NY futures retreated during this holiday-shortened week, as July gave back 146 points to close at 62.87 cents/lb, while December dropped 127 points to close at 62.67 cents.
The market has once again been unable to push past the formidable 64.50 cents resistance area and was forced to pull back this week. In doing so July has formed a double top on the chart and it remains to be seen whether it can garner enough strength to launch a third attempt before time runs out.
What speaks against it is that next week the market will encounter a lot more liquidity, as index funds are going to roll their massive net long position to December starting on Tuesday. This will provide plenty of sell-side liquidity and allow most of the remaining shorts in July to get squared away. July options expiration at the end of next week should also take a big bite out of the remaining open interest.
As of last Friday, May 27, there were still 2 million bales in unfixed on-call sales on July, which is a record amount for this date. While we understand that it is tempting for mills to wait for lower prices, we believe that anyone staying in the game beyond the index fund roll period and options expiration is playing with fire and may get trapped. We would therefore advise mills to get their fixations done by latest June 13.
The current futures market seems to follow in a very similar path as the one of a year ago, which may provide us with some clues as to what to expect next. On June 2, 2015, the July contract closed at 63.60 cents, while December stood at 64.06 cents. Although there was a small amount of carry available, it was nowhere near the amount needed to carry a certified stock that amounted to 134,005 bales at the time.
However, even though the certified stock would continue to rise to as much as 180,387 bales by late June, there were ultimately only 21,600 bales tendered during the July notice period. During the three weeks leading up to First Notice Day on June 24, the July contract had closed in a very tight range between 63.21 and 65.24 cents, while the closing range for December was equally narrow between 63.63 and 65.79 cents.
Right now the certified stock amounts to 107,731 bales, or about 26,000 bales less than a year ago, and at current prices we don’t expect a lot of this cotton to get tendered. Ending stocks outside China and the US are about 5.3 million bales less than a year ago, with fewer premium qualities in the mix. Mills still need to buy a considerable amount of cotton until October and there are not that many places to turn to anymore, which is why we think that the certified stock will either find takers or will not be given up by its current holders.
US ending stocks are in a similar spot as last season, with the USDA currently estimating that 4.0 million bales will be carried over compared to 3.7 million a year ago. However, if shipments keep up their current pace, we might end up with exactly the same inventory as last July.
China continues to dispose of its massive stockpile at an impressive pace, as nearly 2.9 million bales have so far been sold to mills and traders. Although these Chinese auction sales may not have any immediate impact on the ROW balance sheet, we feel that they will eventually lead to reduced yarn and cotton imports and therefore affect mill use in the ROW.
Even the positions of traders are remarkably similar to last year. The latest CFTC report as of May 24 showed speculators at 3.4 million bales net long (vs. 2.7 million a year ago), whereas the trade has a 10.1 million bales net short (vs. 9.1 million last year) and index funds are 6.7 million bales net long (vs. 6.4 million).
So where do we go from here? The old saying that “history doesn’t repeat itself but it often rhymes” seems to apply to the current cotton market, as it follows in a similar path as a year ago. What’s different is that the ROW has less cotton available, which is supportive, while China’s reserve sale should have a negative impact over time. To us it all adds up to a market that is going to trade sideways between 62-65 cents as we head into the July notice period.