NY futures rallied sharply this week, with July gaining 209 points to close at 64.96 cents/lb, while December advanced 263 points to close at 65.30 cents.
Cotton futures rose as another wave of aggressive speculative buying lifted the entire commodity complex, as measured by the GSCI commodity index, to its highest level since last November. Since making a low in early March the GSCI index has now gained about 33 percent, with its Ag subcomponent advancing around 20 percent.
When we take a step back and look at the cotton market over the last six months, we notice that the price movement has a high correlation with the change in the net spec position. Between the middle of December and the end of February, speculators sold over 10 million bales net and during that time frame cotton futures dropped from around 65 to 55 cents.
Since the beginning of March speculators have bought an estimated 10.5-11.0 million bales net and the cotton market has risen from around 55 back to 65 cents. In other words, speculators played an important role in this ebb and flow of the cotton futures market, with prices moving about 100 points for every million bales speculators bought or sold over the last six months.
However, it was not entirely the spec’s doing that pushed the July contract through the 64.50 resistance area earlier this week. As we had pointed out a couple of weeks ago, there were several catalysts like the large amount of unfixed on-call sales or the high open interest in July call options that acted in support of higher prices as well.
As of last Friday there were still 1.9 million bales of unfixed on-call sales in July and with the market moving higher this number has probably not been reduced by much as mills keep waiting for a break. On the other hand July call options won’t have much of an impact anymore since they will expire tomorrow.
Tomorrow’s WASDE report is expected to be neutral to slightly friendly, as US exports for this season are likely to increase by 0.3 million bales based on the pace of shipments, which would reduce US ending stocks to the same level as last season, namely 3.7 million bales. Despite the somewhat slow and difficult start to the US crop, the abundant moisture should ensure good yield potential and we therefore expect the optimistic crop outlook to be maintained for now.
When we look at the ROW numbers (=all countries except China), the USDA currently has a ROW production surplus for next season of 4.58 million bales, which would be absorbed by Chinese net imports of 4.5 million bales, therefore leaving ROW stocks basically unchanged at 39.76 million bales. We see no reason for any major changes to ROW production and mill use numbers, since they are nothing more than educated guesses at this point.
US export sales for the week of May 27 to June 2 have remained strong, as 247,400 running bales of Upland and Pima were sold for both marketing years combined. Participation remained broad-based with 16 markets buying and 24 destinations receiving shipments of 214,800 running bales. Total commitments for the current season now amount to 9.2 million statistical bales, of which 7.4 million bales have already been exported and 1.8 million bales remain open. Sales for the 2016/17-season are at around 1.6 million statistical bales so far.
So where do we go from here? The cotton market has once again turned into a high stakes battle between speculators and the trade. After having been as much as 4.5 million bales net short just a little over three months ago, we estimate speculators to be around 6.0 to 6.5 million bales net long by now. The trade has used the market’s strength to hedge new crop positions and is an estimated 13.0 million bales net short at this point.
Although the upcoming July notice period will temporarily force the market to reconcile with the cash market, there will be a five-month break after that until the next notice period rolls around (October delivery being a non-event). During that long interval speculators have an opportunity to take the market hostage, especially since the trade has already amassed a sizeable net short position at this point.
Speculators are mainly driven by trends, momentum, money flows and macro-economic factors. With nearly USD 10 trillion in bonds around the globe earning negative interest, money is increasingly migrating to other asset classes, such as stocks and commodities. It may sound illogical, but the worse the economy does, the more likely it is for these assets to rise, as central banks are forced to print more and more money and to keep interest rates at or even below zero.
Fortunately there are position limits that prevent unlimited amounts of speculative money to enter commodity markets, but even so speculators could easily double their current long holdings and we wonder whether the trade has the will and wherewithal to keep speculators at bay over the next five months.
Therefore, when simply looking at cotton fundamentals the case can easily be made that cotton at 65 cents is fully priced and that it should eventually trend lower if major crops develop well. However, the chart, price action and money flows offer a different view at the moment and specs might continue to bid the market higher.
Even if the specs pull back their horns we feel that the market will be well supported in the low 60s based on the limited availability until new crop, while outside factors have the potential to push prices into the high 60s or low 70s over the next few months.