Hanging by a Thread?
Fundamentals
Cotton futures have been trapped in a period of consolidation for the past week, resulting in a tug of war between bulls focused on demand and bears focused on acreage and ending stocks. Last week's USDA report gave traders a bit more insight into crop conditions. Ideal growing conditions have led to a sharp jump in crop yields from 815 pounds per acre to 845 pounds per acre. Carryout is now expected to be 3.5 million bales, versus an estimated 2.8 million bales a month ago. Demand has, at times, overshadowed the large supplies. Export demand is expected to be 14.3 million bales, up from the 13.5 million June estimate. The large supplies could pressure prices, as there are signs that demand may begin to taper off. There have been some rumors out of China indicating that textile mills have built-up inventories over recent months. This could offset some of the negative crop news in China's North Plain growing region. With the large supply forecast, some traders may be focused on the demand side of the equation. Considering the large jump in yields, the 700,000 bale increase in ending stocks is not as large as one may expect.
Trading Ideas
The fundamental outlook for the Cotton market is a bit unclear at the moment, given the increase in both supply and demand. Considering the seemingly huge pile of Cotton the US will be sitting on, demand will likely be the key driving force going forward. The chart seems to favor the downside; however, there has been no confirmation of a downside breakout. Some traders may wish to enter into a bear put spread by buying the November 71 puts (CTX071P) and selling the November 68 puts (CTX068P) for a debit of 0.70, or $350. The trade risks the initial debit for a potential reward of 2.30, or $1,150.
Technicals
Turning to the chart, the December Cotton chart shows prices in a consolidation pattern. Since the preceding trend was lower, the consolidation can be seen as a bear flag, which if confirmed, could result in prices tumbling below the 70.00 level. The immanent downward crossover of the 20 and 50-day moving averages can be seen as bearish in the intermediate term. The momentum indicator has moved lower at a very steep angle, outpacing both price and RSI. This hints at further weakness ahead.
Robert Kurzatkowski, Trading Specialist
