Come on, Cotton

Because of low prices, farmers in the cotton belt, which includes states such as Louisiana and Mississippi, planted the lowest cotton acres in 25 years. The profit margins work out better for other crops, such as soybeans.

Lower acres equal lower supplies; add in a small carryover of supply from last year’s poor crop and supplies at the tail end of this crop are projected to be the smallest in seven years.

These projected supplies are low even assuming good growing weather. This market can ill afford any weather problems that could potentially reduce yields for an already short crop.

China accounts for 30 percent of US cotton exports, and it appears as if the Chinese economy is on the mend. Bottom line: Growing demand combined with dwindling supplies is the classic recipe for higher future prices.

As the chart below illustrates, cotton prices have already rallied nicely from last November’s (multi-year) lows. But despite this I don’t see signs of the top yet. Tops (and bottoms) in cotton are generally formed during periods of high volume (as I identified on the chart). High volume was evident during the accumulation phase in April, but thus far there have been no volume spikes during the recent price appreciation that would be associated with a top formation.

Cotton Volume

Source: Commodity.com

And though it might appear on the above daily chart as if the cotton market has already made a massive move, the weekly chart below puts the recent action in perspective. Viewing the longer-term price trends, cotton prices certainly have additional room to run.

Weekly Cotton

Source: Commodity.com

The questions are, how much upside running room remains, and at this point in time what would constitute a good entry price for new crop (December) cotton futures?

The chart below shows the history of the December 2009 cotton contract. In March 2008 prices topped out just above 90 cents a pound. Prices then collapsed to approximately 37 cents by the following November. A cotton futures contract represents 50,000 pounds; therefore, every penny per pound move in price equals a $500 profit or loss per contact traded.

December Cotton

Source: Commodity.com

As we go to press, December cotton futures are trading either side of 60 cents a pound. A 50 percent retracement of the entire bear move (from the highs to the lows) works out to be 64 cents. This would represent our minimum upside objective.

In other words, at approximately this price point you would need to analyze how the market is acting. Is the volume picking up without appreciable additional upward price movement (an indication of a possible top), or is the market able to easily slice above this 50 percent level, a bullish sign?

What about a good entry point? December cotton has had a nice run recently, from below 50 in March to above 60 in May. It’s not out of the question to expect to see a normal correction of this recent rally that, should it occur, will set up a buying opportunity. How much of a break? This, of course, is the big question.

Note the breakout level on the above chart just above 52. This is the major support level, and the market, if any good, shouldn’t trade under this level for the remainder of this contract. In other words, it would be nice if we were able to buy close to the 52 to 53 level because our risk (assuming we risk to under this area) would be low.

However, the markets don’t always dance to the tune we set, and a more normal bull market correction in the cotton market runs in the 3 cent to 6 cent range, with an average of about 4 cents. I would look to be a buyer on a correction (top to bottom) of about this number (with entry on the way back up, using a stop just under the higher low).

After all, the fundamentals are bullish, the trend is up, and, in my humble opinion, the high price for 2009 cotton is yet to be seen.

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