Fiber Flop
Fundamentals
Cotton futures have pulled back in recent sessions, held back by lower demand from textile mills and an increase in short-term supplies. Mills have been reluctant to keep-up the pace of purchases in the face of tight supplies and rising prices. China sold 7 million bales of the fiber from its reserves, which amounts to about 2 months of domestic demand from mills. This could result in significantly lower demand for US imports in the near-term. The rally that had stalled out recently began in late March, as traders viewed the the commodity as undervalued. The rally then accelerated Cotton when traders became more bullish on the economic outlook, pushing prices up to the 61.67 level. This run-up in prices has hurt demand and turned the near-term fundamentals bearish. The long-term picture for the fiber, however, is expected to remain bullish. Inflationary pressure and an eventual recovery in economic conditions are expected to add outside support for the market. A sharp increase in metal and energy prices could spill over to other commodities, especially markets that may appear "cheap." US acreage is expected to shrink to 74 million acres for the 2009-2010 crop year from 76 million acres the previous year. Global demand is expected to rise to 107.1 million bales this marketing year, up from 105.06 million last year. In the near-term, Cotton may continue its choppy, sideways-to-lower trend on lack of fresh news and falling open interest. A clearer weather outlook for western and southern Texas could result in more orderly trading.
Trading Ideas
Given that prices are quickly approaching a significant support area at 52.73, traders may possibly want to hold off on entering the market with a short-term strategy. However, some long-sighted traders may perhaps wish to use the pullback in prices to enter a long-term bullish strategy, such as a bull call spread. An example of one such strategy would be to buy a December 70 call and sell a December 75 call for a debit of 0.50, or $250. The trader would risk the initial investment for a possible return of 4.50, or $2,250, if the December contract closes above 75.00 on the November 13th expiration date.
Technicals
Technically, the July Cotton chart has turned negative and would likely need to remain above support at 52.73 to avoid further selling pressure. The recent closes below the 20-day moving average suggest that a relative high of 61.67 may be in place. For the market to regain its upside momentum, prices would have to move above this relative high. The 14-day RSI has dropped sharply, outpacing prices to the downside. This could be viewed as a negative indicator and suggests that prices may continue to fall in the near-term. The 20-day momentum indicator is in danger of crossing into negative territory, further bolstering the negative short-term outlook.
Rob Kurzatkowski, Senior Commodity Analyst
