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The August USDA Crop Production and Supply/Demand report for cotton did not give the bulls or the bears much news but it did fail to raise world cotton consumption figures. As a result, the focus of the cotton market shifted away from following the stock market higher to following the supply trend lower. The weather in Texas has improved significantly in recent weeks, and this has traders believing that production forecasts in future monthly reports will be on the rise. The weekly Cotton Conditions report showed 53% of the crop was rated good/excellent as of Sunday August 16th, up from 50% the previous week and 48% last year. The 10 year average for this time of year is 53%. In Texas, the crop is was rated 43% good to excellent, up from 40% the previous week and above the 10-year average. In Georgia crop ratings improved to 56% good/excellent from 53% the previous week. While cotton crop conditions are right on the USDA 10-year average, the yield estimate is still well under the trend-line going back to 1994 And there is more and more talk of the advancement in seed technology and how this may boost yields further.
The strong stock market into mid-August and the outlook for an expanding world economy helped support commodity markets like cotton, but traders are now second-guessing the outlook for a robust world economy and instead are looking at a slower recovery and sluggish consumer spending into next year. If we see a period of less bullishness on the global economy, a firm US dollar or a setback in energy and other commodity markets, then commercial and speculative long liquidation selling could be significant bearish force for cotton. The USDA has already raised its world cotton consumption forecast for 2009/10 to 112.76 million bales, up from 110.6 million in 2008/09. If the world economy is slow to recover, we may see some adjustments lower. China built a massive reserve of cotton and other commodities during the first half of the year, and expectations for continued strong demand from China in the months ahead are easing.
Trend-following funds built a net long position of nearly 25,000 contracts as of August 11th, which pushed the combined large and small spec net long position to 40,982 contracts. This is in sharp contrast to a net short position of 5,728 contracts as recently as March 17th. This overbought condition suggests to us that long liquidation selling could develop if support levels are violated like they were on August 14th and 17th. Last week the market traded to its highest level since October of 2008. Following that with a lower close on the week (which appeared likely as of this writing) would be a bearish technical development.
Relative strength topped out at lower levels as the market made successive, higher peaks of 63.75 on May 12th (RSI 77.15), 64.98 on June 21st (RSI 76.2) and 65.347 on August 13th (RSI 65.3). This indicates a considerable loss of upside momentum and could help attract new selling this week. If demand news turns even less bullish and the focus shifts even more to the supply side of the equation, the market could see a significant setback into harvest.
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