It’s a tough call at the moment, since there are several factors that have the ability to move the market, be it trade sanctions, the large unfixed on-call position, drought conditions in West Texas, lower acreage in India or a chart that is sending weak signals.
The situation hasn’t changed much from last week. We still have a massive on-call position that needs to be fixed, which provides a solid layer of support underneath the market. Most of the buy orders by mills seem to be placed between 80.00 and 82.50.
Trade shorts seem to be in trouble, because the chart looks strong and fundamentals are supportive as well in view of the strong export performance. Speculators are bullish and have room to add to their net long position, which is still 2-3 million bales shy of its previous peak, while the trade needs to buy back a sizeable portion of its net short over the next three months. Who is going to provide the selling?
Renewed speculative buying has been the driver behind this latest rally, while trade shorts and particularly mills are still fighting against higher prices. Mills were proven right to wait with their March fixations, but there is no guarantee that speculators will run for the exit again in May and July.
As mentioned last week, we see the current constellation in the spec/hedge position as supportive to prices. The trade still has to fix around 7 million bales of on-call sales on May and July, among other shorts that need to be bought back until the middle of June, but unlike last year the spec net long position is a lot smaller now.
The fact that mills were able to get out of March fixations with relative ease, thanks to specs liquidating about a third of their net long, might lull them into a false sense of security in regards to their upcoming May and July fixations.
The market has a lot of similarities to last season, as price, open interest and the amount of unfixed on-call sales are nearly identical. However, although export sales are ahead of last season, there is more cotton available, both in the US and on a global basis, which should keep a lid on prices.
Speculators have so far demonstrated a lot more staying power than we thought. Maybe the weaker dollar, higher inflation expectations and stronger GDP growth around the globe keep specs invested for now. This would be bad news for the trade, who needs sell-side liquidity from speculators in order to get out of fixations/shorts.
The market is setting up for another epic showdown between spec longs and trade shorts and at this point it is still anybody’s guess who will prevail. Like last year this could turn into a drawn-out process, with prices moving in a narrow band for another two or three months before a final blow off and/or collapse occurs.
History doesn’t necessarily repeat itself, but it often rhymes! Like in 2008, the trade is putting up a fight, matching new spec longs step-by-step with additional shorts, which has led to this historic open interest. At this point the trade remains convinced that the futures market is out of line and that it will sooner or later have to correct back down.
The short squeeze is on and it is difficult to predict how far it will run. The problem is that open interest is still near a record and so are unfixed on-call sales. This means that there is plenty of ‘energy’ in this market, which can lead to some wild and overextended moves.
The trade has been waiting for a meaningful correction for the last six weeks, but the market hasn’t given back much more than a cent or two a couple of times. This is clearly frustrating the shorts and/or mills who still need to fix a lot of cotton, and over the last couple of sessions we have seen some fixations move up to the market. It is this kind of action along with bullish options strategies that keep feeding this bull market!
Speculators led the initial charge of this bull run and now nervous members of the trade are fueling the flames by engaging in bullish strategies in order to protect their short position. The old saying ‘there is no better buyer than a commercial short’ seems to hold true at the moment and it is therefore difficult to gauge at what point this bull market will finally run out of steam and reverse.
Speculators have so far led the charge in this bull move and increased their net long by around 7.0 million bales since July. The trade has been slow to react to this rally, not really believing it could happen, but as it is often the case we are now seeing defensive moves via bullish options strategies helping to fuel the advance.
The market has a sell-side liquidity problem, similar to what we saw last season. Speculators like the market’s strong performance and are adding to their net long, while the trade is desperately hoping for a break in order to get out of some shorts and/or to fix its over 11 million bales in current crop on-call sales.
Over the last couple of years the price of cotton has been closely correlated to the spec net long position. When specs are buying the price is going up and vice versa. The next move will therefore depend on what speculators decide to do. Will they continue to throw money at the cotton market or are they done for now? We’ll have to wait and see!
There will be no report today as the author is travelling. Back next week.
The relatively high open interest in December, which was still at 24k contracts this morning, tells us that there are still quite a few fixations to be done. This should continue to underpin the market as we head into the notice period a week from now.
Today’s WASDE report didn’t give the market a reason to break out from its current trading range. On the one hand we still have a sizeable seasonal surplus and an inventory buildup later in the season, but on the other hand mill demand has now risen to a plateau of nearly 120 million bales, which requires continued near-record crop production in the ROW going forward.
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.