NY futures corrected to the downside this week, as December gave back 90 points to close at 72.97 cents.
The fear and panic that drove the December contract to an intraday high of 75.00 cents last Friday – the highest level on the continuation chart since July 2014 – started to subside this week, as sellers regained some control of the market on Monday.
Implied volatility for the December contract, which is a reliable ‘fear’ indicator, has dropped by over three percentage points since last Friday, but at 25.6% remains considerably higher than before the up move. On July 8, the day before the market started to take off, December volatility was still at a sleepy 19.4%.
The latest CFTC report as of July 12, which is already a bit stale dated in this fast-paced market, shows that speculators up to that point had already added 2.5 million bales to their net long position, which amounted to around 8.0 million bales. We estimate that since then speculators added another 2.0 million bales to their net long, which would bring them to around 10.0 million bales net long.
The trade was a strong seller into the rally and as of July 12 was carrying a 14.0 million bales net short position, which by now has probably grown to some 16.0 million bales. Index Funds make up the difference with a net long position of just over 6.0 million bales.
In this regard we would like to remind our readers that the Index Fund long position does not react to market moves and only changes due to rebalancing or when money is being added or withdrawn. Therefore, since about 43 percent of the net long position is not ‘in play’, it can lead to an imbalance between market-driven longs and shorts and exacerbate a move to the upside.
Another interesting fact the CFTC report reveals is the increase in the number of large spec accounts, which went from 135 to 160 accounts in just one week, as the breakout from a two-year sideways trend attracted new players to the cotton market. Also, while the net long/short position amounted to ‘just’ 14.0 million bales, the outright long/short position or total open interest including all futures and delta-adjusted options was more than twice as large at 28.6 million bales.
Stronger than expected US export sales gave the market another boost today. For the week that ended on July 14 the US sold 275,700 running bales of Upland and Pima cotton, of which 81,900 bales were for prompt shipment. Once again there were 18 markets buying and 24 destinations receiving shipments of 193,600 running bales. This brings total commitments for the 2015/16-season to 9.9 million statistical bales, of which 8.7 million bales have already been exported. Sales for the 2016/17-season have now reached 2.4 million statistical bales.
Most of these new sales were done ‘on-call’, as mills felt a need to secure nearby supplies, but wanted to give themselves an opportunity to fix the price on a break. The just released ‘on-call’ report confirms this hypothesis, as unfixed on-call sales jumped by 4,461 contracts (=446,100 bales) last week and now amount 7.04 million bales. This should provide a strong layer of support underneath the market!
Assuming that the US sells another 300k for both crop years and ships 400k before by the end of this month, we would end up with the following statistical position: Beginning stocks on August 1 would be at 4.0 million bales, which combined with a potential crop of 15.8 million bales would add up to 19.8 million bales of supply. From that we would have to deduct 3.6 million bales for domestic mill use and 3.5 million bales for existing export commitments.
This would leave 12.7 million bales for sale, which is still a considerable amount. Even if the US crop would have to be scaled back to 15.0 million bales due to drought conditions in West Texas, there would still be 12 million bales available. We therefore feel that it is too early to get overly bullish. No doubt that stocks in the ROW will remain relatively tight during the course of next season, but as long as the US, Indian and Pakistani crops don’t suffer any major setbacks, there should be enough cotton to get by without having to destroy demand via high prices.
So where do we go from here? Considering that we have the second tightest ending stocks in the ROW since 2009 and given the much higher price levels in China and India, the US market has been too cheap at 65 cents and was therefore forced to adjust to a higher price plateau.
73 cents futures means that US high grades are now priced in the mid-80s landed Far East, which may still be on the cheap side when compared to the 90+ cents in India and 100+ cents in China. But we feel that both Chinese and Indian prices will eventually come under pressure as we approach harvest and that US prices should therefore no longer have to play catch up.
Speculators and weather scares have the power to move prices temporarily higher, but for now we are sticking to our 68-76 cents trading range.