Market Comments – May 7, 2015

NY futures reversed course this week, as July dropped 225 points to close at 65.53 cents, while December fell 121 points to close at 65.43 cents.

After trading to a 7-1/2-month high of 68.13 cents last Friday, the July contract finally ran out of steam and started to reverse, giving back about half of the gains it garnered during this latest bull run. Surprisingly, despite dropping nearly 300 points, open interest has basically remained unchanged, which tells us that there hasn’t been any meaningful long liquidation yet.

Last Thursday July open interest reached a peak of 125’173 contracts, from which it has dropped just 1’184 lots or less than 1% as of this morning. Overall open interest actually increased by 4’827 lots this week and amounted to 198’069 contracts before today’s session. The longs seem to have a lot more staying power than we expected! Typically a decent amount of spec longs gets flushed out during a decline like this as sell stops are being triggered, but so far this hasn’t happened. There may have been some rotation, with some longs exiting and new ones replacing them, but by and large spec longs are still hanging in there.

The same can be said for the trade, which continues to operate from a rather sizeable net short position. The latest CFTC report showed the trade at 10.5 million bales net short, composed of 4.0 million bales outright longs and 14.5 million outright shorts. As we have pointed out last week, the trade was once again unimpressed by the market’s latest advance and kept selling into it, thereby stalling its momentum and forcing a reversal. In other words, speculators have so far been unsuccessful in pushing the trade to cover its shorts.

US export sales cooled considerably from the pace of previous weeks, which is partly due to higher prices and partly due to a lack of desirable qualities. Net new commitments of Upland and Pima cotton for both marketing years rose by just 46’700 running bales last week, with 15 markets still interested in the bits and pieces that remain of the US crop, but there were also a number of cancellations.

Shipments of 419’800 running bales were the bright spot in today’s report, as they were about twice the weekly amount needed to reach the USDA estimate of 10.7 million statistical bales. Total commitments for the current season are still at 10.9 million statistical bales, of which 7.9 million bales have now been exported.

Apart from a technical reversal we had abundant rains in West Texas that added to the bearish sentiment this week. Heavy precipitation was received across the region, with most stations in West Texas getting anywhere from 1.5 to 6 inches of rain. Lubbock got just shy of 5 inches this week. This latest round of rains has boosted the chances for an above average crop this year, with low abandonment and promising yields.

Improved weather conditions in the Mid-South and Southeast finally allowed farmers to start planting. Like in the case of Texas, there is abundant moisture to ensure a decent start to the crop, with the promise of above average yields this season. The only negative about the US crop at this point is that it is a little behind schedule. This may become an issue in the fall, since El Niño conditions are expected to persist and we therefore have a higher risk for a wet harvest. With US high grades in short supply, the market will likely carry a weather premium until the outcome of the US crop is known.

Next week, on May 12, the USDA will issue its first set of numbers for the 2015/16 marketing year. Expectations are for a US crop of around 13.5-14.0 million bales and a world crop of around 107-108 million bales, which would amount to a reduction of around 10% from this season. Since China will account for a large part of this reduction, the numbers to watch out for in regards to price direction are the ROW (rest of the world) production surplus and Chinese imports.

In the current season we had a ROW production surplus of 13.2 million bales, of which China absorbs only 7.5 million bales via imports, which is why ROW ending stocks are increasing by nearly 6 million bales. Therefore, with Chinese imports expected to drop to just 5.5 million bales next season, the ROW production surplus needs to be at or below this number in order to prevent a further increase in ending stocks. At this point we feel that the odds still favor a slight increase in ROW ending stocks next season, maybe by a million bales or two, which would keep a lid on prices.

So where do we go from here?  The short-term trend of July is down, but from a longer-term perspective prices are still in the middle of a 4-month uptrend channel, with the lower trendline currently running through 63 cents. Although spec longs have been hanging on to their positions so far, a drop below 65 cents would likely lead to increased liquidation and force values down towards that 63 cents support area, where we expect trade short covering to intensify. On the other hand, if July manages to hold above 65 cents level over the next few days, we may see another push higher. 

Tuesday’s USDA report will play an important role in determining the market’s next move. At this point we expect a neutral to slightly bearish report, since it doesn’t look like Chinese imports will be strong enough to absorb next season’s ROW production surplus.