Technically Speaking

Yes It's True: Cotton Looks Bullish

Source: DTN ProphetX

One of the interesting things about travel season is that at the end of each presentation, you have time for questions on any market. Recently I've been asked what the outlook for new-crop cotton might be. And after years of being the bearer (get it, "bear", as in bear market?) of bad news it looks like the cotton market has finally turned a bullish corner.

As I discussed during DTN's Trading Markets Quarterly Outlook back on January 6 (you can see the rebroadcast at:…) cotton's long-term monthly chart showed the potential for a long-term bullish change. Eventually, January saw the nearby contract post a fresh low of 57.05 before rallying to close out the month. Unfortunately, at least from a bullish standpoint, the market did not establish a true bullish turn signal heading into February.

But as we work our way through the unofficial close of winter (February), the more active May contract continues to rally. Last Friday (February 13) saw the contract close at 63.32, just a few ticks of last week's high (and the monthly high) of 63.49. This has monthly stochastics (long-term momentum indicator) nearing a bullish crossover well below the oversold level of 20%. If this signal is established at the end of the month, it would be similar to what was seen in the corn market this past October indicating the major (long-term) downtrend that began back in March 2011 has come to an end.

But what about the new-crop December contract specifically? Similar to the major trend of the market, Dec cotton looks poised to establish a secondary (intermediate-term) uptrend on its weekly chart. The first seeds of such a move were planted the week of August 3, 2014 with an initial bullish crossover by weekly stochastics (second study). However, as is sometimes the case, this signal failed to generate strong follow-through buying despite the contract moving to a new 4-week high the week of August 24. From there the market fell back to a new low of 62.85 the week of September 28.

The following week saw Dec cotton rally, establishing a secondary bullish crossover by weekly stochastics that would presumably confirm the first change in momentum seen in August. But once again, after a few weeks of struggling to trade higher, Dec cotton posted a bearish outside week and again headed lower to eventually post a new contract low of 61.28 the week of January 18, 2015.

Here's where the contract seems to finally change its mind though. After closing near its new low that week, the contract posted a solid rally the next. As we head into mid-February Dec cotton is on the cusp of posting another new 4-week high if it can get above last week's peak of 64.37 again hinting at a secondary uptrend.

Skeptics will ask, "What makes this time different than all the other failed bullish signals?" That's a fair question, and it comes down to market structure of the contract.

Take note of the net-futures position of noncommercial traders, as reported in the weekly CFTC Commitments of Traders report released each Friday (third study, blue histogram). While the cotton market was seeing one failed bullish signal after another, this group continued to defend their net-short futures position (histogram columns down, below the dashed "0" line). This time around noncommercial traders are building a net-long futures position, reported last Friday at 23,748 contracts.

More importantly the view of expected market fundamentals has changed. The bottom study shows the trend of the December 2015 to March 2016 futures spread (green line). Notice that from August 2014 through early December 2014 the trend was down, reflecting a strengthening carry in the futures spread. However, from its low weekly close of 1.27 (week of December 7) the spread has moved into an uptrend (weakening carry), closing this past week at 0.45, just above the previous high of 0.50 (week of January 25).

With support now coming from both noncommercial and commercial traders, the new-crop Dec cotton contract could make a run at resistance between 68.50 and 72.12, prices that mark the 33% and 50% retracement levels of the previous downtrend from its contract high of 82.95 through its contract low of 61.28. The more bullish market fundamentals become (uptrend in Dec/March futures spread), the stronger the likelihood for a test of the high side of that resistance range.

One last thing: A move to the 50% retracement level by the December contract, particularly if it occurs while this contract is registering on the long-term monthly chart (most active contract), it would be a test of expected resistance between 70.47 and the July 2014 high of 73.70.

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