NY futures moved slightly lower this week, as December dropped 37 points to close at 61.95 cents/lb.
The market popped towards 64 cents earlier in the week, when the weather forecast called for more downpours in West Texas. However, when the rains failed to materialize, the market quickly retreated back towards the 62 level, which marks the middle of the 60-64 cents range we have been in for the last 10 weeks.
The latest CFTC report, which includes positions as of October 27, showed only minor changes in the net positions of speculators and the trade, which reflects the lack of momentum. Speculators were 3.63 million bales net long, while Index funds carried a 6.61 million bales net long exposure. The trade was on the other side of the equation, with a 10.24 million bales net short position.
When we analyze how the positions of speculators, index funds and the trade have changed over the last six months, a time frame during which the market oscillated between 60 and 68 cents, we find relatively little variance in all of these positions.
Starting with the long side, outright spec longs amounted to somewhere between 6.5 and 10.0 million bales since early May, whereas outright trade longs moved between 3.3 and 5.5 million bales. Index Funds, which by design operate from long positions only, were a steady force that maintained a 6.4 to 6.8 million bales net long over the last six months.
Since we believe that there is a large contingent of longs in the spec sector that operates as “quasi index funds”, by maintaining a core long position that is being rolled forward irrespective of price moment, we would argue that a sizeable portion of the long side (some spec longs + all index funds) is quite static.
The short side is a lot more fickle and seems to be the main driver of the market. Outright spec shorts have moved in a range between 2.9 and 5.7 million bales since May, which is about the same bandwidth we have seen in specs longs. Outright trade shorts are by far the biggest group with positions that have varied from 12.0 to 15.8 million bales over the last six months.
The way we interpret the above data is that longs are generally less active than shorts and we therefore need to focus on what the shorts are likely to do next, especially trade shorts. Speculators don’t appear to be very involved at the moment, given the lack of direction and momentum. They would probably jump back into action if the market were to break above or below key support and resistance levels, such as the 64-65 resistance area to the upside or the 60 cents support level to the downside.
The outright trade short of 15.4 million bales is not far from the highest level of the year and we therefore doubt that the trade has a lot more room to add to this position. Last year at this time, with the market at basically the same level as now, the trade had a smaller outright short of just 12.1 million bales, despite the US having a 3 million bale larger crop. Some of the current trade short is against the 6.9 million bales in unfixed on-call sales, of which 3.3 million bales are on December and March. These sales will have to be fixed between now and early February, which should provide support on dips.
We suspect that the remainder of the trade shorts is either hedging physical long positions of various origins or represents bearish bets in the options market, which form part of this trade position. However, with the US loan program acting like a “put option” to growers and with a lot of the US crop expected to trade on recaps this season, we see a diminished need for short hedges going forward.
Furthermore, with high-grade machine-picked cotton in relatively tight supply this season, we believe that mills will become more proactive in covering these better qualities for forward shipment. This should act in support of the market, although one could argue that if these sales are made on-call, it might initially allow for more shorts to be added.
US export sales were a pleasant surprise this morning, as 168’700 running bales of Upland and Pima cotton were sold for both marketing years last week. The sales were spread among 20 different markets and shipments of 166’800 running bales went to 23 different destinations. This leads us to believe that there is quite a bit of pent-up demand for US cotton, with buyers around the globe eager to get their hands on it. With the crop now moving in fast, we expect to see increasing sales numbers in the weeks ahead!
For the current season we now have total commitments of just below 4 million statistical bales, of which 1.5 million bales have so far been exported. Sales for the 2016/17-season amount to 0.67 million statistical bales at this point.
So where do we go from here? With the US and other Northern Hemisphere crops now moving in fast, weather is no longer a major factor and the market will increasingly focus on demand. Demand is quite lousy, no doubt about it, but as we have pointed out last week, global output has also fallen quite sharply compared to last season. We therefore may end up with production and mill use numbers that are very similar, somewhere in the vicinity of 107 million bales each.
When we look at the different quality segments, we feel that high grades are going to be relatively tight this season, whereas we expect to see plenty of medium and lower qualities. This should be reflected in a strong basis for premium cotton, whereas some of the lower qualities will be traded at steep discounts. The jury is still out on what that means for NY futures, because it is not a high-grade contract with grades as low as 51-5-33 allowed for delivery. A lot will depend on what percentage of tenderable qualities we will end up with this season. The first 3 million bales classed have yielded about 58% in tenderable grades so far.
If last season is any guidance, we might see some harvest pressure in the weeks ahead that could push values towards the low end of the long-term trading range or even slightly below. However, for reasons mentioned above, we believe that dips will be well supported and that the market will spend most of the season in familiar territory between 60 and 68 cents.