History doesn’t necessarily repeat itself, but it often rhymes! Like in 2008, the trade is putting up a fight, matching new spec longs step-by-step with additional shorts, which has led to this historic open interest. At this point the trade remains convinced that the futures market is out of line and that it will sooner or later have to correct back down.
The short squeeze is on and it is difficult to predict how far it will run. The problem is that open interest is still near a record and so are unfixed on-call sales. This means that there is plenty of ‘energy’ in this market, which can lead to some wild and overextended moves.
The trade has been waiting for a meaningful correction for the last six weeks, but the market hasn’t given back much more than a cent or two a couple of times. This is clearly frustrating the shorts and/or mills who still need to fix a lot of cotton, and over the last couple of sessions we have seen some fixations move up to the market. It is this kind of action along with bullish options strategies that keep feeding this bull market!
Speculators led the initial charge of this bull run and now nervous members of the trade are fueling the flames by engaging in bullish strategies in order to protect their short position. The old saying ‘there is no better buyer than a commercial short’ seems to hold true at the moment and it is therefore difficult to gauge at what point this bull market will finally run out of steam and reverse.
Speculators have so far led the charge in this bull move and increased their net long by around 7.0 million bales since July. The trade has been slow to react to this rally, not really believing it could happen, but as it is often the case we are now seeing defensive moves via bullish options strategies helping to fuel the advance.
The market has a sell-side liquidity problem, similar to what we saw last season. Speculators like the market’s strong performance and are adding to their net long, while the trade is desperately hoping for a break in order to get out of some shorts and/or to fix its over 11 million bales in current crop on-call sales.
Over the last couple of years the price of cotton has been closely correlated to the spec net long position. When specs are buying the price is going up and vice versa. The next move will therefore depend on what speculators decide to do. Will they continue to throw money at the cotton market or are they done for now? We’ll have to wait and see!
There will be no report today as the author is travelling. Back next week.
The relatively high open interest in December, which was still at 24k contracts this morning, tells us that there are still quite a few fixations to be done. This should continue to underpin the market as we head into the notice period a week from now.
Today’s WASDE report didn’t give the market a reason to break out from its current trading range. On the one hand we still have a sizeable seasonal surplus and an inventory buildup later in the season, but on the other hand mill demand has now risen to a plateau of nearly 120 million bales, which requires continued near-record crop production in the ROW going forward.
There is currently nothing to suggest that the market is going to break out of its trading range anytime soon. Overhead trade selling should keep a lid on the market, while 14.0 million bales in unfixed on-call sales and the Indian MSP should provide support at the lower end of the range.
The increase of Gujarat’s MSP combined with some potential freeze losses in West Texas this weekend won’t add up to a bullish market, but they may make it a little less bearish. In other words, we may deal with a slightly higher trading range going forward, with March possibly holding near the mid-60s instead of the low-60s. The upside looks limited until we have cleared the extra inventory, which will only start to happen once China enters the scene as a stronger importer.
The path of least resistance seems to be down. Crop pressure is starting to build and the technical picture is now pointing lower as well. Mills need to fix a record amount of cotton but will probably take their time and do so on a scale down basis only. This should open the door for a move into the mid-to-low 60s, maybe not for December, but certainly for March. Only a last minute problem in West Texas or India would alter this scenario in our opinion.
Today’s WASDE report has given the trade a green light to increase its short position, while speculators are likely to reduce their net long position further.
Once the crops have moved in, we could be faced with a situation in which the trade may want to put on additional short hedges against inventories and on-call sales, while a weak chart might force speculators to abandon its net long. In other words, there may plenty of selling and not a lot of buying ahead, other than scale down mill fixations.
There is currently a shortage of cotton in the cash channels and the basis for early arrivals is therefore quite strong. Only once the crop has moved in and nearby commitments have been applied will the market start to feel some pressure. This will probably not be the case before the second half of November or early December. We therefore see December futures well supported, while March should eventually start to feel the crop pressure.
As crops are approaching the finish line and the weather premium is fading away, the bulls will find it harder to defend their territory.
Interestingly, when we add up production and mill use over the last three seasons, from the 2015/16-season to the current one, we get a combined output of 323.74 million bales vs. a combined mill use of 342.68 million bales. In other words, mill use has been outpacing production by around 19 million bales over those three seasons.
Traders are quite nervous at the moment due to all these weather-related threats we had over the last couple of weeks. However, the market has probably gone up far enough for now and if no further production setbacks occur, the trade will eventually emerge as a stronger seller again and cap the market.
Markets don’t like uncertainty and right now there is plenty of it! With an almost empty supply pipeline and with some of the early arrivals falling prey to bad weather, the margin for error has become rather thin. Heavy rain in the Delta at the moment and possibly another storm system bringing more unwelcome moisture next week are likely going to impact the quality of the 4.0 million bales grown in that region.