NY futures continued to slide this week, with December giving up another 285 points to close at 69.01 cents.
Spec long liquidation continued to drive the December contract all the way down to an intra-day low of 66.88 cents on Tuesday, before trendline support finally surfaced and momentum reversed, with the market closing nearly two cents above the lows.
This price action has formed a bullish “hammer” pattern on the candlestick chart, which was confirmed by the small up moves that followed. In other words the near-term chart picture looks constructive at the moment and offers some hope for the large contingent of spec bulls. But it will take more than a couple of up days to repair the damage done between August 5 and August 16, when prices dropped some 1100 points in just eight sessions!
The latest CFTC report as of August 9, which was the day the market had closed limit down at 73.05 cents, showed speculators at 10.0 million bales net long, which was about 0.4 million bales more than the week before. Although open interest in futures has since dropped from around 24.5 to 23.5 million bales, it remains elevated, which tells us that not that much long liquidation, or short covering, has taken place yet.
Last Friday’s USDA supply/demand report disappointed bullish expectations and caused the market to sell off. Most traders, including us, were expecting to see a significant downward revision in Indian stocks and a somewhat smaller US crop. However, the government didn’t oblige and kept Indian stocks at a rather high 10.86 million statistical bales, or 13.8 million Indian bales.
As for the US crop, the USDA increased its estimate slightly to 15.88 million bales, which was mainly due to a low abandonment figure of just 4.9%. The yield of 800 lbs/acre is still quite a bit below the longer-term average, which is at 822 lbs for the last 13 seasons, with a range of 766 to 891 lbs. In other words, the USDA estimate already factors in some yield disappointment!
When we look at the ROW numbers (=World minus China), there were only some minor changes, as ROW production and mill use both slipped slightly, resulting in a projected production surplus of 4.32 million bales, down 0.13 million bales from last month. Since Chinese imports are still expected at 4.5 million bales, the ROW production surplus would therefore be absorbed and ROW ending stocks would remain more or less unchanged year-on-year.
ROW ending stocks are currently estimated to be at 38.91 million bales at the end of July 2017, which compares to beginning stocks of 38.88 million bales. However, while ROW stocks are not going to change much overall, inventories in the US are slightly more plentiful at 4.7 million bales (+0.8 million), while they decline to 34.2 million bales elsewhere (-0.8 million bales). This should bode well for US exports, which are expected to capture 33.8% of global trade, up from 26.3% last season.
US export sales for the week that ended on August 11 amounted to 236,900 running bales of Upland and Pima cotton for both marketing years, with 16 markets buying and 19 destinations receiving shipments of 181,700 running bales. Total commitments for the current season are therefore at around 4.0 million statistical bales, which is 1.3 million bales more than a year ago. Exports are so far at 0.3 million bales for the first eleven days of the new season.
Preliminary figures show Chinese cotton imports at around 4.4 million statistical bales for the 2015/16-season, which would be 0.1 million bales below the USDA estimate of 4.5 million bales. However, while Chinese imports may have been a shade lower than anticipated, domestic auction sales of so far 8.5 million statistical bales have greatly surpassed expectations and may end up at over 11.0 million bales before they are suspended for the season.
This means that China is making great strides in reducing its burdensome inventory, which could lead to an interesting situation down the road. For now China can bridge its increasing production gap by releasing surplus stocks into the market, but what will happen when these stocks are used up? At the moment the ROW doesn’t have more than 4-5 million bales a year to give, but what if China were to require three times that amount? There is still plenty of time for the world to adjust, but it is probably fair to say that under such a scenario prices are more likely to trend higher than lower over time.
So where do we go from here? So far the market has been able to close above the 5-1/2-month uptrend line dating back to late February, which is currently running through around 67.80 cents. This has kept most of the spec longs in the game, but a close below this trendline would probably flush out a large percentage of these longs.
On the other side we have mill buying supporting the market, with nearly 7.3 million bales in unfixed on-call sales and a lot of pent-up demand for fourth quarter shipments.
At the moment the market seems to be at a level at which mills are becoming more active on the buy side, be it through new business or fixations, whereas spec longs are hanging on to their positions. The market has stabilized for the time being and we may therefore churn sideways in a 68-72 cents range over the coming days or weeks. However, there isn’t much margin for error to the downside and we feel that it is just a matter of time until the uptrend line catches up to the market and triggers a sizeable flush out of spec longs. If this were to happen, it would present a long-term buying opportunity in our opinion!
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