Cotton Fundamentals Bearish; Price & Spreads Bullish

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July cotton prices have risen approximately 100% since September and 30% in 2011, despite a large retracement from the 200 level. The 20-day ATR, what many traders use to look at volatility, has gone from 4.75 to 8 and back down to about 6.5 today. That means your position sizing has been all over the place.

How does you model adjust for spikes and large drops in volatility? You do adjust existing positions for increases in volatility don’t you?

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As you can see, the market for cotton is inverted…the highest price is in the front month and it decreases each successive month. There are no carry charges. This market is saying “give us all you have right now.” The market will pay you about 15 cents per pound more if you sell today, rather than in October. You can look at that as a penalty for putting cotton into storage.

The rest of the months look almost the same. Here are the expiration months and the differences between the prices:

July – Oct = 15 cents
Oct – Dec = 12 cents
Dec – Mar = 11 cents
Mar – May = 7 cents

You can chart these spreads and watch them narrow and widen. It will give you a good feel how to trade spreads.

An article at agrimoney stated “Global balances are likely to ease over the coming months, with year-on-year higher production across key cotton producers,” BarCap analyst Sudakshina Unnikrishnan said on Thursday.”

With grains prices at all time highs, I’m not sure that farmers will be planting cotton in lieu of grains. It requires different machinery for harvest as well, so it’s not that easy to say “Hey, let’s try cotton instead of corn this year.”

The article continued, “Rabobank analysts remain bullish on prices, at least over the summer, flagging the “production risks associated with recent prolonged adverse weather conditions”, such as drought in Texas, the top producing state in America, which is the biggest cotton exporter.”

“The proportion of the Texas cotton crop rated in “good” or “excellent” condition was 33% as of Sunday, compared with 61% a year before, US Department of Agriculture data show.”

“More than 30% of the crop was rated in “poor” or “very poor” health – up from 3% a year ago.”

You may rely solely on fundamental analysis. You may rely solely on technical analysis. But frankly, you have to marry both to get the best picture. Then you watch how the market is behaving and how other traders are acting. Then you’ll be trading more like Michael Marcus, for example.