The brown cow spread: Buy cocoa • sell cattle

February 20, 2017 09:00 AM
The brown cow spread: Buy cocoa • sell cattle

The brown cow spread: Buy cocoa • sell cattle

The cocoa market has benefitted substantially by the economic prosperity of the developing world during the last 15 years. Cocoa processors have seen continued demand for basic chocolate products that once seemed like a luxury. The slow and steady global demand increase shows up in the COT reports as processors step up to the buy side locking in their future supplies at what they feel are currently bargain prices while growing their total position and stockpiles to all-time highs.

The cocoa market has declined by more than 30% since its last notable high in August. This drop appears to have once again been halted above the magic $2,000 per ton price that has stemmed four previous declines. In fact, we have to go all the way back to 2006 to find a low beneath this support and even then, it only made it down to $1,988 per ton. In practical terms, it has been 15 years since cocoa has traded below $2,000 per ton. 

Given that the structural change in Ivory Coast cocoa production under President Alassane Ouattara is still in transition, we see no reason why this time it would be different. Therefore, it seems appropriate to take our cue from the cocoa processors whose recent purchases have pushed their net position into positive territory for the first time since 2012. The aggressive processor buying has set a record total commercial trader position. This situation is very similar to all of cocoa’s declines in the last 15 years, a pattern that occurs regularly in small, tightly controlled commodity markets.

Nestlé (NA) is one of the largest cocoa processors in the world. Board members include Jean-Pierre Roth who was the former chairman of the Swiss National Bank and International Monetary Fund Governor for Switzerland where Alassanne Ouattara was the former Deputy Managing Director; Ann Veneman, the current Secretary of the Department of Agriculture, Bradley Alford of ConAgra and Mary Ann Citrino of Kraft. These are the people that guide the companies’ decision-making processes and in a market as small as cocoa, it doesn’t make sense to bet against them. 

Cattle prices have moved steadily higher for three months, nearly 25% above their October low. Just shy of $120 per hundred weight, the market is near its 10-year midpoint. However, with grain prices well below their long-term averages, and expected to remain so, cattle farmers have rapidly begun to sell their herds forward to lock in profits thanks to the widening spread between cattle and feed. This is where the action lies.

The COT report shows the recent rally has been primarily driven by speculative short covering as they’ve been net buyers of more than 70K contracts even as their total position has declined by 17K contracts. Commercial traders, specifically cattle farmers, have sold nearly 60K forward contracts while increasing their total position by more than 70K contracts in the same period. 

Finally, the total positions of the speculators and commercial traders were nearly equal at the end of September. However, thanks to speculative short covering and the increased selling by cattle ranches, the commercial traders’ total position is now more than 60% larger than the speculators’ position. The commercial traders are beginning to gain control over this market, and that bodes poorly for cattle prices.

About the Author

Andy Waldock, owner of the brokerage firm Commodity & Derivative Advisors and the subscription service, is a third generation commodity trader with over 25 years of experience on all of the main U.S. exchanges. Andy stays abreast of modern programming developments due to the trading programs he employs for his own account and managed money.  He can be reached at