For the seventh time in the last eight months, the nearest-futures cocoa/sugar (x2) spread made a higher monthly high. The July 20th high of +$7,904.40 (premium cocoa) is the biggest premium that one cocoa contract in twenty-nine years. However, this is only just a little bit beyond weekly double top between the 2008 high of +$7,258.80 and the 2002 high of +$7,771.60. A reversal from here on the weekly charts would create a failed breakout attempt or a sloppy-looking triple top.
Based on historical precedent, we expect a reversal in the cocoa/sugar (x2) spread to be followed by a minimum bear market decline of $23k per spread. Remember, this is the minimum expectation. The spread has made much larger declines than this from historic extremes.
With only three trading days left for July, we are going to raise the entry signal parameters again. What we are looking for is a change in the current bullish price structure to tell us that conditions are changing and that the spread is ready to reverse. A break below price support would accomplish this.
What to Watch For
Since bottoming in the second half of January, the December-October cocoa/sugar (x2) spread has not traded below a prior month’s low. This makes the July low (currently at +$4,754.80) a key point to watch. Furthermore, the spread has closed above the rising 50-day Moving Average every single day since early February.
Coincidentally, the July low and the 50-day MA are in close proximity to each other right now. A two-day close below the 50-day MA for the first time in nearly half a year and a break below a prior month’s low would alter the price structure and entice us into the short side of a December-October cocoa/sugar (x2) spread. Once a bear market starts to materialize with defining resistance levels, we will talk about adding to the position.
Cancel the current hypothetical order in the September-October cocoa/sugar (x2) spread. Place a new hypothetical order to sell one 10-ton December cocoa contract (note that we changed from the September contract) and simultaneously buy two 112,000 lb. October sugar contracts if the spread makes a two-day close below the 50-day MA (currently around +$4,841) or a one-day close below the current July low at +$4,754.80, whichever occurs first. Initially, the spread will be liquidated on a two-consecutive day close $500 above the contract high that precedes the entry.