How a hedge fund exodus reshaped international cocoa markets 

By Nell Mackenzie, Tom Wilson and Maytaal Angel

LONDON (Reuters) – Behind a file surge in cocoa costs this 12 months, a nook of monetary markets that drives the price of chocolate underwent a seismic shift: the hedge funds that oiled its workings headed for the exit.

Confectionery costs, from sweet bars to sizzling chocolate, are closely influenced by futures contracts for cocoa beans. These monetary devices, traded in London and New York, enable cocoa patrons and sellers to find out a worth for the commodity, forming a benchmark for gross sales internationally.

In the course of final 12 months, hedge funds – a category of traders that use privately pooled cash to make speculative bets – began pulling again from buying and selling cocoa futures as a result of worth swings available in the market have been elevating their value of buying and selling and making it more durable to make income.

They accelerated their retreat within the first half of this 12 months as cocoa costs hit a file in April, pushed by provide points in West Africa, in line with Reuters calculations based mostly on information from the U.S. Commodity Buying and selling Futures Fee (CFTC), which oversees the New York market, and ICE Futures Europe, an trade that compiles figures for buying and selling in London.

“This market turned more and more unstable,” mentioned Razvan Remsing, director of funding options at Facet Capital, a $9.3 billion London-based fund that makes use of coding and algorithms to seek out trades. “Our system’s response was to trim our positions.”

Facet slashed the publicity to cocoa in its Diversified Fund from practically 5% of its web asset worth in January to lower than one % after April, in line with a presentation reviewed by Reuters.

The departure of hedge funds and different speculators brought about liquidity available in the market to droop, making it more durable to purchase and promote, stoking volatility to file highs and fueling the worth spike nonetheless additional.

Reuters spoke to a dozen fund executives, cocoa market brokers and merchants who mentioned the retreat – described right here intimately for the primary time — has left lasting strains available on the market. That has resulted in larger gaps between the worth at which cocoa may be purchased and offered, and has prompted some business gamers to hunt different devices, leaving an enduring impression on the sector.

This month, the variety of futures contracts held globally on the finish of a given buying and selling day – a key indicator of market well being generally known as “open curiosity” – hit its lowest since at the very least 2014, the worldwide figures present, an indication the futures market total has shrunk considerably. Knowledge previous to 2014 was not obtainable.

On Wednesday, New York cocoa futures costs topped their April peak.

The futures market is a vital cog within the cocoa business, permitting producers and chocolate firms to hedge their publicity to swings within the worth of beans.

Futures dictate revenue for the farmers and low-income nations that produce the world’s cocoa – the vast majority of which comes from Ghana and Ivory Coast in West Africa.

Hedge funds and speculators have turn into larger gamers in commodity markets over the previous twenty years as the worth of their total property has grown. However, as purely monetary traders, they don’t have any want to stay available in the market at occasions of stress.

The impression of hedge funds’ exit illustrates how reliant buying and selling has turn into on these frivolously regulated funds that more and more form monetary markets. Reuters has reported this 12 months on how hedge funds are piling into the euro zone’s $10 trillion authorities bond market, drawing regulatory scrutiny, and on their rising sway in European inventory buying and selling.

Contacted by Reuters, the CFTC declined to remark. A consultant for Britain’s regulator, the Monetary Conduct Authority, mentioned that, in step with its market supervision observe, “we’ve been working with buying and selling venues and contributors to watch the orderliness of the market.”

Bernhard Tröster, an economist on the Austrian Basis for Growth Analysis (ÖFSE) in Vienna, who final 12 months co-authored a paper on the rising position of monetary actors in commodities derivatives markets, mentioned the withdrawal of hedge funds had helped gas the disaster in cocoa markets. 

“When markets turned so unstable this 12 months, it was clear how hedge funds  and different monetary actors have turn into so essential,” he mentioned.    

SUPPLY ISSUES HIT PRICES

Hedge funds and different speculators’ share of the market peaked at 36% in Could 2023, the best in at the very least a decade, after which their retreat started, the worldwide information calculated by Reuters present. 

Then, at first of this 12 months, international cocoa costs soared after high producer Ivory Coast was hit by adversarial climate and illness. Quantity two producer Ghana fared even worse, with smuggling, unlawful gold mining on cocoa farms and sector mismanagement added to the combination.

In early February, cocoa costs surpassed a earlier file excessive set in 1977. Executives at 5 hedge funds advised Reuters they started to withdraw as volatility grew and the price of buying and selling elevated.

When markets turn into too sizzling, exchanges require speculators to extend the quantity of collateral they put down per futures contract, elevating their prices. Lawrence Abrams, president of Absolute Return Capital Administration in Chicago, mentioned the price of buying and selling a single cocoa futures contract soared from $1,980 in January to $25,971 by June.

Excessive costs and volatility, mixed with falling liquidity, started to have an effect on “our system’s buying and selling and threat administration choices,” Abrams mentioned, whose fund offered out earlier than costs peaked in April. He declined to element how a lot his fund managed, citing regulatory causes. 

Many hedge funds promise traders they won’t exceed a certain quantity of threat, that means that if a sure market turns into too unstable they’ve to scale back their publicity. 

The distinction between costs supplied and searched for futures, the so-called “bid-ask unfold”, soared following the hedge funds’ withdrawal. That has made buying and selling more durable: decrease liquidity and wider spreads imply merchants wrestle to execute massive trades with out shifting total costs. 

“You want speculators,” mentioned Vladimir Zientek, a buying and selling affiliate at brokerage agency StoneX, referring to hedge funds, which aren’t amongst his purchasers. “With out speculators available in the market, you lose a number of liquidity, which permits for these very broad and erratic market swings.”

By mid-April, New York contracts hit a then-record above $12,000, up three-fold from January, prompting hedge funds to promote down their positions.

“Tendencies do not final eternally,” mentioned Remsing at Facet Capital. “Keep too lengthy in dimension and also you stand to provide again all of your beneficial properties.”     

Hedge funds’ share of the cocoa futures market dropped to 7% in late Could, its lowest in at the very least a decade, the worldwide information present.

One European dealer, who requested anonymity to debate purchasers’ trades, mentioned that panic available in the market elevated in March and April as liquidity drained away.

Volatility in cocoa futures hit an all-time excessive in Could, up five-fold from a 12 months earlier, in line with information from the London Inventory Trade Group (LON:LSEG). 

Day by day common worth swings that month neared $800, some 15 occasions the degrees of a 12 months earlier, in line with a Reuters evaluation of figures from market information supplier PortaraCQG.

RISKIER MARKETS 

For main buying and selling homes that purchase and promote cocoa beans – a gaggle that features Singapore’s Olam, Switzerland’s Barry Callebaut, and U.S.-based Cargill – the liquidity drain and related worth surge exacerbated the extra than-$1 billion greenback hit they took on their futures positions.

The losses got here earlier this 12 months after Ghana, following a disastrous harvest within the October 2023 to September 2024 season, delayed supply on practically half the beans the nation had pledged to promote, upsetting cocoa merchants’ futures market methods. 

These merchants sometimes use futures to lock in costs achieved for cocoa beans, or to hedge towards the chance of falling costs. 

However that technique unraveled as Ghana delayed its deliveries. Merchants have been pressured to liquidate, at steep losses, quick positions for the month of anticipated supply, and take new quick positions.

The market turmoil has prompted some buying and selling homes and producers to hunt options to futures. 

Australian funding financial institution Macquarie, a giant participant in commodity markets, advised Reuters it offered over-the-counter merchandise to buying and selling homes, processors and chocolate makers when cocoa volatility hit file ranges this 12 months, and demand stays excessive.

One main agri-commodities dealer is now utilizing such bespoke contracts, in line with a supply who requested anonymity citing delicate business relationships. They declined to touch upon the magnitude of the enterprise.

Such merchandise sometimes defend patrons towards narrower worth swings than is feasible with futures, limiting their use, a European dealer mentioned, declining to be recognized to freely talk about purchasers’ exercise.

‘COCOA TOURISTS’

Some hedge funds have returned to the market. Together with different speculators that commerce utilizing traders’ money, they accounted for 22% of futures buying and selling this month, in line with the worldwide information. However shopping for and promoting within the cocoa market’s altered panorama has turn into more durable.

Zientek, the buying and selling affiliate at StoneX, mentioned bid-ask spreads can now high 20 “ticks” – $200 per contract – in comparison with about 2-4 ticks earlier than cocoa’s rally to file highs.

“This makes bigger orders harder to execute with out seeing an instantaneous distortion available in the market,” he mentioned. 

Daniel Mackenzie, managing director of Cocoa Hub, a UK-based firm that sources and sells cocoa beans to artisan chocolate makers, mentioned larger and extra unstable costs have been forcing small and medium-sized makers to resolve between passing prices to purchasers or decreasing product sizes. 

One chocolate maker he labored with has been shuttered and one other offered, he mentioned, with out offering additional particulars. 

As hedge funds exited, short-term traders corresponding to day-traders – which purchase and promote property inside a single buying and selling day – have stayed available in the market, the European dealer and the dealer on the agri-commodities financial institution mentioned.

The cohort that features day-traders this month accounted for five% of the market, about the identical as the beginning of the 12 months, the worldwide information present.

Day-traders can’t fulfill the liquidity-provision position historically performed by hedge funds, the 2 brokers mentioned.

“I wish to name them ‘cocoa vacationers’ – they transfer in, maintain a place for a day or two, then transfer out,” the European dealer mentioned.