Softs Looking Soft: Coffee, Cocoa, Sugar

By Ken Hughes

The softs market has been hit by the financial market meltdown, as just about all commodities have declined on ideas global demand is set to slow significantly. I’ll take a look at the fundamental and technical picture for coffee, sugar and cocoa futures.

Coffee

Let’s start with coffee. Commercial selling from Brazil and liquidation of index funds continue to pressure the market. Continued strength in the U.S. dollar is also adding to the weakness, as December coffee futures hit a 17-month low Monday, October 27, 2008, at $1.0505 a pound. The Commodity Futures Trading Commission’s latest Commitments of Traders Report shows funds and small speculators were net short 13,381 contracts, versus 12,080 from the previous week. Institutions with commodity index-related positions were net long 42,658 contracts, versus 44,556 in the prior week.

The only bullish news I see for coffee is a 12 percent drop in Columbian production in September. However, that was offset by big crops in Brazil and Vietnam. Technically, the market is in an obvious downtrend, with near-term resistance at $1.1120. A close above that level could send trade back to the recent highs at $1.20- $1.21. A rejection from $1.1120 should send the market back down to the upturn level of 2007 at $1.0035.

Looking at a monthly chart, the market broke through that longer-term trendline, which leaves the door open for $0.9000-$0.7500. Strategies I recommend (depending on your acceptable risk level) would be to buy puts, sell calls, buy vertical spreads, or sell the outright futures. You can also buy a call and look for bounce, then sell a futures contract with the call as your protection.

Cocoa

As with coffee, this market has been under pressure. Cocoa dropped 6.8 percent the week of October 20-24, and has fallen 23 percent this month. The December contract is finally bouncing back a bit this morning after trading lower nine days in a row, but I am not sure this will stick as the longer-term trend remains down technically.

The latest weekly CFTC data showed index funds have reduced their long positions in cocoa futures to 6,100 contracts from 13,385. Funds decreased their net longs to 3,626 contracts from 3,871. Speculators added 3,075 short positions and 2,830 longs. On Monday, October 27, trade unions in Abidjan urged cocoa farmers to go on strike to push for higher prices. The only unrest came in Abengourou, where farmers blocked cocoa trucks. The area produces 18 percent of the Ivory Coast’s cocoa crop, and the Ivory Coast produces 1.3 million metric tons of cocoa yearly. Last week, disgruntled farmers briefly blocked the port of San Pedro, which exports 40 percent of the area’s crop.

Even with all this going on, cocoa failed to mount any kind of rally. However, this unrest, combined with the approaching holiday season and a belief the U.S. dollar is looking overbought, I feel this market has good potential for short-term gains. But watch the recent low at 1,867 per metric ton in the December contract; if support gives, the downtrend will resume. If cocoa takes out last week’s low, there should be another down leg into 1,750-1,300. Near-term resistance comes in at the 9-day moving average around 2,054. A close above there, and I see the potential of reaching 2,220. I recommend aggressive traders can look to sell at that level as the rally is likely to lose steam. Less aggressive traders should wait to see if we get a bounce around the 40-day moving average at 2439, which happens to be the 61 percent retracement.

Sugar

Sugar has followed a similar path as coffee and cocoa, in a downward spiral for over a month. CFTC data showed funds and small speculators were net long 48,759 contracts in the latest weekly reporting period, versus 53,127 the previous week. Index funds reduced their long positions to 255,209 from 266,144. There isn’t much fundamentally going on here. Cane crushing in Brazil’s center-south region was up 7.4 percent in mid-October. (Their harvest ends in December.) Sugar production from cane was down 6 percent on the year, due to a decrease in ethanol production.

Technically, there is trendline resistance at 11.39 cents a pound in the March 2009 contract. If the market breaks that, the market has the potential to reach 12.07, which represents a 38 percent retracement. Aggressive traders could sell there, while I recommend less aggressive traders should wait to see if the market gets up to 40-day moving average at 12.91, or a 61 percent retracement at 13.08 to go short. Major support comes in at 0.900-0.800, as seen on the weekly chart.

With all this being said, keep in mind that most of the direction in these markets is being played off the U.S. dollar and the state of the global economy. If fear remains that we are in a recession globally, these markets will have a hard time finding any kind of sustained rally. Feel free to call me with questions about this topic, or to develop a more specific trading strategy to suit your needs.

Ken Hughes is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 866-284-7124 or via email at khughes@lind-waldock.com.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

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