December Cotton futures have depreciated nearly 20% since the first week of May. It would appear that prices are finding their footing near 68 cents consolidating just above that level for the last week of trading. As one can see the stochastics are extremely oversold and prices are the furthest they’ve been from their 50 day (blue) and 200-day MAs (red) in the last 12 months. On a mean reversion trade I expect prices to bounce back to a minimum of 75 cents in the coming months, this would represent a move of 10% from current trade.
- Supply: Weather has shifted and we are starting to experience dryer conditions which have caused a slight drop in crop conditions and marginally supportive to the market. According to the USDA 52% of the crop is rated good/excellent…well ahead of last year’s pace at this time showing 44%. The 10-yr average at this time is 50% so we are looking better than par.
- Demand: Buyers have become more active likely because futures are at their lowest levels in 2 years. Global demand is returning but not at a feverish pace particularly in China; the 800 lb. gorilla in global softs/Ag markets. Chinese import data indicates that in June cotton imports were down better than 19% from 13’ and ytd imports were off by over 40%. A number of other countries are emerging as buyers as value is being found near 68 cents. While past performance is not indicative of future results looking at the weekly chart prices have been supported around current trade for the last 2 plus years.
Where to from here and how to capitalize? The idea is that like other Ag products the crop is perceived to be large, yields plentiful and going into this yr. ending stocks were burgeoning…all bearish factors. However that in my opinion is currently reflected in the price and that is why futures are lower by 20%. The what if weather issues into blooming, demand emerging or we get a dead cat bounce I think the risks are outweighed by the potential reward at current levels. My suggestion is to sell December puts OR buying December futures and selling out of the money calls 1:1 targeting a move to 75 cents in the coming months. That being said have an exit strategy to cut losses if we continue to see lower trade…have a plan and manage your trade.
