NY cotton futures rallies again last week

Plexus Cotton Limited reported that NY futures reversed course and rallied again this week, with December advancing 421 points to close at 76.80 cents. 

The choppy trading we have seen over the past couple of weeks is caused by a tug-of-war between a bullish technical and macro picture, and a still rather bearish fundamental outlook.

For traders who have no knowledge of what is happening in the world of cotton and are simply guided by the chart, the recent price action has to be quite encouraging. After dropping to a low of 71.59 cents following the USDA report, the market spent a few days treading water and then started to rally again in the wake of bullish outside markets.

Volume has improved as well during this latest rally, confirming the move, but what has been missing so far is an increase in open interest. During this latest advance, which began last Friday, open interest in the December contract has actually dropped by 146 contracts to 127’696 lots.

The current lack of selling by the trade has a lot to do with timing. At the moment we are still in a relatively tight supply situation, since existing stocks in the US are well committed and inventories in other origins are either not readily available (China, India) or are relatively expensive (Central Asia, Australia).

This has caused a temporary bottleneck during which the trade has been reluctant to aggressively sell futures. Also, there is a lot of uncertainty at the moment that keeps sellers at bay, with crops still out in the field, with China’s new crop policy anybody’s guess and with competing crops surging to record highs.

However, once crops start moving in and provided there are no unforeseen weather issues, we should see unsold supplies build quickly, which in turn should lead to selling pressure in both physicals and futures.

So where do we go from here? Although technical traders and hedge funds may give the market another boost in the very short term, based on a constructive chart and a more positive macro outlook, the impending harvest is likely to change the balance of power in favor of the trade, as it provides it with a lot more ammunition to sell.

We therefore expect prices to retreat in the October/November time frame, possibly to below 70 cents, which would set the stage for a longer-term advance when we face planting decisions in the first quarter of 2013.