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Cotton Indicator Hits All-Time Low and Strongly Suggests the Soft King Will Double


Indicators suggest it may be time to reverse the bearish outlook.

In my first article on Minyanville, I wrote that commodities are The Worst Possible Asset Class to Invest in Right Now. The commodity leader at the time was cotton. Cotton peaked 17 calendar days later and then collapsed 61.6% over the next 9.5 months. Now there are a couple of indicators which suggest it may be time to reverse the bearish outlook in King Cotton. The indicator we will look at today is the 252 trading day ( year) rate of change in the price of cotton. The daily cotton data used for this article (from starts in 1967. Since then, when cotton drops 40% over the course of one year, it has always doubled.

The table below lists all the times since 1967 when cotton dropped 36% in one year. To avoid excessive repetition, the table will only look at the extreme reading in each "group." For example, since 1967 the most cotton has dropped over a one-year period was on March 2, 2012 when it dropped 58.5% from 252 trading days prior. Since then cotton has had 30 rolling 252 day periods where it dropped over 51% from a year ago. The 30 days after the March 2 extreme reading will be skipped. The table lists the signals in order of strength (rather than chronologically) and then lists the subsequent rally cotton had from the exact signal date to its subsequent high:

Here is the chart with cotton at the top in black, commodities in the middle in blue, and the rate of change indicator at the bottom in red:

You can see when the indicator on the bottom got low, cotton always rallied.

Another interesting aspect of the aforementioned dates is that they were almost always close to commodity bottoms as well. The only real exceptions were 1) commodities continued down for the first two months of 1975 and 2) the 1988 signal when commodities flatlined for 20 months. This is yet another indicator that's popped up recently and should give the commodity bears pause. While stocks still appear to be the best bet over most commodities and bonds, at this point, shorting commodities is not the no-brainer it was a year ago.

On the last day of 1973, the No. 1 song was "Time in a Bottle" by Jim Croce. Oil traded at $4.31, gold hit $114, silver closed at $3.32, and the median price of a house was $35,700. That day cotton hit $0.90. Today, cotton is trading below that!

The 2009-2011 spike is also very reminiscent of the 1972-1973 breakout. Here are the highs of cotton over the decades leading up to the 1973 breakout:

You can see that cotton had serious resistance around 0.40 for decades. In 1971 Richard Nixon took the US off the gold standard. This provided the catalyst for cotton to finally break through resistance and shoot straight up to the aforementioned 0.90 at the end of 1973. In the tradition of classic technical analysis, the prior resistance level in the 0.40s became support. Cotton did occasionally go above 0.90 and below 0.40 over the next 36 years, but as you can see on the chart, those times did not last too long. It was a massive multi-decade trading range.

It is very possible we are witnessing the same phenomenon play out now. If the pattern repeats, over the next few decades cotton won't spend too much time above $2.19 and it won't spend too much time below $0.90

Now one possible criticism of this indicator is that it only goes back to 1967. To counteract this, we can look at monthly data which goes back to 1870. From March 31, 2011 to March 31, 2012, cotton dropped 53.3%. That is ranked No. 11 for the most cotton has dropped in a rolling 12-month period. The top-10 were the rolling 12 months ending December 31, 1920 to August 31, 1921 (nine overlapping times) and December 31, 1974.

Cotton went down 25.4% in the first quarter of 1921. That was a major bottom which would hold for years. From the December 31, 1920 original signal to December 31, 1923, cotton went up 128% despite the shaky first three months. If cotton would behave in the same manner, it would go down to $0.69 by June 30, 2012 and hit $2.13 by March 31, 2015. The $0.69 represents the "maximum downside" implied by this indicator. Note the $2.13 is very close to cotton's all-time high of $2.19 which fits the multi-decade trading range theory.

As for the December 31, 1974 signal, that marked the exact low. Cotton went up 145% over the next 18.5 months. If history would repeat, cotton would hit $2.29 by October 15, 2013 which would, once again, be close to cotton's all-time high.

There is even more good news. The futures are expecting virtually no movement in cotton. The March 2014 contract is $0.87. So if you buy a long-term futures contract today, you shouldn't lose anything due to contango.

In summary, in the past when cotton has lost half of its value over the course of the year, it has doubled. This has been an extremely reliable indicator and it has a 140-year track record. In my opinion, now's the time to buy cotton.
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