Cotton Analysis

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Above is a chart of May cotton futures. I have a couple studies on there. The MACD shows a bearish divergence at the new peak of this recent leg up. The RSI has a similar and strongly angled bearish divergence. Some other interesting components of the chart are a failed breakout above the recent swing high from Feb, a bearish candlestick pattern (evening star) at the recent high, and a three push/5 wave move up since the November lows. All of these are technical findings that "fit" with a market that is, compared to historical standards, extremely overbought and set for a large decline. Watch the dashed trendline also for further confirmation.

Now the large money players from the Commitment of Traders data also paint an interesting picture that I want to go into some detail on because I think it is telling and a great example to learn from.

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The chart above shows the Commitment of Trader's data and is broken down into large speculators (funds, etc), small speculators, and commercial hedgers. The large speculators tend to follow the direction of the market and increase their long exposure as the market rises. They are trend followers. The commercials hedgers can be doing a few different things, basically all of which involve shorting as prices rise or buying when they fall.

For instance a company that grows cotton and owns cotton would short the futures to hedge against their commodity produce. If they think prices are too high, they short to hedge or profit on the decline. Now a clothing company that wants to buy cotton for its operations will buy the futures contract on dips to perceived price value areas.

As far as the cotton chart above, notice that in the current run up the large speculators maxed out their long exposure in the fall and even as prices have gone higher now, their exposure hasn't. This is probably a sign of lack of funds to follow/push it higher. So that is a type of bearish divergence. Also notice that contrary to the usual pattern, the commercial hedgers have been the only group to increase their net long over the past 4 weeks as prices broke out above the November highs. Basically this means that they are caught in a large short covering rally forced to buy back short contracts to avoid larger losses. Once they cover their shorts and the last buying fuel is expended, prices should start to fall. Then as they fall the large speculators will start to sell and take profit, and also to follow the down trend by shorting.

This will put pressure on prices in dramatic fashion, I believe, once the last forced buying occurs by commercials. Watch for a quick move back to the November highs, then followed by a more drawn out move back to below where this leg up started at the November lows.