Cotton's Consolidation Continues
Fundamentals
Trade in Cotton futures has been choppy lately, as market participants weigh a fairly bullish USDA report vs. a general sell-off in commodities. Cotton prices declined on Tuesday, despite the USDA lowering U.S. Cotton carry-out totals to 4.3 million bales, vs. 4.5 million bales in the December report. The USDA also lowered 2009 all-Cotton production to 12.401 million bales, vs. 12.592 million bales as of December 1st. However, a sharp sell-off in the grain complex tied to a bearish USDA report spilled over into Cotton and commodities in general. Adding to the misery for Cotton bulls was the announcement out of China of another interest rate increase. This is being done to help tighten credit conditions and curb excess speculation in the world's most populous nation. Traders fear this will curtail Chinese demand for commodities in general, including Cotton, which could cause a major hit on U.S. exports this year. However, much of Tuesday's declines were wiped out yesterday, as fresh buying emerged near recent support at the 72.50 level. Despite the sideways trade of late, the longer-term trend is still bullish for Cotton, as world production estimates continue to decline. There is still hope for a stronger world economic outlook this year, which should lead to increased Cotton consumption.
Trading Ideas
Cotton prices are up almost 50% from the lows made back in March of last year, and the recent consolidation phase may have encouraged weak longs to exit the market, which could be a catalyst for renewed buying should the up-move resume. Some traders looking to take advantage of the price consolidation to establish a long position in Cotton may possibly wish to look at the Cotton options market to establish a bullish trading strategy. An example of one such trade would be buying a bull call spread in July Cotton, such as buying the July 80 calls and selling the 90 calls. With July Cotton trading at 75.68 as of this writing, the spread could be bought for about 2.50 points, or $1,250 per spread, not including commissions. The premium paid is the maximum risk on the trade, with a potential profit of $5,000 minus the premium paid should July Cotton be trading above 90.00 at option expiration in June.
Technicals
Looking at the daily chart for March Cotton, we notice prices starting to consolidate after they failed to move above 77.00 in the first week of 2010. The ensuing sell-off moved prices below the 20-day moving average, which triggered a sell-signal for short-term momentum traders. However, longer term prices are still well above the 100-day moving average, and it would take a close below 70.00 to turn the longer-term trend bearish. In addition, prices are holding well at the uptrend line drawn from the August 27th lows of 59.47. The 14-day RSI has turned neutral, with a current reading of 49.58. The recent lows of 72.43 should act as near-term support for the March contract, with major support found at the 100-day moving average near the 69.50 area. Resistance is seen at the recent high made on January 4th at 76.77.
Mike Zarembski, Senior Commodity Analyst
