Weekly Investment Insights – Correction potential builds for cotton
Highlights
Cotton has experienced a strong rebound following years of decline.
The rally is supported by a record accumulation of speculative positioning and is vulnerable to a pullback.
A more robust supply picture could threaten recent gains as the cotton price trades at resistance levels.
Cotton rebounds
After plunging to seven year lows in late February 2016 cotton prices have staged a considerable rebound (up approximately 39%*) to currently sit at the USc 75.8/lb level. The recovery follows a multi–year decline from 2011 highs of over USc 200/lb as competition from low-cost manmade fibres (such as polyester) resulted in a 78% drop in cotton imports from China. The recent moves have been driven by a cotton market that, according to US Department of Agriculture (USDA) estimates, looks set to be in deficit for the second year in succession. The relatively strong fundamental situation has been helped by healthy and stable global demand and stalled output from India, historically a key cotton exporter responsible for almost a fifth of global exports. However, cotton pricesappear increasingly vulnerable to a reversal from unwinding of record speculative futures positioning and more buoyant supply prospects in coming months, creating a potential attractive opportunity to acquire short exposure to the soft commodity.
Figure 1: Cotton rebounds from nadir
(click to enlarge)
Indian output to normalise
Recent estimates of the 2016/17 cotton market shortfall from the USDA and other organisations have been revised lower as US harvest forecasts have been upwardly adjusted. Some of the tightness in the market last year came from reduced Indian output as less cotton was able to reach the global market due to the government invalidating larger banknote denominations. This created a scarcity in cash and in turn payment problems and delivery delays, leading to what Commerzbank estimate to be 16% less Indian production available to the wider market between October and December last year. Once this issue abates, supply should return and place further pressure on an ever smaller looking cotton market deficit and in turn the cotton futures price.
Stretched positioning and resistance – tomorrow
Speculative long futures positioning towards cotton is currently sitting at a record high, at over double its previous high from August 2013 (when the price was above USc 90/lb), while shorts are half their five year average. This one sided nature of the market leaves the cotton price susceptible to a pullback if sentiment amongst speculators should shift, something that could be spurred by future reports of a more robust supply picture. The price has struggled to sustain a break higher than the USc 75.5/lb level and is likely to face resistance at the early February high of USc 77.4/lb. Should more bearish fundamentals emerge, then the price could fall to its recent low of USc 73/lb or further to its 100 daily moving average of near USc 71.4/lb.
Investors wishing to express the investment views outlined above may consider using the following ETF Securities ETPs:
ETFS Cotton (COTN)
ETFS 2x Daily Long Cotton (LCTO)
ETFS 1x Daily Short Cotton (SCTO)
ETFS EUR Daily Hedged Cotton (ECTN)
Swiss Franc Daily Hedged Cotton (CCTN)
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Chinese inventory auction weighs on cotton price – Chinese inventory auction weighs on cotton price
US cotton prices are currently hovering at seven year lows following a -8.7%* fall year to date. The decline comes after an announcement from China’s National Development and Reform Commission detailing plans to offload a portion of the nation’s vast cotton reserves, a move which risks further depressing import demand from the world’s largest consumer. Cotton prices have fallen 73% from a 2011 peak of over USc 200/lb as rapidly declining import demand from China and tough fibre competition from man-made materials (such as polyester) have pressured global prices (see Figure 1). However, at current depressed levels a tactical opportunity may be on the horizon. Chinese cotton auctions, like the one recently announced, have, in the past, fallen short of market expectations. If the upcoming stock sale disappoints then cotton prices could quickly become subject to a short covering rally, especially as speculative short cotton positions currently sit at record highs. In addition, there are some initial signs that the fundamental picture of the global cotton market may be improving, albeit by a small amount.
(Click to enlarge)
Market awaits auction details
Last year, a similar cotton auction held by the Chinese authorities failed to muster considerable buying interest as offered prices exceeded market levels, resulting in only 3.4% of the total stock on offer being sold. Details of the upcoming inventory sale remain unknown. Revelation of its size and speed will have considerable bearing on cotton prices in the near term. Should the auction fail to meet market expectations, cotton prices have potential to gain some upward momentum as speculators with short cotton positions are forced to hedge exposure. Similarly, risks lie to the downside if the opposite occurs, however the market will be harder to surprise in this direction as negative implications from the auction have already been somewhat priced in.
While fundamentals for cotton prices remain far from ideal, there are some small signs of improvement. Recent reports from the International Cotton Advisory Committee (ICAC) and the United States Department of Agriculture (USDA) show that global cotton stocks are set to fall by approximately 8% this year, the first decline in five years. The decline in ending stocks looks to be driven by falling production from China as domestic producers reduce output in response to ongoing price weakness.
Shorts near record levels
Net speculative cotton positioning reached a 10 year low this month as short positions rose to an all-time high and speculative long positions retreated to a two year low (see Figure 2). The rapid accumulation of short positions leaves cotton prices vulnerable to a pullback, should an appropriate catalyst emerge. With the upcoming Chinese reserve auction at the forefront of market concerns, it has the most potential to be a cause of such a pullback.
(Click to enlarge)
Investors wishing to express the investment views outlined above may consider using the following ETF Securities ETPs:
The complete ETF Securities product list can be found here.
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ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
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