NY futures continued to move sideways this week, as May gave up just 13 points to close at 88.33 cents, while December advanced 57 points to close at 87.94 cents.
The market has been forming another flagging pattern, which either signals a pause in a prevailing trend or a potential reversal in the making. For the last eleven sessions, the May contract has settled in a very tight range of just 263 points, between 86.59 and 89.22 cents, and it is quite likely that we will soon see a breakout from this triangle formation. The question is in what direction?
Typically these patterns are resolved in the direction of the trend, which in this case would be up, and there are still several factors acting in support of higher prices. The most important in our view remains the unusually large open interest in May and July, which as of this morning still amounted to a combined 166’424 contracts or 16.6 million bales. This is just 1’868 contracts less than last week, which tells us that instead of getting out of current crop futures, traders prefer to roll their May positions into July, hoping for a better outcome down the road. In doing so they increase the likelihood for some fireworks over the next couple of months, since the July contract will mark the end of the line as far as current crop is concerned.
Another element of support is the continuous strong demand for US cotton. Today’s US export sales report revealed that last week a combined 232’300 running bales of Upland and Pima cotton were sold for both marketing years. Total commitments for this season now add up to 12.0 million statistical bales, whereof 8.5 million bales have already been exported. Unshipped commitments are down to just 3.5 million bales, which is 1.2 million bales less than a year ago, and at the current pace of shipments it would take just nine weeks to get these remaining commitments shipped.
When we look at the current US balance sheet, we started with total supply of 20.36 million bales, of which 12.0 million have so far been sold for export and 3.4 million go to domestic mills. However, existing stocks will also have to supply about 0.9 million bales for domestic mill use and an estimated 0.8 million bales for export commitments between August and October, before new crop cotton becomes available. This leaves just around 3.5 million bales available for sale at this point, which at the current sales pace of 150’000 bales a week would all be gone within five months, or by the end of August. We therefore expect a slowdown in export sales from here on forward, not because mills are no longer interested, but because the US can’t possibly continue to sell at the current pace.
There were some interesting developments on the macroeconomic front this week, which may have an impact on our market. Potentially bullish, especially in the longer run, is Japan’s decision to unleash US$ 1.4 trillion in quantitative easing, effectively doubling its monetary base by 2015. This is by far the most aggressive move by any central bank so far when compared to the size of the GDP.
Whether this is just another chapter in an ongoing currency war or whether it is part of a concerted effort by central banks to keep their economies from imploding, the outcome is going to be the same! Running the printing press is tantamount to confiscation by eroding the purchasing power of the currency! Investors are starting to realize that having money in a bank or in a low-yielding government bond is probably not the wisest decision in the long run, because their money is at risk of being confiscated either directly, as in the case of Cyprus, or by debasement of the currency. Investors are therefore increasingly seeking diversification into tangible assets, such as real estate, stocks and commodities.
Another development that needs to be watched is the recent temper tantrum by North Korea, which has the potential to grow into a full-blown conflict. So far most observers believe that North Korea is more bark than bite, but any escalation of the situation could prompt hedge funds to move to a “risk off” position, which would have a negative impact on commodity markets, as we have seen on previous occasions.
So where do we go from here? The tug-of-war continues, as neither the spec longs nor the trade shorts are willing to part with their position. The shorts seem to have the weaker hand though, because they don’t really have much cotton left to back up their bets. An estimated 3.5 million bales of uncommitted US cotton, some of which is not going to be tenderable, against 16.6 million bales of open interest in May and July futures. And with every decent export sales report this pool of available US cotton shrinks further. Physical demand for US cotton shows no signs of slowing down yet, as mills still have a lot of holes to fill between now and new crop, and there aren’t that many cheap alternatives to US cotton at the moment. We therefore feel that as the trade procrastinates, it sets itself up for a short squeeze in the next couple of months! The trade of course hopes that speculators will blink first and somehow get spooked out of their longs, but this is just wishful thinking at this point.
Source: Plexus Cotton