Market Comments – March 19, 2015

NY futures rebounded this week, with May rallying 173 points to close at 62.95 cents, while December gained 88 points to close at 64.11 cents.

After declining by more than 600 points in fourteen sessions since February 26, the market suddenly started to reverse course on Wednesday morning and has since rallied around 300 points with heavy volume changing hands. By closing at 62.95 cents today, the May contract has once again moved above its 20-, 50- and 100-day moving averages and has now the important 200-day moving average at around 65 cents in sight.

This reversal has put any further spec long liquidation on hold for now and shifted the action to short covering by speculators and the trade. The first wave of buying on Wednesday was apparently tied to some overnight cash business, while the second wave was clearly related to weakness in the US dollar following the Fed meeting.

The wizards at the Federal Reserve continued to mesmerize financial markets with their word parsing this week. Although the Fed changed its language in regards to raising rates from being “patient” to wanting to be “reasonably confident that inflation will move above two percent”, they later elaborated during a press conference that while “they were no longer patient, they were definitely not impatient”.

What this ambiguity seems to tell us is that the Fed will abstain from raising interest rates anytime soon, pending further signs of economic strength. Since we feel that US economic indicators are likely to disappoint going forward, we don’t expect to see any US rate hikes at all this year. To the contrary, we expect the printing press to be running again before the end of the year.

The financial markets had a kneejerk reaction to this Fed gibberish, with the US dollar index falling around 4% on Wednesday, only to recoup all of its losses during the following session. The initial weakness in the US dollar sparked a rally in commodities across the board, but these gains were short-lived once the greenback started to regain its strength.

While most commodities turned lower again today, cotton was able to buck the trend thanks to a constructive US export sales report. Net new sales of Upland and Pima cotton of a combined 289’900 running bales for both marketing years beat expectations by a wide margin and rekindled fears of a shortage in US tenderable styles. Once again it was impressive to see that 20 different markets were chasing after US cotton, with China’s 85’600 running bales leading the field.

Shipments continued at a strong pace as well, with 311’300 running bales leaving the country last week. Total commitments for the current season now amount to 10.2 million statistical bales, whereof 5.5 million bales have so far been exported. Since NY futures have traded at even lower prices during the current week, we expect to see another good export report next Thursday.

The big question going forward is how many tenderable grades are left in the US? Looking at the balance sheet for US Upland cotton only, we had a crop of around 15.5 million statistical bales and we further assume that beginning stocks contained around 2.2 million bales of Upland. Therefore, total supply amounted to around 17.7 million bales this season. Export sales of Upland are at 10.0 million bales so far and domestic mills will have used up around 3.7 million bales by the end of July.

This leaves around 4.0 million bales, from which we still need to deduct around 0.9 million bales for domestic mill use between August and October as well as export commitments of an estimated 0.7 million bales for the same time period . This means that there are probably no more than 2.4 million bales of Upland cotton still available for sale at this point. That’s a rather low number considering that there are still around 6-7 months to go until new crop.

Furthermore, since we know that only a little more than 2 out of 3 bales were of deliverable quality this season, we sincerely doubt that there are many tenderable bales left for sale, if any! Actually, it is quite possible that such grades are overcommitted, which would explain the persistently strong cash basis for high grades as well as the nearly depleted certified stock.

So where do we go from here? If our assumption about tenderable grades is correct, then the shorts in the NY futures market could find themselves in a vulnerable situation.

Although speculators have reduced their net long by an estimated 2-3 million bales over the last three weeks, the market’s sudden upturn will likely cancel any further long liquidation. The other net long belongs to index funds, which will simply be rolled forward in a couple of weeks from now and then again in June.

Since the trade has no longer any valid reason to add new shorts in current crop futures, because most cotton has already transitioned from growers to merchants, it may become difficult for trade shorts to find counterparties willing to take the other side if they wanted to close out their positions. With certified stock in short supply, with spec and index fund longs not likely to sell in a rising trend and with mills still having to fix and buy additional quantities over the coming weeks and months, we feel that the dynamics for a short-covering rally are in place.

December is a different story, because we are likely to see an increase in grower hedge selling as the Northern Hemisphere crops get planted. For this reason we continue to believe that current crop futures will eventually invert over December, possibly by a considerable margin.