Technically Speaking
Darin Newsom DTN Senior Analyst

Monday 07/28/14

The End is Near for Cotton

Anyone who has watched the cotton market since in 2014 knows it has been under pressure, to say the least. The epitome of the struggle is the December 2014 contract, which after posting a high of 84.74 (cents per pound) the week of May 4 fell to a low last week of 64.53, a drop of about 24%. But as July is nearing its end, DTN Six Factor analysis gives market bulls in hiding a ray of hope.

Source: DTN ProphetX

First, the trend remains down. However, weekly stochastics (a momentum indicator, second chart) are in single digits, well below the oversold level of 20%. A move toward a higher close this week could lead to a bullish crossover, the faster moving blue line crossing above the slower moving red line with both below 20%, signaling a change in momentum to a secondary uptrend.

Next is noncommercial activity (third chart, blue histogram). If the secondary trend is going to turn up, noncommercial traders will need to start buying again. Last Friday's CFTC Commitments of traders report (positions as of Tuesday, July 22) showed this group moving to a small net-short futures position of 922 contracts. The question is now, why would this group cover their newly established net-short position?

The commercial view of fundamentals has slowly been growing less bearish, as indicated by the weakening carry in the December-to-March futures spread (fourth chart, green line). This factor is far from bullish with Monday morning's trade still showing a carry of 0.78 cents. However, other factors could soon come into play that might spark renewed buying interest from the commercial side, and them possibly noncommercial traders.

Monday morning finds the December contract priced at 65.70, putting it in the lower 5% of the market's 5-year distribution range. If there is any truth to the old economic rule of low prices creating demand, then both sides of the market (commercial and noncommercial) could view cotton as undervalued and ready for a rally.

Seasonally the cotton market has been following its 5-year index (weekly close only) relatively closely for much of 2014. That being the case, traders could take note that the market's seasonal low weekly close occurs the third week of July, corresponding with last Friday's settlement of 65.32 (Dec contract). From the close the third week of July through the close the last week of November, the December contract tends rally 13%. Using last Friday's close as a starting point projects a close in late November of roughly 73.80.

Notice on the weekly bar chart (as opposed to the weekly close only chart) that this would have December cotton testing resistance near 74.63 for a weekly high, a price that marks the 50% retracement level of sell-off from 84.74 through last week's low of 64.53. Given the neutral to bearish December to March futures spread, a 50% retracement would be the maximum move anticipated at this time.

Finally, market volatility remains high at 14.7%. While a possible reason for noncommercial short-covering, it could also limit potential buying interest from investors unless a dramatic change is seen in the commercial view of the market.

In a nutshell, or cotton boll if you prefer, the market appears poised for a move to an uptrend based on these six factors. This week's activity could go a long way in determining the trend for the coming months.

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.

Posted at 8:00AM CDT 07/28/14 by Darin Newsom
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