NY futures continued to advance this week, as May gained 153 points to close at 58.36 cents/lb.
The market continued to dig itself out of the hole it fell into on February 29, when the May contract had collapsed to a low of 54.50 cents. Since then the market has clawed back nearly 400 points and chart action has been constructive, with the 7-day exponential moving average about to cross over the 21-day, which has proven to be a reliable buy (or sell) signal over the years.
As mentioned in our last report, we believe that the shorts are out of bullets, which is substantiated by the fact that speculators sat on a record number of shorts last week. According to CFTC data as of March 8, speculators (non-commercial and non-reportable positions) carried a 4.0 million bales net short, composed of 6.7 million bales on the long side and 10.7 million on the short side. Both the net short and the outright short are at all-time highs!
The trade reduced its net short by 0.6 million bales last week and is now just 2.8 million bales net short. Index Funds remain the lone long position at this point with a 6.8 million bales net long.
The higher than usual spec participation has kept open interest higher than usual at currently 212k contracts, whereof 115k are in May. By comparison, last year we had just 181k contracts open at this date, despite a larger US crop, and two years ago it amounted to 180k. We see this large open interest as a bullish factor, because it means that speculators have hardly covered any shorts yet despite the market’s turn higher and a short-covering rally may therefore still lie ahead of us.
We wonder what the rationale of these short speculators might be to justify such large positions? From a fundamental point of view we see a rather tight supply situation over the next 6-7 months and on the global macro front things have definitely improved lately, with stock markets recovering, many commodities rallying and the US dollar starting to lose ground against emerging market currencies.
If short sellers based their decisions on the yet to be announced Chinese reserve policy, it may well be that they have been betting on the wrong horse. From the information that has been leaked in recent weeks it seems that China will try to dispose of its stock in a relatively slow and measured way over the next five years. In other words, we don’t think that Chinese stocks will change the tight supply situation that currently exists in the ROW in a meaningful way over the coming months!
Speaking of tightening supplies, the US saw another 294,200 running bales of Upland and Pima cotton committed for export last week, with 24 markets on the buyers list and 23 destinations receiving shipments of 186,100 running bales. For the current season commitments have now reached 7.6 million statistical bales, whereof 4.5 million bales have so far been exported.
When we look at the current backlog of just 3.09 million running bales in outstanding commitments, which is a lot lower than last year’s 4.56 million bales, it may help to explain why shipments are not breaking any records. At 200,000 bales a week it would take just 15 weeks to clear out what’s currently on the books and we still have 24 export reports to go until July 31st. So let’s not worry about the pace of shipments just yet!
When we look at the US statistical situation, we had total supply at 16.6 million bales this season, whereof 7.6 million bales are now committed for export and 3.6 million bales are going to domestics mills. However, we further need to reserve 0.9 million bales for domestic use between August and October and we also assume that 0.7 of the 1.0 million bales in export commitments for August onwards are coming out of current crop. This would leave just 3.8 million statistical bales for sale, which is not much considering that we are only in March and that premium qualities were less plentiful this season. What’s left is likely going to be a mixed bag of grades and we would therefore advise mills to book any remaining US needs without further delay!
So where do we go from here? Supplies are tightening rather quickly, not just in the US, but in other exportable origins as well! We feel that the bearish price action over the last three months and the prospect of Chinese stocks being released has lulled mills into a false sense of security when it comes to the availability of cotton. The ten-cent drop in the market was entirely caused by speculative selling and Chinese reserve auctions are not going to help mills in the ROW feed their factories in the 2nd and 3rd quarters.
Fundamentals are pointing to higher prices and we believe that it is just a matter of time until this massive spec short position will be forced to cover. Last year, between late January and early March, specs reversed a 2.9 million bales net short position into a 5.3 million bales net long, which moved the market about eight cents higher. With ending stocks in the US and the ROW expected to be a lot lower than last season and with speculators sitting on a record short position, we expect to see a similar rally over the coming weeks. We therefore remain bullish on May and July, as well as current crop vs. new crop spreads!
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