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 prices appear 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)

Important Information

This communication has been provided by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”). The products discussed in this document are issued by ETFS Commodity Securities Limited, ETFS Hedged Commodity Securities Limited and Swiss Commodity Securities Limited (together the ”Issuers”). The Issuers are regulated by the Jersey Financial Services Commission.