracked by S&P to trade higher, posting a 13% gain in London trading as dry conditions hit the harvest. This year cocoa is trading 4% lower after dropping as much as 7% earlier in the week, a decline first triggered by expectations of increased supply.

But the size of the moves has surprised brokers, who say buying and selling is being driven by the computerized traders that are increasingly dominating this market.

“There are a lot more system funds involved in cocoa than there ever have been before,” said Jonathan Parkman, head of agricultural brokerage at Marex Spectron. “There’s been a power shift.”

Algorithmic trading systems buy or sell based on sets of rules linked to price levels and the timing of market movements.

The rising ability of algorithmic trading to influence prices has affected other markets, including U.S. Treasurys, one of the most heavily traded markets in the world. That is leading to amplified swings that often don’t reflect economic fundamentals, particularly in smaller markets like cocoa, some analysts say.

It is unclear what percentage of trade in cocoa is coming from these systems, as data from the ICE exchange, which tracks market positions, doesn't distinguish between different kinds of investors.

Cocoa soared in 2015 as dry weather and production shortages in Ghana, where about 17% of the world’s cocoa is grown, crimped supply. In early December, cocoa prices hit £2,326 ($3,397) a metric ton, their highest since March 2001 when the world’s largest producer, Ivory Coast, was in the midst of a cocoa export ban and civil war.

Those gains came as other commodities were hit by a combination of oversupply and concern about weaker demand from China. The S&P GSCI Index, a measure of 27 commodities, lost 32.9% in 2015. Only cocoa and cotton ended the year in positive territory.

Cocoa’s big climb may have been helped by buying from the algorithmic traders who are now being blamed for the downdraft.

“There was a big speculative bet on cocoa prices [in 2015],” said Carlos Mera, a senior commodities analyst at Rabobank.

In late December, a pickup in cocoa shipments sent the cocoa price lower. Early this week, the downward drift became a rout, the size of which surprised analysts.

“If you really believed the fundamentals, [investors] should have just been selling a little every week,” said Max Goettler, a cocoa trader at Rotterdam-based Cocoanect.

Analysts are mixed on whether the market will continue to fall. Some point to what could be a larger crop from West Africa that will winnow down the current deficit. Other analysts say that potentially dry weather in Ghana could hit the crop.

Some traders say the early new year fall is bringing back buyers. On Friday, the market had recovered some of its losses, with the price of cocoa rising more than 2% by midafternoon in London.

Either way, market participants believe that cocoa will continue to see volatility as trade is exaggerated by the presence of algorithmic traders.WSJ

 

Source: WSJ

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