Wednesday, March 06, 2013

Trading Cotton Futures: King Cotton's Stealth Resurgence

Just nine months ago, we were licking our chops at cotton's blue light price special.  Cotton had been smashed from a post-Reconstruction high of over $2 to WAYYY down below the $0.70 mark.
Cotton futures have quietly dipped to their lowest levels in two years, prompting our "contrarian alert" to sound.  Likely, cotton will base out a bottom, and slowly restart an ascent likely to carry it well above $1. As we wait for a breakout to the upside, King Cotton is a nice potential trade to keep an eye on.  (Full analysis at Seeking Alpha)
Since then, The King has dusted himself off, and began his somewhat-long-awaited rally...

Cotton Futures Price Chart 6 Months
King Cotton picks himself up off the mat...

Cotton Futures Price Chart 5 Years
...and it's a LONG way back to the top of the hill. (via Barchart.com)

While the top-most chart (past 6 months) shows an impressive rally, the latter chart (past 5 years) shows recent stratospheric levels that cotton has traded at.  While a challenge of 2011 highs may be a bit much, a rally above $1 seems like a more reasonable thesis.

Going Long Cotton

I went long cotton in January upon its breakout past the $0.78 mark.  When soft commodities "base" for as long as cotton did, a breakout above the trading range should usually be bought...so far so good here.

We'll revisit the fundamentals of the trade next, but our stop-loss will be purely technically based.  If cotton hits a 15-day low, or decisively breaks current support at $0.82, we will close this trade out, book a modest profit, and wait for the next opportunity.

Cotton Fundamentals, and the Tape

Last May, we speculated that cotton supply may decrease because farmers would have fond eyes for the grains:
Corn and soybeans are not exactly cheap right now either - with corn above five bucks a bushel and 'beans in the lower teens, farmers are making some good coin on these crops. It's unlikely they'll replace this acreage with cotton at current prices.
Bloomberg today reports this is exactly what happened:
American farmers may sow 9.4 million acres of cotton in 2013, as they switch to more profitable crops, Macquarie Group Ltd. said today in a e-mailed report. That compares with 12.3 million a year earlier, government data show.
With corn and soybeans currently sitting higher than they were last spring, it's likely the bearish trend in cotton plantings will continue.

So demand is decreasing - how about supply?

This is the wild card that is more difficult to predict.  There have been reports that the real catalyst of the recent cotton rally has been China buying up as much cotton as it can.  While I find it impossible to get a macro-read on China from my comfortable office chair in Sacramento, I do have access to the cotton price chart, which does appear to be moving upwards.  Hence we'll continue to use the chart as our real-time indicator of Chinese demand for cotton.

We know the potential for a supply/demand imbalance is there.  It has been for years, and it tipped in a big way a couple of years ago.  Our working theory is that this could happen again - especially with central banks with their collective fingers on the money printing triggers.  So, we'll keep a speculative long position in cotton, thanks to the breakout as our cue.

Other Commodities to Watch

Rice and cocoa are both trading towards the lower end of recent ranges - these appear the most intriguing in the short term.  We'll also be keeping an eye on sugar and coffee...both of which continue to tumble, as cotton did in late-2011 and early-2012 before finally finding a nice base to prepare for this current rally.

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