NY futures had a strong week, as December gained 127 points to close at 70.16 cents.
December climbed back above 70 cents for the first time in over six weeks, as a combination of factors supported the market. Tight nearby supplies, a weaker US dollar and spec short covering were all contributing to the market’s firmer tone.
Today’s US export sales report, which was seen as ‘disappointing’ by many commentators, was in fact testimony to the extremely tight supply situation that exists not only in the US, but just about everywhere else outside of China. Net new sales amounted to only 82,700 running bales of Upland and Pima cotton, as there were 91,800 running bales cancelled in 18 different markets.
Cancellations are typically seen as a weak sign but in this instance they were likely initiated by shippers due to a lack of available supplies. It simply doesn’t make sense to us that mills in 18 different markets would suddenly cancel all these bales at the same time, during a week when prices hardly moved. Instead we believe that shippers couldn’t come up with the necessary goods and needed to either postpone the shipment to new crop, switch to another growth or buy-back the contract.
What supports our theory is that shipments were excellent last week, with 284,500 running bales going to 25 different markets, including all 18 that had cancellations. Total commitments for the 2016/17-season, with 4 days of data still missing, were at 15.7 million statistical bales, of which 14.79 million bales have been shipped.
We estimate that the final export number will be at 14.9 million statistical bales, or 0.4 million bales higher than the current USDA estimate, which will drop US ending stocks for the 2016/17-season to just 2.8 million bales.
Export commitments for the 2017/18-season, which started on Tuesday, are already at 6.35 million statistical bales, including a carryover of 0.9 million bales from last season.
Open interest in December futures declined by 1,840 to 155,602 contracts over the last five sessions. This leads us to believe that spec short covering was the primary force behind this up move, while the trade was probably adding new shorts on a scale up basis.
Specs had 5.74 million bales in outright shorts last week and a lot of these shorts were added after the market broke below 72 cents on June 13. Specs are typically very disciplined in their risk management and therefore quick to cover losing positions, which seems to be what is happening here.
However, a strong market needs to see fresh buying and an increase in open interest, since short covering will carry it only so far, especially if trade shorts are waiting for an opportunity to establish new positions.
The US dollar index continued to lose ground this week and has now dropped to a two-year low. This has given commodities a boost, as the GSCI index has gained about 8.5 percent since June 21. There is no end in sight to the dollar weakness, as even the Indian rupee continued to advance after a 0.25% interest rate cut earlier this week, rising to the its highest level against the greenback since July 2015. US cotton is already relatively cheap on the international front and this dollar weakness adds further to its attractiveness.
On the weather front the US crop seems to be doing quite well, especially after West Texas received some very timely and abundant rain this week. A US crop of 19 million bales or more is therefore still in the cards. Opinions vary in regards to the Indian crop, with flooding in Gujarat and Rajasthan and fears of pest attacks in Punjab and Maharashtra raising some concerns, but we feel that India still has the potential to produce about 10-15% more than last season.
So where do we go from here? The market advanced on some spec short covering this week and may eventually test major resistance at 7200 over the coming days or weeks. However, from a fundamental point of view there is no reason for traders to chase prices higher, since the crops are still holding on to their potential. Many producers are waiting for a chance to hedge their output in the 70s and there are plenty of scale-up sell orders already in place.
Stocks will be extremely tight over the next 2-3 months, but if crops around the globe turn out well, they will eventually fill up the pipeline again and guarantee ample supplies throughout the season. Therefore, as long as traders don’t sense any problems on the production side, the market will find it difficult to move much higher.
At the same time there is a lot of buying waiting near the recent lows, as unfixed on-call sales have already reached 10.99 million bales. We therefore feel that the market will remain confined to a 67-72 cents trading range in the foreseeable future. Since we expect a severe supply bottleneck in the 4th quarter, regardless of how big the crops ultimately turn out to be, we still expect the Dec/March inversion to expand.