Cotton's Long And Arduous Climb

by: Andrew Hecht

Record highs in 2011, then a low in March 2016.

A steady rally and a spike in August 2016.

Cotton regroups and makes a new high.

Another spike in May 2017.

Correction will likely lead to a new high as inventories have declined.

Cotton volatility has been off the hook over recent weeks. The price of the fiber has once again become uber-volatile in the wake of a move to the highest level since June 2014.

The price of cotton impacts most people on our planet as the chances are that most of us wear garments made of the fiber. We have seen a bumpy ride when it comes to the price of cotton since 2011. Cotton futures began trading on the New York Board of Trade which was subsequently purchased by the Intercontinental Exchange back in 1972, and until 2010, the price traded in a range of 26.44 cents per pound to $1.172. In 2010, a shortage caused the price to move to a new record high that would eventually take the soft commodity to just under double the prior price peak. In 2011, cotton briefly traded above $2 per pound and moved to a new all-time pinnacle at $2.27 in March of that year.

Record highs in 2011, then a low in March 2016

The price of cotton experienced the biggest spike in modern history starting in 2010 and ending in 2011. Source: CQG

As the quarterly chart highlights, the price broke to the upside making a record high in 2010 and continued to soar until reaching its all-time peak in March 2011. As often occurs in commodities markets, the price rose to a level where consumption ground to a halt. China, the world's major consumer of cotton switched to using synthetic fibers instead of paying prices that were more than quadruple the level seen in 2009. At the same time, production increased in response to the high price and inventories began to skyrocket. The commodities economic cycle often works like a game of musical chairs and the music suddenly stopped for the bull market in cotton during the second quarter of 2011. Source: CQG

The monthly chart illustrates that the bottom fell out of the cotton market and after an initial spike to the downside that took the price down to below $1 per pound by November 2011; the fiber proceeded to make lower highs and lower lows until reaching a bottom at 55.66 cents per pound in March 2016.

A steady rally and a spike in August 2016

Since the March 2016 lows, cotton has experienced a steady rally where the price has been making higher lows and higher highs. Source: CQG

The weekly chart shows the trajectory of the recovery in the cotton futures market. Cotton tends to be an extremely volatile commodity, and the price rose steadily until August 2016 at which point it spiked higher to 77.80 cents per pound, which was the highest level since late June 2014. The spike higher came at a time when inventories were still at high levels in the United States and China, and the price quickly retreated to lows of 65.22 cents by late August.

Cotton regroups and makes a new high

Cotton futures bottomed at the August 2016 lows of just over 65 cents per pound and made a higher low. The fiber then spent the next nine months moving to the upside. Cotton finally reached and marginally surpassed the August 2016 highs in March of this year, and after a brief correction that took cotton to 75.35 cents in mid-April, the price exploded to a new and higher high. Cotton inventories continued to move lower, and a weaker dollar encouraged U.S. exports according to reports from the United States Department of Agriculture in their monthly World Agricultural Supply and Demand Estimates report issued on May 10, 2017. In the wake of the USDA's report, the price of the fiber spiked higher once again.

Another spike in May 2017

Cotton repeated its price action from August 2016 in May in the wake of the WASDE report, and it spiked to a higher high.

Source: CQG

The daily chart shows the latest price spike that took the price of nearby ICE cotton futures to highs of 87.18 cents per pound on May 15, 2017. As soon as cotton reached the most recent pinnacle, the price fell sharply in a repetition of the price action from August 2016. As of Friday, June 2, active month July cotton futures traded at 76.69 cents per pound, over ten cents lower than the price peak just fifteen days before. Support for cotton futures now stands at 76.17 cents, the May 11 post-May WASDE lows and 75.35 cents, the bottom dating back to April 10, 2017. Cotton futures will need to hold these levels over the days and weeks ahead to maintain the pattern of higher lows.

Correction will likely lead to a new high as inventories have declined

Cotton has been making higher lows and higher highs since it traded at 55.66 cents per pound over fourteen months ago. The latest rally took the fiber to the highest price since June 2014, and it had some fundamental wind behind its sails. Cotton inventories continue to decline, and the dollar is now trading at close to the lowest level of 2017. Source: CQG

As the daily chart of the U.S. dollar index highlights, the U.S. currency is trading at the lowest level of 2017, and it has been making lower lows since trading to highs of almost 104 in early January. The weaker dollar is supportive for the price of cotton as it makes U.S. exports of the fiber more attractive on global markets. The weaker dollar has encouraged Chinese imports of U.S. cotton which has caused inventory levels to decline.

As we are now in the 2017 growing season, it will be weather in the United States, and around the world, that will determine the ultimate path of least resistance for the price of the fiber. However, with inventories on the decline and demand increasing because of a weaker dollar, if cotton can hold critical support levels that are close to the current price we could see another period of price recovery as April 2017 when cotton climbed back to its highs and eventually moved to a new peak. Cotton has fallen by 12 % since May 15 which should attract buyers for the fiber. The bull market in cotton futures which commenced in March 2016 at just under 56 cents per pound remains intact, and if technical support can hold over coming sessions, the next target for the fiber is the 90 cent level. It could take cotton months to recover from its latest price thump, but cotton's long and arduous climb higher is likely to continue over the months ahead. I am a scale down buyer of cotton at the current price level with a stop below 72 cents per pound.

Each Wednesday I provide subscribers with a detailed report on the major commodity sectors covering over 30 individual commodity markets, most of which trade on U.S. futures markets. The report will give an up, down or neutral call on these markets for the coming week and will outline the technical and fundamental state of each market. At times, I will make recommendations for risk positions in the ETF and ETN markets as well as in commodity equities and related options. You can sign up for The Hecht Commodity Report on the Seeking Alpha Marketplace page.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.