Positioned In 2017
The IMC blog continues to ride the bear market in the cocoa/sugar (x2) spread. The blog was holding a short position in the September-October cocoa/sugar (x2) spread that was entered on September 30th from the equivalent of +$1,834.40 (premium cocoa), a second ‘add-on’ position that was entered at the equivalent of -$1,521.80 (premium sugar) on February 18th, and a third ‘add-on’ position that was entered at the equivalent of -$4,731.20 (premium sugar) on April 19th.
Due to the Last Trade Day for the September cocoa contract, we rolled both the cocoa and the sugar to the March 2017 contracts at the close of September 13th. The March spread is trading $1,797.20 lower than the September-October spread, so we’re now short the spreads from the equivalent of +$37.20 (premium cocoa), -$3,319 (premium sugar), and -$6,528.40 (premium sugar).
Still Strapped In
In prior posts, we mentioned that our minimum downside target the cocoa/sugar (x2) spread is -$20,000 (premium sugar), basis the nearest-futures. Well, we’re nearly there and the March 2017 spread has already hit -$19,340.40 (premium sugar).
So what now?
We are going to maintain our short position. The reason is two-fold. First of all, the trend is still down. Over the last several months, the March 2017 cocoa/sugar (x2) spread has made three different bear market bounces that peaked just above the declining 50-day Moving Average. The spread then rolled over and made new bear market lows just a few weeks or even days later. So until the spread is consistently above the 50-day MA, the bear market remains firmly intact.
The second reason to stay short is because of the history of the ratio between cocoa and sugar. Historically, whenever the ratio between the value of a 10-tonne cocoa contract and a 112,000 lb. sugar contract has reached 2.5:1 or higher it has ultimately reversed and entered a multi-year bear market. The ratio peaked at a thirteen-year high of nearly 2.7:1 one year ago this week. Therefore, we may only be in the middle or even early stages of the current bear market.
Furthermore, prior bull markets that peaked at 2.5:1 or higher have been followed by substantial bear markets that pushed the ratio below 0.8:1 each time. Think of it this way: whenever a cocoa contract has been worth at least two and a half times the value of a sugar contract, the bear market that followed pushed the sugar contract value to a premium of 35% or more over the cocoa contract.
Although sugar has been outperforming cocoa over the last few months, it still has yet to reach an equal value to the cocoa contract. Therefore, history suggests that the smart macro bet is to stay positioned on the short side of the cocoa/sugar (x2) spread until in the value of a sugar contract is greater than the value of a cocoa contract.
We like smart macro bets! Therefore, as long as the trend remains bearish, we’ll stay the course.