Thompson on Cotton: Will the Dec. Contract Spike Once July Expires?

Cotton bales in gin warehouse. ©Debra L Ferguson Stock Images

The cotton market has been no place for the faint of heart in recent weeks. Both the July and December contracts have taken it on the chin, with funds liquidating their July longs and the trade content to watch it go lower offering no buying support.

In the past three months December has given up over 8 cents from its high of 75 cents with a third of that coming in the past week. Thursdays close at 66.74 was the lowest close since last September.

This really defies logic, as cotton fundamentals and now even technical indicators favoring cotton. But who ever said the market had to trade logically. What it does reflect is the power and influence the spec and fund community have on the market.

Though tested every time a support level has been broken, it is still our belief the December contract will see a spike in price once July is off the board. Upon July’s expiration next week, December becomes the cover month for both old and new crop, but not subject to the vagaries of July any longer.

At some point, the market will trade on fundamentals rather than technical charts and algorithms.

Our optimism is drawn from the fact cotton fundamentals have been strengthening for some time. Export demand has remained strong and shows no sign of letting up.

Case in point, this week’s export sales report showed combined sales of both old and new crop totaled 652,300 bales. More importantly, new crop sales alone were 475,300 bales.

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In addition, the Chinese reserve auction has been less than successful in its second year. They are selling on average only about half the nightly offerings, which most likely is a result of quality concerns.

So, despite large volumes of reserves, their nine million bale deficit will have to be erased by increased imports. They were one of the largest purchaser of this week’s export sales, second only to Vietnam.

Furthermore, the market hasn’t fully digested a shrinking U.S. crop. Estimated at 19.2 million bales but once thought to push 20 million, we will fall well short of these numbers. Some analysts are predicting by as much as million and a half bales.

Finally, don’t forget about the specs who now have cash in their pockets looking for a home. Improving fundamentals and technical indicators, which all signal an oversold market, may be just what they’re looking for to boost their December long position.

Of course, there are some negatives.

First off, the specs will determine when the bottom of this sell off will occur, when they have a change of heart and curtail their liquidation. The greatest of these is potential export competition from India that was lacking last year and the fact cotton continues to see its overall market share slip to man-made fibers.

Though this could temper any rallies, current prices will bolster trade buying and provide some desperately needed support.

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