Seasonal Sector Trades: Not So Sweet Cocoa By: By Christopher Mistal & Jeffrey A. Hirsch | March 10, 2015 | Email | Print

Cocoa tends to begin a seasonal decline in early to mid-March through the end of May (shaded in yellow below), instituting a short position in our seasonal best-trade category. Selling on or about March 13, right before St. Patrick’s Day and holding until on or about April 16, for an average holding period of 23 trading days, has been a winner in 32 of the past 42 years. Even in the face of the 2008 great commodity bull-run, this seasonal trade worked with a potential profit of $1,730 per contract. Since 1997, this trade has only posted two losses. 

Cocoa has two main crop seasons. The main crop from the Ivory Coast and Ghana in Africa accounts for approximately 70% of the world production and runs from January through March. As inventories are placed on the market, this has a tendency to depress prices, especially when demand starts to fall for hot chocolate drinks and chocolate candy in the spring and summer time. After briskly rebounding from its late-January/early-February low, cocoa’s momentum has stalled with technical indicators signaling overbought conditions just ahead of typical seasonal weakness.

Futures traders could consider an outright short position or bearish option strategy using the July contract to take advantage of this setup. Stock and ETF traders could try to short iPath Pure Beta Cocoa ETN (CHOC) however; it is not that liquid with barely two thousand shares, on average, trading hands over the past three months. 

Another possibility, with plenty of liquidity and possibly less risk is Hershey Foods (HSY). When cocoa prices rise, Hershey’s price tends to decline and the opposite often holds true as well. However, HSY is also subject to currency exchange rates as a global company. A surging U.S. dollar will inevitably impact earnings and share price even when HSY’s input costs decline with falling cocoa.

However, even more interesting is Rocky Mountain Chocolate Factory (RMCF). With a market cap around $85 million, this is definitely a small-cap company. They are headquartered in Durango, Colorado and operates as a confectionery franchisor, manufacturer and retail operator. RMCF’s valuation is reasonable with a P/E of 17 and a price to sales ratio right around 2. Cash on hand and debt are also reasonable. They also pay a respectable dividend (3.4% yield) and have a share buyback program. RMCF does have some foreign operations, but the majority of their operations are in the U.S. which mitigates much of the potential damage a stronger dollar could cause. 

Up until the past few trading sessions, 2015 had been good to RMCF. Shares had rallied from $13.12 on December 31 to a high of $15.60 on February 26. Shares have since pulled back to trade just under $14.00. The move lower has turned stochastic, relative strength and MACD indicators all negative, but the 50- and 200-day moving averages have not been violated on a closing basis, yet. RMCF could be considered on dips below $13.62. If purchased, a stop loss of $12.60 is suggested. This trade will be tracked in the Almanac Investor Small-Cap Portfolio. Falling input costs, reasonable valuation, solid growth prospects and reduced concerns about the stronger dollar make RMCF attractive.