Cotton Collapse
Today's Idea
Cotton futures have very few fundamental factors that could support the market. Prices moved higher too dramatically relative to supply and demand fundamentals. Now there is concern that Chinese demand, a major driver of prices, could falter at a time when a large crop hits the supply chain. Technically, the Cotton market appears to be in a freefall - a common characteristic for markets that have previously moved higher in a parabolic fashion. Speculators become too long, and the panic selling along with stop cascading and margin liquidations wipe out the buy side of the market. Some traders may possibly wish to test the short side of the market somewhat cautiously by entering into a bear put spread, such as buying the July Cotton 145 put and selling the July 140 put for a debit of 2.00, or $1,000. The spread risks the initial cost and has a maximum profit of $1,500 if the July futures contract were to close below 140.00 at expiration.
Fundamentals
Cotton futures have offered traders the ultimate roller coaster ride, routinely making limit moves. The correction could very well be a sign of a reversal, suggesting prices may continue to plummet. The quick drop in prices after the May first-notice day and the price disparity between months also offered confirmation that a short squeeze and panic buying had a lot to do with Cotton's ascent. Fundamentally, traders have continued to focus across the Pacific on China. There is concern that the Chinese consumer may begin to spend less, alleviating demand. Many traders are also expecting further rate increases from the People's Bank of China in an effort to stem inflation. There is also concern that the upcoming crop year may offer a more than abundant crop, as Brazil and Australia are expected to see a spike in output. The US outlook remains uncertain because of extremely dry conditions, which does offer a ray of hope for bulls.
Technical Notes
Turning to the chart, we see the July Cotton contract breaking out of a wedge formation to the downside. The parabolic move higher in Cotton has resulted in very little technical support. Prices have already moved through the 38.2% Fibonacci retracement level and are quickly approaching the 50% retracement at 139.25, which is an area of technical support. Failure to hold 139.25 suggests that prices could test the 61.8 retracement level at 123.95. Prices have closed below the 100-day moving average yesterday, which can be seen as a bearish technical signal over the longer term.
Rob Kurzatkowski, Senior Commodity Analyst
