My go to man on commodities says this:-

Summary

The composite of five soft commodities - sugar, coffee, cocoa, cotton and frozen concentrated orange juice (FCOJ) - futures rose by 6.86% in Q3 after falling 15.04% in Q2. This sector was the best performer in 2015 and now, year to date, it has gained 22.11%. Soft or luxury commodities were the only bright spot for commodities last year and they are one of many this year.

Four of the five commodities in this sector posted gains in the third quarter. FCOJ was the winner in Q3, moving over 15.72% higher while sugar surged by over 13%. Coffee and cotton put up respectable gains while cocoa moved just over 8% lower.

Let us look at the action in the softs in Q3 and the outlook for this sector over the coming three months.

Sugar Review

Sugar was 4.96% higher in 2015 after falling 9.7% in 2014. So far over the first half of 2016, the sweet commodity has gained an incredible 50.92%, making it the best performer of all commodities that trade on U.S. exchanges. In Q3, sugar rallied another 13.13%. It traded in a range of 12.45 to 23.56 cents per pound during 2016. Ample supplies of sugar had caused the commodity to make a series of lower highs and lower lows since 2011. The lows came in August 2015 when the sweet commodity traded down to 10.13 cents per pound. Sugar then proceeded to rally, making a series of higher lows and higher highs culminating with the recent highs in late September. Sugar closed on September 30, 2016, at 23 cents per pound on the active month March ICE futures contract.

Sugar prices traded as high as 36 cents per pound in February 2011. In countries like the US and EU, the price of sugar is subsidized by the government. However, the major sugar cane producers, Brazil, Thailand and India are not. In Brazil, the weakness of their currency, the real, throughout 2015 contributed to a lower sugar price. Brazilian producers were dumping sugar into a falling market in dollar terms, but as the real moved lower, the price of sugar in Brazilian currency had done much better. At the same time, lower energy prices decreased demand for biofuels and in Brazil, ethanol production comes from sugar cane. The price of the real began to recover and sugar caught a bid. At the same time, crude oil recovered from lows of $26.05 per barrel on February 11 and that raised the prospects for domestic demand for the sweet commodity regarding ethanol production in Brazil. Additionally, El Nino-related droughts in Asia have caused production to decline in China, India, Thailand and Indonesia. After five straight years of surplus conditions, the sugar market went into a small deficit in 2015/2016 and that imbalance has increased in the 2016/2017 crop year. Sugar is now in its second year of a deficit and the price has reflected its fundamental condition.

When prices fell to lows of just above 10 cents per pound because of a huge surplus of physical sugar, it made economic sense for producers to cut back. However, the most significant help for sugar may have come from Mother Nature and the trajectory of the U.S. dollar. The strongest El Nino since 1997 first caused a rally in the price of rice and sugar was the next agricultural commodity to wake up. Sugar is, historically, a very volatile commodity, the amount planted and the weather each year in the major growing countries has a direct effect on price.

The sugar market had been moving back and forth between contango and backwardation during the rally, but recently the higher price has led to a sustained backwardation. When the nearby price of a commodity is greater than the deferred prices, it signals a tightness or supply concerns in the raw material market.  Source: ICE

The forward curve in sugar futures highlights the backwardation that exists in the sweet commodity. Backwardation is a condition where deferred prices are lower than nearby prices and it is a sign of tight supplies.

Source: CQG

The monthly chart of ICE sugar futures emphasizes the power of the current trend. The price target for sugar was 23.10 cents which was the 50% retracement level of the move from 36 cents in 2011 to just over 10 cents last August. The price has climbed above that level over recent sessions but pulled back in aftermarket trading on the final day of the third quarter. Brazil is the world' s leading producer of the sweet commodity and weather in the South American nation will likely dictate the path of least resistance for the price.

Source: CQG

As the weekly chart illustrates, open interest in sugar futures has increased and decreased with price moves. The first correction that took sugar from 15.85 to lows of 12.45 came with a move in open interest from 897,318 contacts on January 29, 2016, to 748,537 contracts on March 9. The price decreased by 21% and open interest fell 16.6%. Sugar then proceeded to take another leg up to 16.75 cents and open interest exploded to over 860,000 contracts. When sugar corrected to 14 cents on April 11, open interest fell to around the 790,000 contract level. Since then, sugar has been nothing short of a moonshot and open interest peaked at over 922,000 contracts on June 6.

Open interest was at just under 856,000 contracts as of June 30 and has fallen to the 841,000 level at the end of Q3, a decline of around 15,000 contracts is a sign that some longs have taken profits. It is possible that sugar is not attracting the same number of speculative positions now that the price has more than doubled since last August. The value proposition for a long position in sugar has declined at over 20 cents per pound.

Sugar is one of the most volatile commodities that trade, in past years daily historical volatility had exceeded 100%. At the end of Q3, daily historical volatility stood at 23.11%, which is 19.21% lower than it was on the final day of trading in Q2. Lower volatility is because of the slow and steady rally that has had few price spikes. If sugar decides to break above the 24 cents per pound level that could quickly change and we could see wild volatility in the market.

Sugar Outlook for Q4

In my Q2 report I wrote," I suggest approaching sugar by buying dips and taking profits on rallies in either the sugar futures market or with the ETF and ETN products  CANE  and  SGG. Keep an eye on the forward curve, as this is the best indicator of a continuation of a shortage of sugar."   The forward curve volatility tells us that the supply-demand picture remains bullish. I would be a buyer of sugar on dips. Initial support is now at just above 21 cents per pound level with more critical support at 19 cents. Sugar has been making higher highs and higher lows for over one year and it is possible that this pattern will continue. A continuation of the bullish trend will depend on the weather in central growing regions and a price that puts the 23.10 pivot point in the rear view mirror. Watch for an increase in volatility in sugar in Q4 as the current level of daily variance is at a very low level and is likely to move higher with the current price level.

Coffee Review

Coffee was the number one, the best-performing commodity of 2014, registering gains of 43.19%. Therefore, it should come as no surprise that coffee had a rough time in 2015 it was the worst performing soft commodity. Coffee futures fell 23.95% in 2015. Active month December ICE coffee futures closed on September 30, 2016, at $1.5155 per pound - coffee was up 5.17% in Q3 and has appreciated by 19.61% thus far in 2016. The price range over the first three months of 2016 was $1.1105 on the lows to $1.6090 on the highs, the lows of the year occurred in January and the market reached the highs on September 22. Coffee has been making higher highs and higher lows and trading in a bullish technical pattern since March.  Source: CQG

The daily chart of December ICE, coffee futures illustrate the bullish trend. The market continues to expect a shortage of Robusta beans this year. Any lack of Robusta coffee, which is the bean needed to make espresso, is likely to translate to more demand for Arabica beans which is the coffee traded on the ICE futures contract. Open interest in coffee futures increased over the last three months. Open interest stood at 174,148 contracts at the end of Q2 and rose to 185,874 at the end Q2 - an increase of over 6.7%. The increase in open interest as the price appreciates tends to be a positive technical sign in the futures markets.

There is a great inverse correlation between the price of Starbucks (NASDAQ:SBUX) stock and the price level of coffee futures.  Source: Barcharts

The price of coffee rose 7.45 cents over the three-month period and SBUX fell by $2.98 per share over the same time frame. The stock closed on September 30, 2016, at $54.14. Short-term support for September coffee futures is now at the $1.3785 level with resistance at around $1.6090 per pound. If you own or trade SBUX, it is important to follow the coffee price to avoid any unpleasant surprises.

Coffee Outlook for Q4

Coffee is a wild ride it is one of the most volatile commodities that trade daily trading ranges of 8% are the norm rather than the exception. Demand for coffee around the world continues to grow with population and the growing number of coffee shops like Starbucks and imitators around the globe. In Asia, the traditional tea-drinking community has been adopting coffee as a preferred substitute which has increased global demand.

Weather patterns, as well as crop disease (leaf rust) in the main growing regions, will determine price direction of this soft commodity. Like in sugar, a deficit could emerge given the problems with the Robusta crop related to the recent El Nino. Although supplies remain ample, Brazil took advantage of a plunge in their currency to sell all of their inventories and now relies on another bumper crop from the country that is the world' s number one producer of java beans.  Source: ICE

The futures curve in coffee remains in contango with deferred contracts trading at a premium to nearby contracts. However, the cash price is higher than all contracts on the board out to May 2019 which could be a signal that the market is tight. The shortage continues to be in the Robusta beans, but the Arabica is following higher.

I continue to believe that coffee is bullish. At the end of Q2 I wrote,"   It is at the upper end of the trading range as of the end of the second quarter. Coffee is not  a trading  vehicle for the faint of heart given its penchant for extreme volatility on a daily basis. I am a scale down buyer of coffee futures under current levels on the  active  month ICE futures contract."   Coffee rallied to $1.5765 over the first two weeks of the third quarter and then plunged to $1.3785 before resuming its rally and making a new high. As I have been saying in previous quarterly reports, I expect higher coffee prices in 2016. If you do not trade in the coffee futures market, consider the  JO  ETN product. Coffee is a wild ride so always be prepared for massive price volatility in this percolating commodity.

As in sugar, given the volatility of this market, I would only buy on dips to initiate positions and look to take profits on rallies. If you have been following this strategy, the results have been highly profitable since March.

Cocoa Review

Cocoa was the best performer in the soft commodity sector in 2015. In fact, cocoa was the only commodity that posted a double-digit gain in 2015 and won the gold medal for performance across all of the raw material markets that I cover. As is often the case, the best performer for one period often turns into the worst for the next. Cocoa was the worst performing soft commodity in Q3, falling 8.09% over the three months. Cocoa is down 14.01% so far in 2016 and it is the only soft commodity that posted a loss in Q3 and 2016. Cocoa closed on September 30, 2016, at $2761 per ton and traded in a range of $2708-3241 per ton during the last nine months. Cocoa has been highly volatile.  Source: CQG

The daily chart of ICE cocoa futures illustrates the huge moves we have seen in 2016. Cocoa traded to highs of $3,241 per ton in early May and then fell to lows of $2,896 in only two weeks. The price the proceeded to rally to $3,190 on June 23 and the Brexit vote took it down to $2956. Cocoa closed the third quarter close to the annual lows. Open interest in ICE cocoa futures has increased from 199,992 at the end of Q2 to 230,206 last week. The rise of 15% while the price has made lower lows is worrying for the future price direction of the primary ingredient in chocolate.

Cocoa is highly sensitive to moves in the British pound as the hub of global cocoa trading is located in London. Given the unusual move in the pound, cocoa has rallied in that currency, but it has declined in dollars. The monthly chart highlights the long-term rally in cocoa futures which has been demand-based.  Source: CQG

The demand for chocolate confectionery products, primarily from Asia, has caused the price of the commodity to increase over recent years making higher highs and higher lows. However, the market action has been extremely volatile over that period. The cocoa market has displayed all of the characteristics of a demand-based bull. One must remember that in the world of commodities, supply-side rallies can be sharp, volatile and short-lived while demand-based rallies tend to be slow and steady with many pullbacks along the way.

The Chinese have developed quite a taste for chocolate and as most people will attest, once you taste the delicious treat there is no turning back. The rally in cocoa started back in late 2013 and since then every price correction has been another buying opportunity. The world' s major producers of cocoa beans are the West African nations of the Ivory Coast and Ghana. Between them, they are responsible for around 60% of the world' s production. Weather-related issues or crop disease such as cases of frosty pod rot in cocoa growing areas could propel cocoa into the stratosphere in the months ahead if there is any damage to West African crops or problems with logistical routes to port. In a recent development, Nigeria decreased their projection for this year' s crop which could be a sign that West African output will decline in the months ahead.

Cocoa Outlook for Q4

Every price dip in 2014 and 2015 was a buying opportunity in cocoa - but each one was scary. The rally was demand-based China and Asia bought cocoa beans and are consuming more chocolate than ever before and volatility is increasing in the cocoa futures market. Daily historical cocoa volatility is at the 29.54% level, only 0.97% lower than last quarter. In March 2011, cocoa traded at all-time highs of $3,826 per ton. One must exercise caution in a market like cocoa, as the charts illustrate there are periods of boom and bust. Cocoa now needs to hold critical support at the $2669 level the February 2015 lows if the bull market is to remain intact. I believe that cocoa is a limited risk candidate for a long position at the current price level. A stop of $2649 is $112 below the Q3 closing price and cocoa could quickly rally above $3000 per ton given the price range of the last two years. If you do not trade in the cocoa futures market, the  NIB  ETN is an appropriate vehicle for short- to medium-term trading positions.

Cotton Review

Cotton was the worst performing soft commodity in 2014 it moved 27.33% lower for the year. In 2015, the price of cotton appreciated by 4.99%. During the third quarter of 2016, cotton appreciated by 8.37%. Cotton is now up by 7.59% in 2016. Meanwhile, in Q3 cotton finally made a big move.  Source: CQG

As the daily chart highlights, cotton broke to the upside in July and peaked at 77.98 cents per pound on August 5 before profit-taking and selling took the price all the way down to the 65.45 cent level. Cotton traded as low as 54.19 cents per pound on a spike down at the end of February and as high as almost 78 cents in early August. Support for the fiber is now at the 66 cents per pound level. Cotton closed on September 30, 2016, at 60.08 cents per pound. In March 2011, cotton traded up to an all-time high of $2.27 per pound on supply shortages. Since then prices had moved progressively lower.  Source: ICE

As the forward curve demonstrates, term structure in cotton futures remains flat. Cotton inventories remain high in the United States and China, but there are signs that they have begun to decline. China is a major factor for the cotton market due to their demand for the fiber. Open interest in the fiber exploded from 186,484 at the end of Q2 to 250,174 contracts on September 29 - an increase of over 34%. Rising open interest and a price increase provide technical validation for the emerging bullish trend.  Source: CQG

As the monthly cotton chart shows, cotton had been consolidating below 70 cents per pound since September 2014, but it broke higher in July and traded to the highest price since July 2014.  Source: CQG

Price action on the daily chart highlights a pattern of higher lows and higher highs since late February, which is constructive price action and resulted in the spike to almost 78 cents per pound.

Cotton Outlook for Q4

The bear market in cotton had been firmly in place since 2011. However, the spike down to 54.19 cents per pound on February 29 on heavy volume, which was the lowest price since July 2009, formed a significant bottom for this besieged commodity. In my Q2 report, I wrote," All the bearish news is already in the price of  cotton,  therefore, price shocks if they occur, will lead to higher prices from current levels.  Weather-related  factors could provide cotton with an upside shock. Given the fact that inventories will eventually  decline  and the price is currently so low compared to where it was over recent years, I expect a rebound in the price of cotton in the second half of 2016. As the daily chart illustrates, cotton is building  technical  cause for a move higher that may surprise everyone later this year. I continue to expect that cotton will test and trade above the 70  cents  per pound level in 2016 for the first time since July 2014. My target is 80 to 90 cents per pound."   Cotton traded to just 2.02 cents shy of my upside target in August.

Current support for cotton lies at those lows and resistance is at just below 65.50 cents on daily charts, but I would place any stops at 62.90 because of the potential for lots of volatility in this commodity. I expect cotton to continue to work its way higher in the months ahead and my target remains above the 80 cent level. Cotton has been making higher highs and the chances are this pattern will continue.

You can trade cotton on the ICE futures and options market or for those who do not have futures accounts the  BAL  ETN product does a good job tracking the price of the fiber futures.

 

The bottom  line

Four out of five soft commodity prices were winners during Q3 and sugar, coffee and FCOJ have posted double-digit returns so far in 2016. Be cautious when trading in this sector as it is highly volatile.

Coffee is a highly volatile commodity, but it could provide excellent trading opportunities for those with the wherewithal to buy on dips and take profits when the market offers them. Critical resistance for coffee is at the February 2015 highs of $1.6990 per pound.

Sugar, which has rallied aggressively throughout the year, continues to present opportunities given the fundamentals for the sweet commodity. I am a buyer of sugar on dips and prefer to continue to trade rather than invest in the sweet market for the balance of the year.

When it comes to cocoa, I expect an ultimate test of all-time highs given the high level of demand from Asia. Buying dips and taking profits on rallies has been the best strategy in the cocoa market and I expect this to continue. Again, weather or logistical problems in West Africa could prove very bullish for the price of cocoa as well as other soft commodities in the months to come. Watch the level of the British pound over coming weeks as it could signal critical entry or exit levels for cocoa. Watch the $2669 per ton support level, if it falls below $2650 stand aside.

I believe that cotton will eventually test above the 80 cents per pound level. I would buy cotton futures or ETF/ETN products (NYSEARCA:BAL) on dips and take profits when the price makes new highs. We saw the first move in Q2 and buying on price weakness and taking profits on rallies have been the best path to profits since March.

When it comes to soft commodities, it is ultimately the weather or logistical events that could cause these markets to move. When trading and investing in this sector, always be prepared to expect the unexpected and anticipate periods of massive volatility. Long options could be the best way to play from the long or short side. When you buy a call or put option, all you risk is the premium. Options allow one to stay with a position if it moves against them for a period and to capture sharp movements.

While I continue to favor agricultural commodities in 2016, I would only buy significant price dips - as the action over the first nine months shows us, high volatility is the norm rather than the exception in this sector.