Kub's Den

Just in time to torture anyone who gave up chocolate for Lent, the cocoa futures market has been making headlines by streaking to ever-higher fresh all-time highs day by day. When the March contract settled at $7,057 per metric ton Monday, it was far and away cocoa's highest-ever high, double the price from just five months ago and beating $3,826 from 2011 or $5,104 from 1977. Furthermore, it's a reminder of what can happen to commodity futures markets when trading volumes are low and when information cascades through a thin market with everyone trying to trade in the same direction.

Unlike the market for bitcoin, which is also experiencing a fragile upward streak this week as speculative traders all cascade in one direction, the market for cocoa is a real one. The New York cocoa futures contracts traded on the ICE exchange must ultimately converge to the cash price for physical delivery of "exchange-grade" product from a variety of African, Asian, and Central and South American origins, delivered to licensed warehouses in the Port of New York District, Delaware River Port District, Port of Hampton Roads, Port of Albany or Port of Baltimore.

However scarce the physical cocoa owned by commercial traders at those warehouses may be -- after black pod disease and a fertilizer shortage curtailed production from West Africa's cocoa trees -- now, as traders are being served delivery notices for the expiring March futures contract, that record-high futures price truly is the price of the real stuff. Traders with short March positions who got squeezed as the contract went into delivery must now pay up to buy cocoa at these historic prices and honor their commitments.

The more actively traded May cocoa futures contract also continues to roil, still $6,330 per metric ton as of Wednesday morning, with 31% of the market's open interest represented by bullish fund traders (the managed money category in the Feb. 27 Commitments of Traders report from the CFTC). Funds are holding three long futures positions for every short trade they've made in cocoa, and by population, these funds outnumber the number of traders categorized as producers, merchants, or processors.

Compare that to the corn market, where it's the other way around. Bona fide commercial hedgers (564 traders) outnumber the managed money funds (248 traders) and altogether represent about seven times as much trading activity as the cocoa market gets. More activity taking place at more price points, with more market opinions and more individual transactions all mean a larger market has more resilience and less vulnerability to frantic price streaks like the one in cocoa. If you have a short position in corn futures and want to buy out of it to close the trade, it's not too hard to find some counterparty among the big traders' many thousands of clients. Someone would be willing to sell you a May corn futures contract somewhere near to the current market price at, say, $4.26 14, or at worst $4.26 1/2, and the rest of the market would hardly notice or react.

But if you are trying to exit a short position in a very thinly traded, quickly streaking market like cocoa, the pickings are much slimmer. As I looked early Wednesday morning, there are maybe only one or two contracts being offered for sale as limit orders a few ticks above the market price, and if anyone actually traded them, the algorithms would surely smell blood and instantly move yet higher again.

With that in mind, I evaluated the average daily trading volume for several commodity markets to illustrate the relative vulnerability of certain agricultural markets to this kind of streaky trade. Below are listed the average daily volumes, rounded to the nearest thousand, for the most actively traded futures contract for each of these markets through the past year -- March 2023 through February 2024:

Crude oil: 339,000

Corn: 166,000

Soybeans: 126,000

Sugar: 68,000

Cocoa: 28,000

Live cattle: 27,000

Lean hogs: 23,000

Cotton: 22,000

Canola: 20,000

Feeder cattle: 7,000

There are some days when corn trades more than crude oil. The overall size of the trading population and the robust daily trading volume of most grain futures contracts may give us some confidence that, even with the hefty net-short positions that have been built up by the bearish fund traders in recent months (they currently hold 2.5 times as many short positions in corn than they hold long positions), these big markets are less vulnerable to volatile daily movements than something like cocoa. Or feeder cattle.

In the meantime, don't expect the volatility of cocoa futures prices to play immediately into the prices we consumers will pay for chocolate Easter bunnies. Certainly, don't expect them to retroactively improve the prices received by West African producers. The wild swings and flails of a futures market can sometimes happen so fast that the only parties affected are the ones trading the futures contracts themselves. But for those who do, the thinly-traded cocoa market's historic outburst is a cautionary tale worth noting.

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Comments above are for educational purposes only and are not meant as specific trade recommendations. The buying and selling of grain or grain futures or options involve substantial risk and are not suitable for everyone.

Elaine Kub, CFA, is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at analysis@elainekub.com.

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