Speculators have forced the market lower by selling around 9 million bales net over the last two months and they can’t keep up this kind of selling pressure. While most of this spec selling was long liquidation, there have also been new shorts established, which could provide the fuel for short covering rallies.
The market is still in search of solid support, but with speculators continuing their net selling and with the trade afraid of the long side, the market could drop more in the weeks ahead.
We feel that the onslaught of spec selling is over for now and that the trade isn’t going to sell the market in the mid-60s either. There are simply too many early commitments on the books and with the crop being drawn out and slightly behind schedule we don’t expect any supply pressure until early 2018.
The market seems to be stuck between a bullish current crop and a potentially bearish new crop scenario.
After a parabolic move to the upside last month, we now have a similar situation to the downside. Given the still sizeable spec net long position in December this selling pressure could persist as long as speculators feel a need to get out of the cotton market. We have seen similar moves in other soft commodities recently, be it sugar, coffee or cocoa.
The market is overextended to the downside after this liquidation drive and is likely to give us a bounce, possibly after tomorrow’s options expiration. If there is still a relatively large open interest left after all the options have cleared, then July might flare up again, especially since the certified stock has become so attractive.
The July liquidation has progressed quite swiftly and orderly so far, but the remaining two weeks might still harbor some surprises. For one we are not seeing the usual liquidity during the ongoing index roll. This means that some of the index position has already been rolled, probably when the July/Dec spread inverted to 13-14 cents a couple of weeks ago.
The rapidly declining open interest in July is sucking the energy for a big move out of the market, and we haven’t even reached the major index roll yet. With July now near its cash value, we expect it to trade in a fairly tight range over the next 2-3 weeks. If technical support levels get breached and specs react to it we could see some flush out dips, but by and large we expect July to be trading in a 76-79 cents range.
The market is approaching critical trendline support and a breach would likely flush out a sizeable number of spec longs. We have seen similar moves in soft commodities like sugar, coffee and cocoa, and would therefore not be surprised if cotton were to follow the same script.
Now that we got the squeeze play out of the way, both the market’s psychology and momentum have turned negative. Fundamentally the market is still too high and specs can’t be happy with their current book. The market may therefore continue to go lower in order to find trade support, both from new business and fixations. We expect that level to be at around 7650-7700, maybe a shade above it.
Today’s powerful move in July was a wake-up call for the many trade shorts that still remain in the game. It has also put any further spec long liquidation on hold for now and we may actually see some specs come back into the market based on this performance.
The specs and the trade are in a game of chicken and it remains to be seen who ultimately has the stronger nerves. If speculators were to give up and let trade shorts out, then the July contract would probably remain in the mid-to-high 70s. At this point speculators have no reason to abandon their position based on what the chart tells them, but that could of course change.
Near-term momentum has turned negative and this may force the market a little lower over the coming sessions. However, we expect heavy trade-short covering tied to mill fixations in the 76-77 cents area. At this point we’d expect the long-term trendline near 76 cents to hold.
The fireworks in the May contract are probably over, since we started the day with just 6,030 contracts open and there were an estimated 5,660 Mays traded today. In other words there won’t be a lot left to liquidate! It also looks like the certified stock, or at least most of it, won’t change hands during the upcoming notice period.
Some traders wonder why the market has not reacted more positively to these excellent export reports in recent weeks. The answer is simple – it was massive spec long liquidation and new spec shorting that kept a lid on the market. The heavy spec selling has diffused an otherwise explosive situation for now. However, in a sense it has made the situation worse, because thanks to a falling market US export sales have continued to increase at a mind-boggling pace. A few more weeks of 150-200k bales in sales and the US will for all practical purposes be sold out!
From a chart perspective the market is at a razor’s edge, sitting right at the long-term uptrend line. At the moment the recent selloff is still to be viewed as a correction in a bull market, but a drop below this important support would change that and flush out some more spec longs. However, trade short covering would likely be there to absorb most of the selling. On the other hand, if the market were to hold over the next couple of session, the momentum could easily turn up again!
US prices remain competitive and both sellers (no carry with an inverted July/Dec spread) and buyers (attractive basis, high quality and the desire to keep spinning US cotton) have an incentive to keep sales going. As mentioned before, with less than 10% of total US supply still available, one would expect some rationing to take place, but this is one of the most uncharacteristic seasons we can remember.
While most of the bullish drivers that have brought prices from about 56 cents to 77 cents since last March are still in place, particularly the large trade short position tied to a massive amount of unfixed on-call sales, we feel that this bull market is living on borrowed time! If specs hold on to their longs, they could still force the market to spike higher over the next three months.
The market continues to be in a holding pattern, waiting for the nearly 8 million fixations in May and July to make their move. Mills didn’t want to fix when the market was below 77 cents earlier this week, so why would we expect them to do so at over 78 cents? However, sooner or later they will run out of time and that’s when things will get interesting! From a technical point of view the market is still in a strong one-year uptrend and there are no signs of a spec long shakeout anytime soon.
From a technical point of view the 53-week primary uptrend is still in force, which is keeping speculators on board. The trade on the other hand seems to be trapped with its large net short position, about half of which is against unfixed on-call sales. Mills are growing increasingly frustrated with this ‘two steps forward – on step back’ market since they don’t seem to catch a break that would allow them to get out of their predicament.