LONDON (Reuters) – Behind a record rise in cocoa prices this year, a corner of the financial markets that drives up the cost of chocolate underwent a seismic shift, with the hedge funds that oiled their operations heading for the exit.
The prices of confectionery products, from bars to hot chocolate, are heavily influenced by cocoa bean futures contracts. Traded in London and New York, these financial instruments allow buyers and sellers of cocoa to set a price for the commodity, providing a benchmark for sales around the world.
Midway through last year, hedge funds — a class of investors that use privately pooled money to make speculative bets — began pulling out of cocoa futures trading as market price swings increased their trading costs and made it harder to make profits. .
They accelerated their decline in the first half of this year when cocoa prices hit a record in April, driven by supply problems in West Africa, according to Reuters calculations based on data from the US Commodity Trading Futures Commission (CFTC), which oversees on the New York Times. York Market, and ICE Futures Europe, an exchange that collects figures for trading in London.
“This market has become increasingly volatile,” said Razvan Remsing, director of investment solutions at Aspect Capital, a $9.3 billion London-based fund that uses encryption and algorithms to find trades. “Our system’s response was to shorten our positions.”
Aspect has reduced exposure to cocoa in its Diversified Fund from almost 5% of its net asset value in January to less than one percent after April, according to a presentation reviewed by Reuters.
The departure of hedge funds and other speculators caused liquidity in the market to collapse, making it harder to buy and sell, sending volatility to record highs and further fueling price appreciation.
Reuters spoke to a dozen fund executives, cocoa market brokers and traders who said the withdrawal – detailed here for the first time – has left lasting tensions in the market. This has resulted in greater differences between the price at which cocoa can be bought and sold, and has prompted some industry players to seek alternative instruments, having a lasting impact on the sector.
This month, the number of futures contracts held worldwide at the end of a given trading day – a key indicator of market health known as ‘open interest’ – reached the lowest level since at least 2014, the global figures, which is a sign that the futures market has shrunk significantly overall. Data before 2014 were not available.
On Wednesday, cocoa futures prices in New York surpassed their April peak.
The futures market is a crucial cog in the cocoa industry, allowing producers and chocolate companies to hedge their exposure to fluctuations in the price of beans.
The future will determine the income for the farmers and low-income countries that produce the world’s cocoa – most of which comes from Ghana and Ivory Coast in West Africa.
Hedge funds and speculators have become bigger players in the commodity markets over the past two decades as the value of their total assets has increased. But as purely financial investors, they don’t have to stay in the market during times of stress.
The impact of the departure of hedge funds illustrates how dependent trading has become on these lightly regulated funds that increasingly determine financial markets. Reuters has reported this year on how hedge funds are piling into the $10 trillion euro zone government bond market under regulatory scrutiny and their growing influence on European stock trading.
Contacted by Reuters, the CFTC declined to comment. A representative of the UK regulator, the Financial Conduct Authority, said that, in line with its market surveillance practice, “we have been working with trading venues and participants to monitor the orderliness of the market.”
Bernhard Tröster, an economist at the Austrian Foundation for Development Research (ÖFSE) in Vienna who co-authored an article last year on the growing role of financial actors in commodity derivatives markets, said the withdrawal of hedge funds could fuel the crisis in the US has stirred up. cocoa markets.
“As markets became so volatile this year, it became clear how hedge funds and other financial players have become so important,” he said.
DELIVERY PROBLEMS AFFECT PRICES
The market share of hedge funds and other speculators peaked at 36% in May 2023, the highest in at least a decade, before beginning their retreat, global data calculated by Reuters shows.
Then, early this year, global cocoa prices soared after top producer Ivory Coast was hit by adverse weather conditions and diseases. Number two producer Ghana fared even worse, with smuggling, illegal gold mining on cocoa farms and mismanagement in the sector.
In early February, cocoa prices surpassed a previous record set in 1977. Executives from five hedge funds told Reuters they were starting to pull back as volatility increased and trading costs rose.
When markets get too hot, exchanges require speculators to increase the amount of collateral per futures contract, increasing their costs. Lawrence Abrams, president of Absolute Return Capital Management in Chicago, said the cost of trading a single cocoa futures contract rose from $1,980 in January to $25,971 in June.
High prices and volatility, combined with declining liquidity, began “to impact our system’s trading and risk management decisions,” said Abrams, whose fund sold out before prices peaked in April. He declined to detail how much his fund managed, citing regulatory reasons.
Many hedge funds promise investors that they will not exceed a certain risk, meaning that if a particular market becomes too volatile, they will have to reduce their exposure.
The difference between the offered and asked prices for futures, the so-called “bid-ask spread”, soared after the hedge funds’ withdrawal. That has made trading more difficult: Lower liquidity and wider spreads mean traders struggle to execute large trades without moving overall prices.
“You need speculators,” said Vladimir Zientek, a trading partner at brokerage firm StoneX, referring to hedge funds, which are not among his clients. “Without speculators in the market, you lose a lot of liquidity, which allows for these very wide and erratic market swings.”
In mid-April, contracts in New York reached a then-record above $12,000, a threefold increase from January, prompting hedge funds to sell their positions.
“Trends don’t last forever,” says Aspect Capital’s Remsing. “Stay in size too long and you’re about to give back all your gains.”
Hedge funds’ share of the cocoa futures market fell to 7% at the end of May, the lowest in at least a decade, global data showed.
A European broker, who requested anonymity to discuss client trades, said market panic increased in March and April as liquidity drained.
Volatility in cocoa futures reached a record high in May, up fivefold from a year earlier, according to data from the London Stock Exchange Group (LSEG).
Daily average price movements that month were nearly $800, about 15 times the level a year earlier, according to a Reuters analysis based on figures from market data provider PortaraCQG.
RISKER MARKETS
For major trading houses that buy and sell cocoa beans – a group that also includes Singapore’s Olam, Switzerland’s Barry Callebaut and America’s Cargill – the liquidity squeeze and associated price increase have compounded the more than $1 billion dollar hit to their futures positions. .
The losses came earlier this year after Ghana, following a disastrous harvest in the October 2023 to September 2024 season, delayed deliveries of almost half of the beans the country had promised to sell, disrupting cocoa traders’ futures market strategies.
These traders typically use futures to fix cocoa bean prices, or to hedge against the risk of falling prices.
But that strategy fell apart when Ghana delayed its deliveries. Traders were forced to liquidate short positions for the month of expected delivery and take new short positions at large losses.
The market turmoil has prompted some trading houses and manufacturers to look for alternatives to futures.
Australian investment bank Macquarie, a major player in commodities markets, told Reuters it was selling over-the-counter products to trading houses, processors and chocolate makers as cocoa volatility hit record levels this year and demand remains high.
One major agricultural commodity trader is now using such bespoke contracts, according to a source who requested anonymity citing sensitive commercial relationships. They declined to comment on the size of the company.
Such products typically protect buyers from smaller price swings than possible with futures, limiting their use, according to a European broker, who does not identify himself to freely discuss clients’ activities.
‘COCOA TOURIST’
Some hedge funds have returned to the market. Together with other speculators who trade with investors’ money, they accounted for 22% of futures trading this month, according to global data. But buying and selling in the changing landscape of the cocoa market has become more difficult.
Zientek, the trading partner at StoneX, said bid-ask spreads could now top 20 ticks – $200 per contract – compared to around 2 to 4 ticks before cocoa rallied to record highs.
“This makes larger orders more difficult to fill without causing immediate disruption to the market,” he said.
Daniel Mackenzie, managing director of Cocoa Hub, a British-based company that sources and sells cocoa beans to artisan chocolate makers, said higher and more volatile prices forced small and medium-sized producers to choose between passing costs on to customers or reducing the product sizes. .
One chocolate maker he worked with has closed and another has been sold, he said, without giving further details.
As hedge funds exited the market, short-term investors such as day traders – who buy and sell assets within a single trading day – have remained in the market, the European broker and agricultural commodities bank broker said.
This month’s cohort of day traders represented 5% of the market, about the same as at the start of the year, the global data showed.
Day traders cannot fulfill the liquidity-providing role traditionally played by hedge funds, the two brokers said.
“I like to call them ‘cocoa tourists’: they move in, hold a position for a day or two and then move away,” the European broker said.
(Editing by Tommy Reggiori Wilkes, Elisa Martinuzzi and Daniel Flynn)
