Market Comments - March 2, 2017

NY futures ended the week slightly higher after a volatile week, as May added 68 points to close at 76.78 cents.
 
Strong export sales got the market excited this morning and we almost saw the first 80-cent print in nearly three years, when July climbed to an intra-day high of 79.97 cents this morning. However, after two days of strong advances the market had reached ‘overbought’ conditions, which triggered some profit taking by speculators. 
 
The selloff was swift, as the market fell about 200 points within ten minutes, with a 100-point drop occurring in a matter of 30 seconds. This leads us to believe that the collapse was caused by algorithmic trading systems, a feature that has triggered some of these ‘flash crashes’ in the past. 
 
After the dust had settled the May contract closed at basically the same level as last week (76.10 cents) and two weeks ago (76.77 cents), with futures open interest still being elevated at 27.15 million bales and mills still having to fix 11.46 million bales, of which 8.04 million are on May and July. In other words, no progress has been made in defusing a potential short squeeze (or spec long liquidation), as both sides continue to dig in, with neither party willing to yield just yet. 
 
What has made progress however were US export sales, which came in at the highest weekly number in over two years. Net new sales for the week of February 17-23 came in at 552,800 running bales of Upland and Pima for both marketing years combined. Participation continued to be widespread with 21 markets buying and 25 destinations receiving shipments of 327,000 bales. 
 
Total commitments for the current season have now reached 11.9 million statistical bales, of which 6.8 million bales have so far been exported. Sales are currently running around 4.7 million bales ahead of last year’s pace! Commitments for August onward shipment, which will mostly be supplied from current stocks, are already at over 1.1 million statistical bales. 
 
The US has sold over million bales in the last two weeks, a pace that cannot be sustained for much longer. With a total supply of 20.8 million bales (3.8 beginning stocks + 17.0 crop) and sales of so far 15.2 million bales (11.9 export and 3.3 domestic), there are around 5.6 million bales remaining. From that we need to reserve at least 2.0-2.5 million bales for the August to October period, some of which has already been committed for export or contracted by domestic mills. The US still has some cotton left for sale, but it is not much considering that we are only at the beginning of March. 
 
US merchants have little incentive to hold on to cotton beyond June, since there is negative carry to new crop. Mills on the other hand continue to load up on US high grades, which are still considered to be relatively cheap thanks to a very attractive basis. The inversion between July and December doesn’t seem to be wide enough yet to discourage mills from pursuing current crop supplies. However, sooner or later the market needs to ration supply, which means that the price will have to become unattractive. 
 
The US dollar index continues to hover near a 14-year high, which has been a headwind for commodity prices, but President Trump’s speech to Congress this week has reinforced our belief that this dollar strength won’t last forever. If the administration were to implement all its promises, the fiscal deficit would balloon to never before seen levels. 
 
More spending on infrastructure and the military, while cutting taxes and leaving entitlement programs unchanged, will rip the budget gap wide open. Add to that the increasing cost of servicing the existing government debt, which will increase by around 200 billion dollars for every 1% increase in interest rates. Once the market realizes that this is all pie in the sky, the US dollar will likely lose its bloom. We still believe that despite all the current optimism the US economy is headed for stagflation (= flat economy + increasing inflation). Inflation and a lower dollar would be supportive of commodity prices in nominal terms. 
 
So where do we go from here? Speculators and the trade continue to hold historically massive long and short positions. Although the market has seen some wild up and down moves lately, it hasn’t really gone anywhere over the last four weeks. 
 
Speculators can’t add much more to their net long position, but with the trend being their friend they aren’t expected to liquidate anytime soon. The trade on the other hand is still waiting for that elusive selloff in order to get its fixations done. We therefore feel that the current standoff will continue for a while longer, but sooner or later one of the two sides will be forced into action. At this point we still feel that the trade has the weaker hand since it cannot afford to remain inactive, while speculators can simply continue to sit on their hands. 
 

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