Weekly Commodity Market Recap: Cotton

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The cotton market enjoyed universal gains in forward markets last week, spurred on by the latest USDA report deemed particularly friendly to the market, but overbought technicals will make continued gains more difficult in coming days. Nearby cotton futures posted their best week since early June, soaring 309 points on the week to finish Friday at 87.49 cents per pound, the highest close in 29 months. The most-traded December contract rose for the fifteenth time in the last eighteen sessions to close Friday at 84.18, the highest in more than ten months.

A decidedly bullish WASDE report from the USDA was a key driver supporting the continued strengthening in prices. In spite of a 234,000-bale increase in the anticipated size of the U.S. harvest to 18.5 million bales, the domestic market is likely to tighten even further, owing to soaring foreign demand. Projected exports jumped 700,000 bales last week to 15.0 million, the second-highest level on record. The bigger U.S. harvest and the outlook for increased foreign demand—particularly from China—bode well for bigger exports in the new marketing year. What’s more, at almost 6.0 million bales, 2010/11 commitments early this marketing year are at a record high and up 122.9% from this point a year earlier, hinting at bigger exports in 2010/11.

Faster growth in demand offset the projected increase in production, implying lower ending stocks and tighter fundamentals. At 3.2 million bales, the anticipated level of ending stocks at the conclusion of the new 2010/11 marketing year is down 300,000 bales from just last month, tightening the stocks-to-use ratio to 17.4%. In turn, average monthly prices have gradually risen over the last year and a half as this ratio has gradually tightened, as the graph below demonstrates. What’s more, this ratio is comparable to the 2003/04 level and approaching the record lows set in 1994 and 1995, suggesting average prices this marketing year may rival the elevated average prices set fifteen years ago.



Nearer term, the outlook for continued strengthening in the market may face serious fundamental and technical headwinds that hamper price. Fundamentally, only isolated trouble spots persist for the crop as harvest nears, particularly in parts of China, Pakistan, and the southern U.S. This outlook suggests the supply-side of the balance sheet may tighten in coming months, but only modestly. Revisions on the demand side also are likely to moderate, as prospects for slower growth in several major economies stifle expansion in cotton mill use. As a result, the 2010/11 balance sheet may be hard-pressed to tighten much more than currently anticipated.

Technically, soaring prices in recent weeks hint at a coming correction. While almost all short-, medium-, and longer-term indicators turned increasingly bullish with Friday’s close, the contrarian in us cautions it may be time to take away the punch bowl, at least for now. At an eye-watering 79.3, December’s Relative Strength Index rose to its most overbought level since March 2008 Friday, several standard deviations above its long-term mean of 50, and is virtually screaming for a near-term consolidation. On balance, while the recent surge in prices is reminiscent of the March 2008 spike, we look for near-term prices to flatten out as gains taper and not mirror the plunge that followed the market’s spike 29 months ago.