NY futures continued to lose ground this week, as December dropped another 203 points to close at 77.18 cents, while March gave up 160 points to close at 79.20 cents.
October has not been kind to the cotton market, as December lost over 1000 points since opening at 87.23 cents at the beginning of the month. A look at the candlestick chart reveals just how depressing the price action has been for the bulls, with the market closing lower than it opened in all but two of the last twenty sessions! What was it that spooked the cotton market into such a dismal performance?
We believe that a combination of factors contributed to this relentless selloff. For one, markets don’t like uncertainty, and there has been plenty of it lately with the US government shutdown preventing important reports from being released in a timely manner. Traders are only slowly starting to catch up on data and we still don’t have an up-to-date “Commitment of Traders” report or a recent USDA supply/demand estimate. There is also a lot of uncertainty when it comes to China, with a variety of rumors making the rounds regarding the timing and price level of potential Reserve auction sales as well as the government’s support policy for the coming season.
The most recent CFTC report as of October 15 showed that large and small speculators liquidated over 10’000 longs in a week during which the market traded sideways between 83 and 84 cents. There was no obvious reason for specs to pare their bets by a million bales at that particular time other than perhaps playing it safe in view of the ongoing government shutdown. The following week, when the market fell through long-term support, specs definitely had a valid reason to dump their remaining longs, although we have yet to find out how much they actually liquidated.
The negative impact of specs abandoning their longs got exacerbated by the rapidly expanding harvest in the Northern Hemisphere, which canceled out any remaining weather premium and prompted traders to become more aggressive with new crop offers. In other words, the lack of data, technical weakness and better than expected crops were the main reasons behind the market’s steep tumble.
However, as today’s US export sales report has shown, not all news is bad! Although the report contained 3 weeks worth of sales, the combined total of 690’800 running bales of Upland and Pima cotton is nothing to sneeze at, since the weekly average still amounted to over 230’000 bales. There were 21 markets participating in the buying, with China leading the way at over 300’000 bales. Shipments of just 250’300 bales were still lagging, but that’s because the supply pipeline is basically empty and new crop is just starting to fill it back up. For the season total commitment now amount to around 5.1 million statistical bales, whereof just 1.8 million have so far been exported.
There is definitely export demand out there, and not just for US cotton, as a number of other origins have also found decent interest in recent weeks. In fact, physical prices have held up a lot better than NY futures lately and basis levels have therefore strengthened. In view of this we still see it as a distinct possibility that the Certified Stock, which has grown to over 180’000 bales (including bales under review), may get sold, especially if futures were to move even lower. We therefore don’t particularly like the risk/reward in shorting the market at 77 cents! At the very least we would advise to use bearish options strategies rather than short futures to bet on lower prices.
So where do we go from here? Trend and price action are still pointing lower at the moment, however the market has closed down for ten consecutive sessions and momentum indicators like the RSI, Stochastic and MACD are all flashing oversold signals. This and the divergence to the physical market suggest that the drop in NY futures may be overdone and that prices should begin to stabilize. Also, we assume that spec longs have liquidated most of their longs by now, while the trade is not likely to go aggressively short in the mid-70s. In other words, selling pressure is probably going to subside and buyers should start to move in. A low of 74/75 cents still seems possible, but we would use that level to enter the market from the long side!
Source: Plexus Cotton