Over the last 25 sessions, dating back to June 28, the December contract has settled no lower than 69.51 cents and no higher than 72.94 cents, giving us a boring trading range of just 343 points, which signals that neither the bulls nor the bears are currently in control of the market. When we look at December’s chart over the last two-and-a-half months, we notice that this contracting price range has been forming a triangle pattern, in this case a symmetrical triangle, marked by lower highs and higher lows.
Since the trendlines in a triangle are converging, it is just a matter of time until the market finally breaks out to either side. Although triangles are sometimes reversing a trend, they are typically seen as continuation patterns, meaning that the breakout usually occurs in the direction of the prevailing trend, which is currently down. More specifically, a break below 70 cents in December would violate this triangle pattern to the downside and probably lead to a retest of support in the mid-60s, while a move above 73 cents would signal a reversal to the upside and likely invite a decent amount of new spec buying.
From a fundamental point of view there seems to be plenty of support for US cotton at the moment. Today’s US export sales report was surprisingly strong considering how quiet the market has been lately. For the week ending July 26, net sales of Upland and Pima amounted to 221’800 running bales, of which 39’700 running bales were for prompt shipment. Once again there were 19 markets participating in the buying last week, which shows that there is broad-based support of US cotton at current levels. Shipments were constructive as well at 310’500 running bales, bringing total exports for the 2011/12-season to 11.65 million statistical bales, with five days to go in the marketing year. This means that US exports will surpass the current USDA estimate of 11.6 million bales by some 200’000 bales, thereby lowering beginning stocks to around 3.1 million bales.
As we alluded to last week, it seems that the US supply situation will remain extremely tight until new crop starts moving in. With around 4.4 million bales in export commitments, most of which are for nearby shipment, and with another 0.9 million bales needed for domestic mill use over the next three months, some shippers may have difficulty in finding cotton for their commitments. Maybe merchants became too cautious in securing supplies when prices were falling and sales contracts were non-performing, and are now finding themselves with some holes to fill. It looks as if the certified stock might be used for this purpose, as it has dropped by 96’041 bales since July 10, amounting to just 36’049 bales as of this morning.
For the futures market this tightness in the cash market is relatively inconsequential, since October has hardly any open interest (just 358 contracts) and December should have plenty of new crop available by the time its delivery period rolls around. However, December may once again prove to be a dangerous contract to be short, especially if something were to happen to the standing crop. Given the crazy weather pattern we have experienced this spring and summer, traders are going to hold their breath until the crops are finally off the field. We therefore sense a certain apprehension by the trade to be short December below 70 cents.
Outside markets have offered little impetus this week, as soybeans and corn consolidated recent advances at around 16 dollars/bushel and 8 dollars/bushel, respectively. Traders are awaiting the upcoming USDA report on August 10, which will offer a first look at the yield potential of these battered crops. Based on private estimates we feel that the market could be in for a negative surprise, as corn may come in as much as 20 bushels/acre below the July estimate and soybean yields may drop another 4 bushels/acre. Although a certain amount of demand destruction is already under way, we feel that corn and soybean prices may have to go a lot higher to discourage enough demand to meet the substantially reduced level of supply.
So where do we go from here? The market remains indecisive, although from a technical point of view we should see a breakout from the current triangle formation over the next week or two. Given that there is also an important USDA report coming up next week, we should see a much more active market in the days ahead. We would be buyers of December on a break towards 66/67 cents, since we feel that the longer-term outlook doesn’t justify prices below that level.
Source: Plexus Cotton