Market Comments – September 10, 2015

NY futures moved sideways during this holiday-shortened week, with December advancing 29 points to close at 63.05 cents/lb.

The market remained flatlined this week, as traders are awaiting tomorrow’s WASDE report. December has now closed the last 11 sessions within just 86 points, between 62.49 and 63.35 cents/lb. Volume has dropped further this week, with Tuesday’s 7’804 lots marking the slowest turnover of the year so far. Open interest has been more or less been maintained near 180’000 contracts, whereof 123’000 are in December.

The CFTC report revealed that the trade was a decent net buyer during the week of August 26 to September 1, reducing its net short position by 1.3 million bales to 10.2 million bales. Seeing the trade on the buy side at these lower levels may have given the market renewed confidence this week. Index funds were small net buyers as well, adding about 0.1 million bales to their net long position, which now amounts to 6.8 million bales.

Speculators continued to reduce their net long by selling 1.4 million bales and now own just 3.4 million bales. Nevertheless, speculators still have fairly large outright positions of 7.2 million bales on the long side and 3.8 million on the short side, which have the potential to create some volatility.

When we look at what potential catalysts might inject new life into this listless market, tomorrow’s WASDE report is probably at the forefront. There are a couple of key numbers we need to keep an eye on. The first one is of course the size of the US crop, which seems to be understated at 13.1 million bales based on current crop conditions. However, if the USDA were to confirm this number, or raised it only slightly, to let’s say no more than 13.5 million, it would probably be perceived as being friendly by the market.

Further we need to watch out for changes in the ROW production surplus, which at 2.34 million bales seems too small considering that global mill use has been so disappointing. However, since Chinese imports of currently 5.75 million bales are probably not going to change, the ROW production surplus would have to jump by over three million bales to match Chinese imports and prevent ROW ending stocks from declining.

Currency fluctuations are another catalyst that could affect cotton prices. We have already written about the steep depreciation of emerging market currencies against the US dollar and the Chinese yuan, which has led to dislocations on the trade front. Next week, on September 16, the Fed will hold its two-day policy meeting, at which it will determine whether to raise interest rates or not. So far the market is seeing the odds of a rate hike at only 40%, which means that it would come as a surprise to many if the Fed did move on rates.

The level of US interest rates is already among the highest in the developed world and a rate hike by the Fed would probably strengthen the US dollar further and put pressure on asset prices denominated in dollars. A stronger greenback would also make it more urgent for China to move away from its dollar peg, in order to not lose further ground on all the depreciating currencies in the region, like the Japanese yen or the Indian rupee. Both of these currencies have depreciated by over 50% against the yuan over the last 5 years, which has been hurting Chinese exports.

So far China has only taken baby steps on the currency front, but what if China were to devalue its currency by 15-20% as some analysts believe? Such a move would lower Chinese cotton prices from the current 86 cents to around 70 cents. This would bring these massive stocks in China back into the picture and it would also act a headwind for cotton and yarn imports. In other words, while global cotton statistics have been able to ignore Chinese stocks for the last four seasons due to the huge price gap that existed between Chinese and international prices, that would no longer be the case if prices were to converge.

So where do we go from here? Tomorrow’s USDA report will give traders something to chew on and likely determine the market’s next move. The report should have a bearish bias, since the US crop is not quite as bad, while mill demand is lousy and not anywhere near 115 million bales! We shall see whether the USDA sees it that way as well!

From a technical point of view a bearish report would probably cause more trouble, since we are less than two cents above the lower end of a 12-month sideways range and a breach of the 61.20 low in December would likely trigger a wave of spec selling. Conversely, if the report were perceived to be bullish, the market has a lot of room to the upside before getting near the 68 cents boundary.

Longer term the market feels more bearish than bullish, but with an near empty pipeline and crops still vulnerable to weather we are not sure the timing is right to go short in the low-60s, or if so only via bearish options strategies.