Cotton has been under pressure for what seems like forever, but in reality has only been since it established a double-top on its weekly close only chart in early May. Compared to its 5-year seasonal index (not shown) this was later than normal. From there the market has closed lower 10 consecutive weeks, quite a run as cotton raced to get back in step with its seasonal index.
But catch up it did, so much so that last week's close of 68.12 (December contract) may actually be right In step with the seasonal low weekly close the second week of July. As the index indicates, the market tends to trend sideways the next two weeks before rallying through its seasonal high weekly close late next February.
What is a seasonal index? In this case it is a study that takes weekly closes over the course of a calendar year, averages each weekly close, then averages all 52 weekly averages, before finally diving the weekly averages by the yearly average. This provides a week by week percentage, marked on the left hand axis of the chart. I then plot the current year's (calendar or marketing) along with the seasonal index for a comparison.
In the case of cotton, the market has generally followed its seasonal patterns if we keep in mind that the index is based on a series of averages. For example, the normal downtrend from the February high through the July low averages 25%. In 2014, last week's close of 68.12 was 72% of the close the first week of May at 94.32 for a decrease of 28%.
If the cotton market is seasonally set to turn bullish, what factors will lead the way? First and foremost is that last week's close by the December contract has the market priced in the lower 7% of cotton's 5-year price distribution range. Based on simple supply and demand rules; low prices tend to create increased demand, be it commercial demand for the actual physical commodity or imaginary demand for paper futures market holdings.
In cotton's case, renewed commercial demand may be slowly building, as indicated by the stabilizing of the trend in the December to March futures spread (bottom study, green line). Just a reminder, futures spreads (the price differences between contracts) reflect the commercial outlook of a markets real supply and demand situation, an outlook that often differs from USDA's report conclusions.
As for noncommercial interest, last Friday's CFTC Commitments of Traders report (third chart, blue histogram) showed this group continuing to decrease their net-long futures holdings (as of Tuesday, July 8) by reducing their long position by 3,303 contracts and adding 3,665 contracts to their short position. The resulting net-long of 5,167 contracts is the smallest is the smallest this position has been since the 4,546 contracts reported the week of November 17, 2013.
Weekly stochastics (second chart) have historically been a good indicator of market turns in cotton. Heading into this week's action, weekly stochastics for the December contract are in single digits, confirming the idea the market is sharply oversold, and could see a bullish crossover (faster moving blue line crossing above the slower moving red line, with both below 20%) if the contract does move sideways over the next couple of weeks. When was the last time a bullish crossover occurred? The week of November 24, 2013, one week after noncommercial traders had pushed their net-long position to a multi-year low.
Commodity trading is very complicated and the risk of loss is substantial. The author does not engage in any commodity trading activity for his own account or for others. The information provided is general, and is NOT a substitute for your own independent business judgment or the advice of a registered Commodity Trading Adviser.