Market Comments – May 26, 2016

NY futures rallied this week, as July gained 326 points to close at 64.33 cents/lb.
 
The market is back in familiar territory, as it is once again trying to overcome the 64.50 resistance area. Between April 20 and May 3 the front month traded above 64.00 cents for ten consecutive sessions, but was unable to close any higher than 64.37 cents at the time. It subsequently fell nearly 400 points and spent three weeks regrouping before launching another attempt this week. 

The odds for taking out resistance have improved since earlier this month, because the market’s newfound strength is supported by a combination of factors, such as:
 
 1)    “Risk on” - Hedge funds and speculators are once again in buying mode, as grains, soybeans, crude oil and stock markets have all moved higher in recent weeks. This is not really surprising, as money is being forced out of the bond market in search of better returns in other assets, like stocks, commodities or real estate.
 
2)    “More buyers than sellers” - with mills still having to fix nearly 2.1 million bales on July (as of May 20), with merchants trying to get rid of basis-long positions in an inverted market and with speculators either establishing new longs or getting out of shorts, there is currently a lack of sell-side liquidity! Index Funds, which hold around 6.7 million bales of July longs, are not in play yet. This means that there is an imbalance between market-driven longs and shorts, which forces prices higher in search of willing sellers. 
 
3)    “Strong cash market” - supplies are relatively tight around the globe, with most origins running low on available supplies. On the Indian subcontinent prices have moved up over 300 points since last week and mills continue to look for imports from West Africa, which are becoming harder to find. It is unlikely that there will be any price pressure in the physical market until new crop arrives!
 
4)    “Delta Force” - with July options expiration still 10 sessions away, some out of the money call options have come back to life and are adding fuel to the fire. For example, between the 61 and 66 strikes in July there were 25,724 call options open this morning, which quickly increase in ‘delta’ as the market moves higher and force traders who are short calls to take defensive actions. Conversely, there are very few July puts in the money, with just 1,941 put options open with strikes above 64 cents, while 63 and lower puts are quickly losing premium. 
 
5)     “Price action” – the market held support right at the 50-day moving average and this week powered through the 200-day moving average at around 62.20 cents. Several attempts to sell off have quickly found support and reversed back up. 
 
US export sales for the week of May 13-19 continued to surpass expectations, as no less than 266,800 running bales of Upland and Pima cotton were sold for both marketing years combined. Once again it was Vietnam, Turkey and China leading a field of 18 different markets, while shipments of 254,700 running bales went to 26 destinations. 
 
Total commitments for the current marketing year, with ten-and-a-half weeks to go, are now at 8.9 million statistical bales, of which 6.9 million bales have so far been exported and 2.0 million bales remain unshipped. Sales for shipment August onward are at 1.4 million statistical bales so far, which is about 0.1 million bales ahead of last year’s pace.
 
When we look at the latest snapshot of the US balance sheet, it becomes evident why the market has been on a firm footing lately. Supply this season amounted to 16.6 million statistical bales (3.7 beginning stocks and 12.9 crop), of which so far 12.5 million have been committed (8.9 export and 3.6 domestic). We further need to subtract about 1.0 million bales (out of 1.4 million) in export commitments for August to October, as well as around 0.9 million bales for domestic mill use during the same time frame. In other words, there are just a little over two million bales available for sale between now and October, which is not much considering that the quality has been below par this season. 
 
So where do we go from here? The market closed right at a critical junction today!  A move above the cluster of resistance, in particular the April 26 high of 64.75 cents, would likely trigger some additional buy stops, which could propel the market another 2-3 cents higher in this illiquid environment. There are still six sessions until the Index roll provides much needed sell-side liquidity and a lot can happen during that time. 
 
On the other hand, if the market stalls again over the next session or two, we could see another setback towards 62.50 cents, at which point we would expect to see plenty of trade support.
 
Based on cash values the market may be slightly overextended, because today’s close puts the certified stock (basis SLM 1.1/16) at around 73.00 cents landed Far East. However, for reasons explained above that doesn’t really matter until we get closer to the notice period and open interest has been greatly reduced. 
 
New crop is being pulled higher by July at the moment. Although there have been some issues with new crop plantings here and there, we would still advise growers to start putting some protection in place, preferably via put spreads in March, which leave the upside open in case something were to happen to the crop. We don’t like December puts for hedging, since it will take some time for the pipeline to fill up again next season. 

 

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