June 17, 2014
Cocoa still has MAJOR short potential?
All markets go up AND down…and Cocoa is no exception.
Back in January, one of my recommendations to start the year was Short Cocoa. In that newsletter, http://www.crokerrhyne.com/newsletters/01-28-14.htm , I pointed out that during the past 14 years (back to 2000), Cocoa had experienced at least an 18% decline at some point in every one of those years.
I also pointed out that Speculative Traders were holding all time record long positions while Commercial Traders were holding all time record short positions, a situation that I believed would ultimately result in at least a 15-20% sell off...at some time this year.
This has not happened. In fact, Cocoa has moved about 4 cents higher during the past 5 months…which, in my opinion, has made for an even better trade.
Specs are STILL very long this market, the bullish “expert” analysis I have observed in the commodity media has become even more bullish, and I HAVE BECOME EVEN MORE CONVINCED THIS MARKET WILL SOON SEE AT LEAST A 20% DECLINE…THAT BEING ABOUT 600 POINTS OR $6000 PER FUTURES CONTRACT.
I put together some interesting research yesterday regarding sell offs in Cocoa going back 30 years.
Start with this: Going back to 1984, at some point during EVERY calendar year (30 years straight) there has been at least a 12% decline in Cocoa’s price….with 23 of those 30 having been at least a 20% decline.
So far, this year, during 2014, the single largest decline in Cocoa has been -5.8 %. In other words, a percentage break that has happened for 30 straight years has yet to appear in 2014.
Here are the actual numbers. Since 1984, there have obviously been bullish years and bearish years for this commodity, but one thing remains constant. IN EVERY YEAR, WHETHER CUMULATIVELY BULLISH OR BEARISH, THERE HAS BEEN A NOTABLE DECLINE AT SOME POINT DURING THAT YEAR.
Cocoa – Largest Declines Observed During Calendar Year- The highlighted column is definitely the main point here.
Again, so far this year, the largest decline in Cocoa has been -5.8 %.
What do I get from this?
Firstly, there is nothing that says a 20% decline HAS to take place this year. That 5.8 % decline we’ve already recorded might be all there is on the downside in 2014.
However, statistically speaking, I DO think having a 15%-20% lower target, sooner or later, is a realistic objective…and considering the overloaded spec long position, I am quite comfortable in looking for AT LEAST 20%...which translates into a minimum objective of about $6000 per futures contract.
From there, it is simply a matter of doing the math. What do options cost? And how much of a multiple can I expect if we DO get that 15 or 20 percent break? And am I willing to lose 100% of that option if I am still wrong…and then do it again? Or should I use the 2 & 1 (2 puts, 1 call)? And how do the numbers work from there?
Look, I wouldn’t know a Cocoa tree if I had one in my front yard. This stuff is all just numbers, probabilities and 34 years of experience to me…and trying to take those numbers and be as mechanical about handling my positions as humanly possible. So, right now, my mechanical side says, “Follow the original plan. This hasn’t worked for almost 5 months. Stay on the trade. Stats say, when it works, it will work for a big multiple”.
So that’s what I’m doing. Keeping the money on the table. Knowing the next 5 months could be a loser as well…But I’m willing to stick my neck out there as I DO THINK THE RISK IS VERY MUCH WORTH THE POTENTIAL REWARD.
It’s all math. I may be dead wrong but I do think this has MAJOR potential.
Here are the charts and option possibilities….
Here’s plenty of time…
Here’s a smart 2 & 1…
Here’s more leverage…
One more time…My assumption is THIS MARKET IS GOING TO BREAK. So far it’s been a loser. And it may still be a loser right now…But if and when that 20% (or bigger) sell off comes, I think any previously incurred losses will be swamped by the potential gain. Maybe I’m wrong. Maybe this is wasted/lost money. But I’ll go with the numbers, as well as this setup of overwhelmingly long specs…and my sometimes decent instincts about the markets…and STAY on this idea.
Give me a call if you have the cash and think this is worth the risk…or just to say hello.
Old Hack Bill
The author of this piece currently trades for his own account and has financial interest in the following derivative products mentioned within: Cocoa