Is Cocoa Ripe For Collapse?

09/23/04 09:30:44 AM

by David Penn

A summer rally breaks up the monotony of an 18-month bear market. But are further declines ahead?

Security: CC
Position: N/A

From some perspectives, the question of whether cocoa futures are in a cyclical bear market is simply answered: Ya think? After all, since soaring to more than $2,400 per metric ton early in 2003, cocoa futures have done little other than move downward. By the end of 2003, cocoa futures had traded as low as $1,400, and managed to end the year just north of $1,500.

As 2004 began, cocoa futures resumed their descent, this time falling as low as $1,300 before rallying sharply and surprisingly late in the summer. Unfortunately, this move had all the earmarks of a bear market rally as cocoa futures shot up from $1,300 to just over $1,700 in about seven weeks. Unfortunately for those on the long side of cocoa, this rally petered out before taking out the previous significant long-term high of $1,761 set during the week of August 25, 2003.

A deep MACDH trough in early September is one of a number of bearish shadows over this "bump" in cocoa's long-running bear market.

Graphic provided by: Prophet Financial Systems, Inc.

So where does that leave cocoa traders now? Especially interesting is the current cyclical bear market in cocoa appears to be a component of an even larger cyclical bear market -- one that began with cocoa's historic peak of (roughly) $5,200 set back in June 1977. Traders might wonder what relevance a 27-year high could possibly have on today's cocoa market. While it is possible there is no relevance, I note it here because it is possible going forward that cocoa's secular bear market -- the larger bear market that began in 1977--could see cocoa prices as extraordinary on the downside as they once were on the upside before the damage is done.

The "bump" (as it appears in long-term cocoa charts) in the summer of 2004 could possibly be the start of a new bull market. In the same way that precious metals enthusiasts have come to believe that, essentially, their much-loved gold and silver have been down "long enough," it would be hard to blame cocoa bulls for succumbing to the same or similar sentiment. In fact, cocoa bulls have suffered far more than gold bugs. The "last gold bull" in 1980 saw his holdings reduced by nearly 60% by 1999. The "last cocoa bull" in 1977 saw his holdings reduced by nearly 80% by 2004.

But the repeated "gapping down" in cocoa futures since the bump's peak in mid-August do not augur well for a move higher in the near-term. In less than a month, cocoa futures had retraced more than half of the advance from the bump, and there is precious little support until prices near the $1,350-1,300 level (some 150-200 points from most recent levels). It is also unfortunate for cocoa bulls that the consecutively lower price troughs in the first half of August and the second half of August were not matched by consecutively higher troughs in the 7, 10 stochastic. Such a match would have provided for a positive divergence between prices and the stochastic, a divergence that would have supported the case for a bottom in cocoa.

The absence of that positive divergence doesn't mean that a bottom wasn't made in the summer of 2004. But it does suggest that cocoa might require some more downside testing before a clear-cut bottom can be confirmed.

If cocoa's correction takes prices below $1,300, then the next level of real support is near the historic lows around $1,000. There is actually a great deal of support at that level, even if there has also been a great deal of directionless churning. It should go without saying that cocoa prices that slip below these levels will be catastrophically bearish. The only support levels of any significance below the $1,000 level are those from cocoa's original ride up -- more than 30 years ago.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Is Cocoa Ripe For Collapse?

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