Time To Cotton On

The cotton market, like most commodities, is subject to the rigors of supply and demand. The main producers (in 000’s metric tons) are China 6 641, India 5,530 and US at 3,942. When it comes to consumption China is the largest at 10,015, then India at 4,355 and Pakistan at 2,323.  As you can see, China has a deficit of 3,374, which comes from either the US, India, Australia, Uzbekistan or Brazil. The US is the largest exporter at 3,135.  Apart from who is buying or selling cotton the market also has to deal with the fact the China controls 46% of the world ending stocks, or so we are lead to believe, and so it has been difficult to get accurate reports on what they actually hold and how this overhang will affect the market. This has partly been one of the reasons as to why the market has dropped. This move we feel is over and we expect prices to be well supported on any dip or at least to US 70.00 and will look for a further 20% gain on top of the gains we have already seen this year Why?

The 2012 crop year was terrible for cotton: not only did the price fundamentally look sick, we saw that global inventories were expected to grow to record levels. It made sense as with prices around US 200 farmers flocked to cotton production. The result was that more and more acreage went to cotton. This in it self-does not provide a good incentive for cotton trading higher for 2013, however for exactly the same reasons as it went down we feel it will go up. This year we see supply being down and demand up, which is a recipe for a strong market.

Firstly, the overall low prices have actually made it a very marginal crop to produce, at US70.00 a pound we are at around the marginal cost of production. Any downgrades at harvest would put the grower at a loss. This means that there is a likelihood that the growers will turn to other more lucrative crops such as soybeans. Further, it is anticipated that the new crop as a result of the low prices will see acreage under cotton drop by about 30% in Australia and Brazil, the world's number 3 and 5 exporters. Fewer exports onto the global market will put a low in place. As it stands we anticipate that we may fall short on production for the first time in four years. In addition to this we have not looked at expectations that the weather will play on the market. The US drought is continuing and if this persists, which our forecasts are telling us, then we will see crop abandonments in the US at a lot higher rate than forecast. We just cannot turn a blind eye to the weather as it so volatile these days. So supply is looking dodgy.

Secondly, on the demand side, world inventories as we are aware are already high, however as we mentioned before China is about to embark on an expansion phase. Although it is the largest producer it is also the largest consumer. Any uptake in consumption from China will not only reduce their current stockpiles but also apply additional pressure on those regions that supply China with cotton. The concern is that these regions will not be producing as much, ie Australia and Brazil. If the US follows suit whilst demand from China is strong then prices will rise. Let's face it, we are all looking for an economic recovery this year so expect demand to remain strong.

So the fundamental picture for cotton looks good at these levels. What does the technical side look like?

Technically the market is in a range US200 to the top and US65.00 on the downside. As we can see there is more potential for the upside from these levels. This is one reason we like trading commodities, as support and resistance are at extreme and can be relied on. So when we see a solid bounce we can be pretty comfortable that a change of trend is on the cards. Momentum indicators on the weekly basis have turned, dailies look a little overbought so look for a dip to buy. Stops can go in at US65.00 or US75.00. Our first target is US100.