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Kotak Commodity Services Ltd

*The trend enjoys a powerful tailwind thanks to the money flowing into systematic macro and an array of quantitative funds, which are seeking new opportunities to boost their returns

*The New York cocoa markets recent run up from the $2,500 a tonne it was trading at in March “had absolutely nothing to do with fundamentals

It is triggering dramatic shifts in prices of your daily needs commodities sparking concern that these commodities are being divorced from their fundamentals of supply and demand. So can we say that computers driving the cost of your food stuff like wheat, corn, rice, sugar, coffee, edible oil to chocolate bar? Specialised small commodity markets such as sugar, cocoa and coffee are becoming the next frontier for the waves of buying and selling generated by algorithmic trading, which has long since carved out a presence in currencies, equities and interest rates.

The trend enjoys a powerful tailwind thanks to the money flowing into systematic macro and an array of quantitative funds, which are seeking new opportunities to boost their returns. Many traders and brokers say computerised trading has driven sharp changes in prices for cocoa, coffee and sugar markets, which have taken market participants by surprise. People are looking for more position markets to deploy that money. Many of the computer-driven strategies are searching for risks and returns uncorrelated with other financial markets.

The number of commodity trading advisers (CTA) managers trading niche markets has more than doubled to about 10 over the past couple of years, and although still relatively small, those funds manage about $15 billion, according to Société Générale. The advance of computer-driven trading, where algorithms execute trades in anticipation of a market rising or falling, has also been spurred by the retreat of investment banks and discretionary hedge funds which in the past supported market making in commodities markets.

A number of important players in agricultural markets are also feeling the heat. Producers, such as Sugar, coffee, cocoa farmers and cattle ranchers, and end users of the commodities including food companies who also rely on the market to hedge their risks have experienced surprising price shifts. For example, in the cocoa market, the New York comex price has jumped more than 50 per cent since the start of the year to a 19-month high of almost $3,000 a ton in April. That punched the New York market to a record spread over the price of cocoa quoted in London, which was trading at about £1,800 a ton.

The New York cocoa markets recent run up from the $2,500 a tonne it was trading at in March “had absolutely nothing to do with fundamentals. That comes as the coffee and sugar markets too have experienced a sharp rise in bearish positions built by “managed money” a market category that includes speculative funds, to record levels. High-frequency traders, who transact small positions in a space of milliseconds, are another group who have pushed into the agricultural commodities markets. High-frequency [traders] has started to enter the commodities space in a significant way.

Some market veterans argue that despite the rise in volatility, the ultimate direction of the price is always determined by the fundamentals of supply and demand. The fact of the matter is that we need speculators. Over time the fundamentals come into play in the market. Nobody is bigger than the market. Date: 18-5-2018

Kotak Commodity Services Ltd

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