Are computers driving the cost of your chocolate bar or cappuccino?

Specialised markets such as 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. It is also triggering dramatic shifts in prices for coffee, cocoa and sugar, sparking concern that these commodities are being divorced from their fundamentals of supply and demand, traders and brokers say.

“People are looking for more niche markets to deploy that money,” said Michael Coleman, founder of $140m discretionary hedge fund Merchant Commodity Fund. Many of the computer-driven strategies are searching for risks and returns uncorrelated with other financial markets.

One group of computer-driven funds active in the commodities markets are the trend-following “commodity trading advisers” or managed futures funds. The number of 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 $15bn, according to Tom Wrobel, director of alternative investments consulting at Société Générale Prime Services.

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.

Alongside commodities trading houses, they historically used assets and global networks to take advantage of dislocations in futures prices, such as selling raw materials into an exchange where prices were excessively high. Yet many of the trading houses that once helped balance the market now focus on profits from processing the raw materials rather than taking advantage of price distortions, said brokers.

In the cocoa market, for example, Anthony Ward, the UK-based trader dubbed “Chocfinger” and known for his multimillion dollar bets, blamed the rise of algorithmic trading for making profits harder to come by when he closed his fund last year.

A number of important players in agricultural markets are also feeling the heat. Producers, such as 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.

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.

In the cocoa market, the New York price has jumped more than 50 per cent since the start of the year to a 19-month high of almost $3,000 a tonne. 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 tonne.

Jonathan Parkman, co-head of agricultural commodities at broker Marex Spectron, said the New York cocoa market’s recent run up from the $2,500 a tonne it was trading at in March “had absolutely nothing to do with fundamentals”.

Normally, London cocoa trades at a premium to New York, but the inversion suggested a shortage in the US market, sending a signal to exporters to ship their beans there in order to meet a scramble for supplies that did not really exist.

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That comes as the coffee and sugar markets have experienced a sharp rise in bearish positions built by “managed money” — a market category that includes speculative funds, to record levels.

One reason why momentum-surfing funds are turning to niche assets reflects how their price movements are not correlated to other financial markets.

Ewan Kirk, chief investment officer of GAM Systematic Cantab, the quant fund belonging to GAM, and whose systematic funds manage $4.8bn, said: “Commodities are particularly interesting because they are very different from everything else,” adding that soft commodities in particular were “a very valuable source of diversification”.

High-frequency traders, who transact small positions in a space of milliseconds, are another group who have pushed into the agricultural commodities markets.

Jean-Jacques Duhot, chief investment officer at Arctic Blue, a systematic commodity-focused fund with $200m of assets under management, said that “high-frequency [traders] have started to enter the commodities space in a significant way”.

Such automated trading firms generate high levels of volume, amplifying short-term volatility. “They are very short-term participants, leading to higher intraday volatility,” he added.

Those who have seen the tectonic shift in other financial markets say a further push of computer-driven trading into commodities markets, including smaller ones such as cocoa and coffee, is inevitable.

“Algorithmic trading has moved from fixed income to equities,” said Thomas Lehrkinder, senior analyst at Tabb Group, a capital markets consultancy. “The next natural step is commodities.”

One consequence of the sharp swings in prices is a drop in the volume of hedging flows from those who buy and sell the physical commodities. The rise in intraday price volatility is making it difficult for some producers and food companies to maintain their hedging positions, while others are reluctant to take positions in the face of the frequent unusual market moves.

“There’s less hedging in the market, that’s for sure,” said Mr Duhot.

Not everyone is alarmed. 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,” said Derek Chambers, the former head of cocoa at commodity traders Sucden. A cocoa trader for five decades, Mr Chambers said: “Over time the fundamentals come into play in the market. Nobody is bigger than the market.”

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