History suggests futures will not stay long in the 70s cents a pound. So which way will they trend?

by Markets Extra | 14 Dec 2017

One of the absorbing factors of investing in agricultural commodities is the diversity of contracts. Even if the sector as a whole is wallowing (as currently, with the Bcom ag commodity subindex 0.5% from all-time lows), there is often at least one contract that is flying. Currently, cotton fits that billing, for March delivery rising 0.7% to 74.70 cents a pound in early deals in New York, the contract’s highest in seven months.

But why?

Chart signal

Technical appeal is one factor, with Tobin Gorey at Commonwealth Bank of Australia noting that charts were showing shorter-term moving averages moving upwards through the 200-day moving average, often considered a bullish factor. “The gap between the two averages is now less than 1 cent a pound, this is closest they have been in 18 months,” Mr Gorey said.

“This bullish indicator should, if it has not already, see technical buyers rush in.” Indeed, investor buying “could take cotton prices past the early-year highs”, with the contract hitting 75.57 cents a pound in March, although spot cotton topped 87 cents a pound in May.

US downgrade ahead?

Ron Lee at McCleskey Cotton, based in Georgia, saw fundamental reasons for price support, including the idea that the US crop could be facing a downgrade, with yields in Georgia, the second-biggest US cotton growing state, shrinking as harvest continues.

“You can ask any ginner in Georgia, and to a man, they will tell you that there isn’t another 564,000 bales within these state lines to meet the USDA’s 2.3m-bale estimate” for the state’s output.

“I think the US crop ulimately comes in slightly under the 21.0m-bale number, which will only add to the bullish nature of the current market,” he said. And factoring in foreign dynamics, he forecast a “string of bullish US Department of Agriculture [Wasde] reports” ahead, as world cotton output “will probably end up smaller” than currently forecast and “consumption could still be somewhat understated”.

‘Evidence of producer selling’

Not, it has to be said, that inputs are universally bullish for the fibre, with Louis Rose at Rose Commodity Group noting “evidence of producer selling pressure at current/recent futures levels”.

And Ecom conveyed a somewhat cautious outlook, downplaying the potential for the 55,986 contracts yet to be fixed against the March lot to provide an upward spark to prices. “Are the speculators hoping for an upside short squeeze?” the trading house asked. “It’s possible but more likely that the market will continue trading the range for the next few weeks.”

One way or the other

But the idea of flat trading is one thing that Mr Lee takes issue with, saying that “I have mentioned many times that cotton prices rarely stay in the 70s for an extended period of time. History proves as much.” And the market has been “trading comfortably above 70 cents for the better part of a month now.” According to Mr Lee, “I’d say pretty confidently that we’ll see 83.00 cents a pound before we see 63.00 cents a pound and I haven’t felt that way in more than five years,” he said. Hedge funds may hope so, having in the three weeks to December 5 near-doubled to 82,409 lots their net long in futures and options combined. Cotton is one ag where speculators’ turn more positive on positioning has not looked premature.