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Cotton prices have declined over 35% since February 2024 but are showing signs of bottoming. Hedge fund positions are at a 5-year low, similar to conditions before a significant rally in 2019. Cotton’s % carry yield is near its lowest level in the past year, indicating the potential for a market reversal. The commodity is also highly oversold and undervalued, often a precursor to a price correction. In India, a drop in cotton cultivation by 10-12% due to lower crop yields and reduced planting areas adds further bullish support to prices. With these fundamental and technical indicators aligning, the cotton market may be on the verge of a rebound. Traders should watch for a break above key resistance levels, which could signal the beginning of a new uptrend and a recovery from the steep declines of the past months.

Key Highlights

# Cotton prices have declined over 35% since February 2024, showing signs of bottoming.

# Hedge fund positions are at a 5-year low, mirroring conditions seen in 2019 before a major rally.

# Cotton's % carry yield is near its lowest level in the past 52 weeks, hinting at a market reversal.

# Relative price and positioning analysis show cotton is oversold and undervalued.

# India's cotton cultivation has dropped significantly, adding bullish support to prices.

Cotton prices have been under significant pressure, declining steadily since late February 2024. From a high on February 28, 2024, to a low on August 8, 2024, the commodity has plunged over 35%. However, recent price action suggests that cotton may be nearing a bottom, as it has begun to break out of a declining wedge pattern, indicating a potential upward bounce if the resistance level is convincingly breached.

Supporting this potential reversal is the latest Commitment of Traders (COT) report, which reveals that hedge fund positioning in cotton is at its lowest level in five years. As of August 6, 2024, net short contracts stood at 54,942, a level not seen since August 6, 2019. Interestingly, this positioning is reminiscent of the situation in 2019 when cotton rallied by over 21% in the subsequent months. Hedge funds have added nearly 150,000 net short contracts in just five months, underscoring the extreme bearish sentiment that often precedes a market reversal.

Another critical indicator is the % carry yield, which reflects the one-year calendar curve yield as a percentage of the contract notional value. Cotton's % carry yield currently stands at -6.8%, just above the lowest level of -7.3% recorded two weeks ago. Such low levels are often associated with a market reversal, as they indicate that the market may be overextended.

The relative price and positioning analysis further supports the case for a bottom. Cotton is among the most oversold and undervalued commodities in the agricultural complex, having remained at this extreme level for several weeks. This condition typically precedes a correction towards more normal levels.

Adding to the bullish outlook is the situation in India, where cotton cultivation is expected to decline by 10% to 12% this season. The Cotton Association of India attributes this reduction to falling crop yields and significant decreases in planting areas. The northern region of India has seen a 35% reduction in crop size due to a pink bollworm infestation, while irregular rains have negatively impacted yields in Gujarat. With the government increasing the Minimum Support Price (MSP) for raw cotton, these factors are likely to support prices further.

From a technical perspective, cotton is currently testing key resistance levels. A break above these levels could confirm the beginning of a new uptrend, potentially reversing the sharp declines observed over the past several months.

Conclusion

With a confluence of indicators pointing towards a potential bottom, the cotton market appears poised for a rebound. Investors and traders should closely monitor the technical levels and upcoming fundamental developments to capitalize on this opportunity.

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