NY futures came under further pressure this week, as December dropped 209 points to close at 60.31 cents/lb.
After December had spent exactly 52 weeks in a 61.20 to 68.11 cents sideways range, it finally broke through support on September 18, with a decisive down move in heavy volume. In the four sessions that followed the market continued to lose further ground and pricing action does not suggest that a bottom is in place just yet.
However, what puzzles traders is that open interest has been rising every single day since the market dropped out of its sideways range, which seems counterintuitive. Typically one would expect to see spec long liquidation and profit taking by trade shorts on such a pronounced move, which would close out positions and reduce open interest.
The fact that open interest jumped by nearly 8’000 contracts since last Friday means that new positions were established - the question is by whom and for what reason? Regarding new longs everything seems to point to the trade, because speculators typically don’t buy the market on weakness. Some rumors have it that a big trade house might position itself to take delivery in November.
However, before jumping to such conclusions we need to wait for the next CFTC report, which will provide a clearer picture since it includes both Futures and Options, whereas the daily ICE report is for Futures only. In other words, it could well be that the new open interest in futures has offsetting positions in options.
The strong US dollar continues to stand in the way of any bullish hopes at the moment as the greenback continued its appreciation against many of the emerging market currencies, notably the Brazilian real and the Turkish lira, which fell to new record lows this week.
US traders are analyzing the market in dollar terms and when they look at cotton prices, they perceive the market as being flat to slightly bearish over the last twelve months. At this date a year ago the December contract closed at 61.57 cents, which is just a little over a cent above today’s value.
The story sounds completely different when we look at cotton prices in Brazilian real, Turkish lira, Indonesian rupiah or pretty much any of these emerging market currencies. What traders in these countries see is a strong bull market in cotton, as prices in Brazilian real are about 50% more expensive than a year ago, while they are 31% stronger in Turkish lira and 17% higher in Indonesian rupiah.
These currency shifts cause market participants to behave differently when it comes to buying and selling cotton. Whereas a US grower is disillusioned with the current cotton market, producers in Brazil, Australia or South Africa seem to be quite pleased with the prices they are able to obtain in local currency. On the other hand mills around the world are singing the blues, because their currencies buy a lot less than they did a year ago and most spinners have a hard time making ends meet.
This situation does not bode well going forward, because apart from the US and perhaps China, most growers will be encouraged to plant cotton next season if this currency constellation prevails, while mill use continues to suffer. We believe that the basis pressure we have witnessed in recent weeks has a lot to do with this currency scenario, as foreign growths have a lot more leeway to discount prices than the US.
This is forcing the US to the back of the line in regards to marketing cotton and it remains to be seen how US growers and traders deal with this role of residual supplier. Ultimately it all depends on demand, i.e. we will have to see whether all this US cotton is really going to be needed in the end. In terms of global mill use we believe that the “line in the sand” is at around 109 to 110 million bales; any less would likely lead to a build up of ROW stocks, particularly in the US. A lot will depend on how the world economy progresses from here, but judging by the current state of affairs there isn’t a lot to be optimistic about.
US export sales came in below expectations this week, as the price break failed to stimulate new business. For the week that ended on September 17 net new sales of Upland and Pima cotton amounted to 105’600 running bales for both marketing years. Vietnam, Turkey and Mexico were once again the strongest takers, leading a group of 16 buyers.
Shipments of 114’500 running bales were pretty decent considering that there isn’t much cotton in the pipeline yet. For the season we now have commitments at 3.2 million statistical bales, of which 0.9 million have so far been exported. Last year we had 5.5 million bales sold and 0.8 million shipped!
So where do we go from here? The market seems to have found some equilibrium near 60 cents, but any attempt to rebound has so far run into stiff resistance. While a lot of traders wanted to buy the dips a month or two ago, they are now waiting to sell rallies. We currently see only two reasons why the market might move higher – a rainy harvest or a weakening US dollar.
The weather window is quickly closing, although there still remains time for El Niño to do a trick on the crop over the next 4 to 5 weeks. If the crop escapes unscathed, it will become very difficult to escape the bearish sentiment and we could see further price pressure ahead.
Exchange rates will continue to influence the price of cotton and traders need to be quite astute in regards to currencies. Today the Brazilian real had a big rebound, which may have contributed to the bounce in the futures market. However, in the long run we see no end to the emerging market woes and therefore don’t expect a reversal of fortune anytime soon.
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