Market Comments – November 2, 2017

NY futures continued to move higher this week, with December gaining 89 points to close at 69.08 cents.
 
The market kept its composure this week and has so far been able to defy the bearish supply/demand outlook. December has been stuck in a sideways range between 67-70 cents for about eight weeks now and settled today near its 50-day moving average, which is at 69.35 cents. Momentum indicators are flat and volatility readings are extremely low at around 17%, suggesting that the market isn’t going anywhere in a hurry. 
 
Last week we mentioned that it might be the high amount of existing physical sales that keeps the trade net short position in New York from growing at this point. Although cotton is moving into warehouses now, it will be a while until supplies catch up to existing commitments, which are still increasing at a healthy clip week after week. 
 
US export sales for the week that ended on October 26 amounted to 275,700 running bales of Upland and Pima for both seasons combined, with 17 markets taking a piece of the action. Shipments were still limping behind at 90,200 running bales. 
 
Total commitments for the current season are now at 9.0 million statistical bales, which is the second highest amount for this date after 2010. Exports of so far 1.9 million bales still have a lot of catching up to do! 
 
The CFTC report showed only minor changes as of October 24. Specs reduced their net long by 0.04 million bales to 4.79 million bales, whereas the trade reduced its net short by 0.16 million bales to 12.58 million bales. Index traders cut their net long by 0.13 million bales to 6.89 million bales. 
 
While the trade may eventually have to increase its net short in the futures market in order to hedge surplus stocks during the second half of the season, we are not so sure anymore that speculators will reduce their net long going forward. 
 
Compared to the stock market commodities are extremely underrated at this point. There were only two prior occasions during which commodities were as cheap relative to stocks as they are today, the first one in the early 70s and the second one during the dot-com bubble in the late 90s. This fact hasn’t been lost on speculators, who seem to be taking a liking to commodities lately. 
 
Since central banks have all but paralyzed the bond market, a lot of money has been chasing global equities in recent years, which has led to extreme valuations. Many investors simply buy Exchange-Traded Funds (ETF), which are baskets made up of a variety of stocks, like the S&P 500. The more money that pours into these funds, the more shares of individual stocks are being bought. That’s why the share price of Amazon trades at a lofty price/earnings ratio of 275, or Netflix at 202.  
 
Could the same happen in commodities? The answer is yes! With commodities being one of the most underrated asset classes and with vast sums of money sloshing around the globe in search of a decent return, we feel that we will see more money being allocated to commodities over time, be it through index funds and/or hedge funds. 

Index funds are a passive form of investment, where a basket of commodities is being bought. As long as more money is flowing into the fund, all the components of the basket are getting bought, regardless of their fundamentals. In other words, cotton may have a bearish outlook, but from an index fund perspective that won’t matter. 
 
In early 2008 the index fund net long in cotton amounted to 12.25 million bales. The financial crisis sucked a lot of money out of the market and a year later, by March 2009, the position amounted to just 5.95 million bales. Since then the index fund net long has been moving sideways between 4.3 and 8.2 million bales. However, we expect the current position of 6.9 million bales to increase substantially over the coming years. 
 
So where do we go from here? There is currently nothing to suggest that the market is going to break out of its trading range anytime soon. Overhead trade selling should keep a lid on the market, while 14.0 million bales in unfixed on-call sales and the Indian MSP should provide support at the lower end of the range. 
 
Whether the market will succumb to bearish forces once the crops are in remains to be seen. While the trade will probably have to extend its net short, a lot will depend on what specs and index funds do with their positions. If they are net buyers going forward it may balance out any additional trade selling. If specs turn sellers themselves, then the market could see a steeper drop. Only time will tell!
 

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