While the cotton market has declined steadily over the past several months, prices could reverse course and move higher amid expectations of tight supplies later this year and increased overseas demand.

Large U.S. stocks and the elimination of government subsidies have put pressure on cotton prices recently. However, the possibility of smaller supplies following lower acreage this season will provide support to the market. Cotton plantings, for example, are expected to drop 20 percent in 2007-08, as growers switch to alternative crops. Growers have more incentives to grow corn amid greater demand for ethanol, which is made from corn. Cotton acreage in Arkansas, Louisiana, and Mississippi is expected to fall one million acres this year. In contrast, corn acreage in the U.S. Delta states is expected to rise by 1.2 million acres.

In addition, increasing demand in China also is expected to be supportive to the cotton market. Production in China is expected to fall four percent from last year to 6.5 million metric tons or 29.9 million bales, while domestic mill use is expected to increase 12 percent to 12.3 million metric tons or 56.5 million bales.

Though demand and weather conditions affecting acres or yield will command attention going forward, I also believe we should watch the U.S. dollar. The U.S. dollar has been falling in value relative to other currencies, and that makes U.S. cotton more attractive for other countries to buy. Already cheap prices for cotton, coupled with a cheap dollar and a decrease in new-crop supply could increase demand from other countries even more.

From a technical standpoint, cotton has been forming a base over the past two years between 45 to 58 cents per pound. The front month July contract is near some of the longer term lows of 46.10 and 46 cents posted in the summer of 2005, and 45 and 46.50 reached in July and November 2006.

Weekly Cotton Chart

Technical indicators, such as the daily RSI and MACD, are also pointing to oversold conditions in the market. The new crop December cotton futures contract currently trades at a premium to July.

Daily Cotton Chart

To capture a move upward in old-crop cotton, I would recommend buying July cotton futures at 48.50 and buying July 48 puts at 110 points or better for downside protection. The breakeven point with this trade is 50.10. If the market declines, you have protection with the 48 puts.

For new-crop cotton, I recommend buying December 62 calls at 70 points or better. The dollar cost for this trade would be $350, and there is plenty of time to see how the market will move.

Carol Hurley is a Senior Market Strategist with Lind Plus. She can be reached at 866-790-4371 or via email at churley@lind-waldock.com.

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