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.
The US crop certainly has tremendous potential, with some early dryland yields coming it at over 3 bales/acre and with plants generally looking healthy and loaded up across the cotton belt. Judging by field reports we feel that this crop might break yield records and come in at over 21 million bales.
Since crops are not quite made yet, selling pressure is starting to subside below 67 cents, while there is some light scale down mill buying becoming evident. This has lead to a slightly more two-sided affair over the last couple of sessions.
The market came within 80 points of the 72 cents resistance level, but after today’s dismal performance the momentum has now clearly shifted to the downside again.
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.
The market seems too cheap to sell below 67 cents and too expensive to buy above 70 cents given the high expectations for the coming crop. However, since US cotton is relatively cheap compared to other growths we feel that there is greater risk to the upside.
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.