Traders are optimistic on sweet contracts

Key points:

• Despite broader commodity weakness, optimism has been high for sugar and cocoa
• The Optimism Index for both contracts has averaged over 70%, among the highest ever
• The contracts tend to struggle with high optimism, as do two individual stocks

Commodities are struggling, but two stand out

As Dean has pointed out, most commodities have been struggling lately. More and more contracts are losing their uptrends, which has tended to lead to even more declines.

But if you pull up the Market Sentiment Overview, two markets stand out, both commodities. Only cocoa and sugar have an Optimism Index (Optix) in the optimistic zone after settling back recently.

When we average the Optix of the two markets, it just recorded its 3rd-highest reading in more than 30 years. It has since settled back but remains above 70% on average.

The chart below shows the annualized return in sugar futures when the combined Optix of sugar and cocoa exceeds 70%. It has not been good, as the contract has tended to see some sudden drops from periods of extreme optimism in "sweet" contracts.

Cocoa futures also tended to show very poor annualized returns after extreme optimism in these contracts.

It might be interesting to look at returns in a couple of stocks where cocoa and sugar can be expense inputs. The table below shows returns in Hershey's stock the average Optix on sugar and cocoa exceeds 70%. That triggered at the end of March, so it has already been a while, and Hershey has rallied significantly. There tends to be more weakness in the stock over the medium-term of two to three months, though it was something of a crap shoot.

For a stock like Coca-Cola, it tended to be more of a potential negative influence. Over the next six months, the stock showed gains only three times out of nine signals, and three losses were double-digits.

What the research tells us...

There isn't a lot of optimism in most major markets at the moment as sectors bifurcate and investors pick and choose potential winners and losers. It has been tough to find optimism among commodity contracts, so sugar and cocoa stand out. Both contracts have tended to perform well during the summer months but they have shown poor annualized returns when optimism on both gets extreme, and that has even filtered through on some individual stocks that have those commodities as inputs.