NY futures traded a lot more two-sided this week, as December was down just 42 points to close at 76.76 cents, while March surrendered 34 points to close at 78.86 cents.
After the December contract had closed lower in 19 out of 23 sessions between October 4 and November 5, losing over 1200 points in the process, a bounce was long overdue. However, even though it felt good to finally see the market up on Wednesday, the rebound was not inspiring at all, since the market closed nearly 200 points off the high after briefly touching limit up and the lack of any follow-through on Thursday makes this rally attempt look like a ‘dead cat bounce’ rather than the beginning of a trend reversal.
The latest CFTC report, which includes delta-adjusted futures and options positions as of October 29, confirmed that it was indeed heavy spec selling that pushed prices lower after the market broke through key support at 81.71 cents. In the five sessions from October 23 – 29, during which the market dropped by 417 points, speculators large and small sold a total of 29’360 contracts net, while the trade was on the other side buying 30’173 contracts net. Index funds accounted for the difference, reducing their net long by 813 contracts.
Over the past four weeks speculators have cut their net long position from 55’098 contracts to 1’107 contracts, a massive drop equating to 5.4 million bales. No wonder prices have been under so much pressure during October! The good news from a bullish perspective is that speculators are now a lot less involved, although they still own outright long and short positions of 4.8 million and 4.7 million bales, respectively, enough to play a role in rallies and selloffs. By comparison, around the middle of August speculators were still a much bigger force in the market with 11.5 million longs and 2.7 million shorts.
With speculators moving to the sidelines, the fate of the market is now primarily in the hands of the trade, who carried a 9.4 million long and a 16.2 million short position as of October 29. Outright trade longs grew quite rapidly during the recent decline, which is at least partly due to the many puts that traders had sold earlier in the belief that the market would stay range bound. A falling market increases the ‘delta’ of short puts and thereby generates a bigger long position, which forces traders to play defense by either rolling short puts down or by selling futures. This exacerbated the selling pressure and helps to explain why the market had such a long string of down days.
The tide started to turn once the market approached 75 cents, as spec selling subsided, there were fewer puts left to defend against and physical business picked up. As merchants were increasingly able to find buyers for their basis-long positions, it required them to buy back short futures as part of the deal. In other words, instead of everyone leaning on the sell side, we once again had a more balanced trading environment.
US export sales reports show that about a million bales of Upland and Pima were sold over the last four weeks. Last week alone we had net sales of 306’800 running bales, with Turkey and China accounting for more than half. Once again it was encouraging to see 16 different markets participating in the buying. Shipments continued to lag as just 94’400 running bales were exported, but that’s mainly due to a lack of supplies in the system and should improve over the coming weeks. For the season total commitments now total 5.5 million statistical bales, whereof just 1.9 million have so far been shipped.
When we look at the statistical position of the US, we have total supplies at an estimated 17.6 million bales (3.9 beginning stocks and 13.7 million crop), whereof 5.5 million have so far been sold for export and 3.5 million are going to be used domestically. This leaves some 8.6 million bales uncommitted and if we were to project ending stocks at 3.8 million bales by the end of July, then the US would have to sell an additional 4.8 million statistical bales for export and ship 8.4 million bales. That’s certainly possible, but competition from India, West Africa, Greece, Central Asia, Brazil and Australia is likely going to be stiff!
Although the Certified Stock has risen to nearly 220’000 bales, including bales awaiting review, the Dec/March spread started to narrow once the market was trading below 76 cents. That seems to be the level at which certified cotton becomes interesting for potential takers and it also makes it difficult to ship new crop cotton profitably to the board. December shorts therefore need to be careful not to get caught in a trap!
So where do we go from here? The market has found some support this week, but whether this is just a temporary stop on the way to lower prices or something more meaningful remains to be seen. Tomorrow’s USDA report will likely determine the market’s next move! The market seems to have already ‘discounted’ a bearish report and we therefore need to brace ourselves for a bullish surprise. This could come in the form of a long overdue adjustment in the Chinese stock numbers to reflect the more realistic US attaché findings.
There have been a lot of rumors lately in regards to China’s upcoming reserve sales, which have contributed to the market’s bearish mood. Although the reserve sales policy is certainly important, we need to be careful not to overplay its role in the price discovery process. As far as international prices are concerned, the formula remains fairly simple: ROW (rest of the world) surplus minus Chinese imports = change in ROW stocks.
We do believe that the ROW surplus is going to increase to around 13 million bales, mainly due to larger crops in the US and India. However, we also believe that China will import at least 10 million bales, no matter at what price the Reserve auctions off its cotton. If international prices were to fall further, then this import number would almost certainly rise on account of buyers willing to pay the 40% duty. So we need to ask ourselves whether a potential 3 million bales increase in ROW ending stocks is reason enough to turn depressingly bearish? We don’t think so!
Source: Plexus Cotton