The market broke out of a sideways move this week and resumed its downtrend, which had its origin 13 months ago. Since reaching a top of around 96 cents in June 2018 the market has dropped 33 cents and there is still no end to this slide in sight.
Since speculators seem to be losing their power to force the market any lower and with growers not willing to chase values below 65 cents at this point in time, it could set the stage for some short-covering rallies. However, the trade is extremely under-hedged at just 2.34 million bales net and it would therefore take a tremendous amount of buying power to push the market through all the scale-up trade resistance.
By and large the market is still stuck in a 400-point trading range, as growers are unwilling to sell the market below 6500, but are waiting for rallies towards 70 cents to do so. Speculators are still holding a sizeable net short position, but the loss of downside momentum and/or one of the potential triggers mentioned above could spark some spec short-covering and new buying.
A few months ago there was probably no one in the cotton trade that expected to see a 62-handle in July. We certainly didn’t! But an escalating trade war between the US and China, an increasingly bearish cotton balance sheet and speculators selling 16.3 million bales net since last June have forced the cotton market to its knees.
Until we get a better grip on the US crop potential, the trade is probably not going to add too many shorts in the mid-60s, but will likely do so on rallies towards 70 cents. This should keep December rangebound in the near future.
The trade needs to increase its net short in the futures market by a substantial margin, but that requires speculators to go net long again. However, with the chart still in bearish territory and with Trump fighting trade wars on several fronts, speculators seem to be in no hurry to reverse their position.
We still believe that a short-covering rally in July is on the cards, but with December and March pulling in the other direction, it remains to be seen whether July can detach itself to force a bigger inversion.
According to our calculations current crop supplies should be nearly sold out by now, depending on how many new crop sales are going to be shipped from existing inventory. This makes July a dangerous month to be short and we therefore wouldn’t rule out a spec short-covering rally over the coming weeks.
The US/China trade scare combined with a bearish technical picture has collapsed the futures market under the weight of heavy spec and index fund selling. However, this drop into the mid-60s has sparked sizeable export business as mills are filling in remaining needs and even bolster their inventories in some cases.
At the moment there is no telling where this falling knife is finally going to stick. The chart looks awful but momentum indicators are in “extreme oversold” territory. This means that a sharp rebound could come at any time, but some positive news is needed to trigger it.
Bearish new crop vibes and a stronger US dollar are weighing the market down and this is not likely to change anytime soon. Having said that, we still believe that July will eventually divorce itself from new crop, especially if these lower prices lead to stronger export sales.
The May notice period has established that current crop futures have plenty of support at 7600. For now the market seems to be stuck a sideways flag, but the risk of a breakout is clearly to the upside in our opinion. US prices are still attractive to overseas buyers and the more we keep adding to the sales tally, the greater the likelihood of July getting squeezed.
We feel that the market is fairly priced at the current level and that May is probably not far from its “cash equivalent value” at around 7600. Therefore, if takers were to emerge who simply look at the certified stock as a recap to put against export sales, then there is no need for the market to go much lower nor do we need to see full carry.
For several weeks the action has been dictated by spec buying into trade selling. With the bullish momentum fading, specs will probably take a breather, which would allow the market to ease off some more. However, we don’t see the trade chasing the market too far down with their hedge selling.
At the moment we are still seeing a fairly even match between spec buying and trade selling, and until one of these two forces gains the upper hand, the market may not move that much.
After rallying to the 78 cents level earlier this week, the market ran into a wall of trade selling and was forced to pull back to the breakout zone near 7600 (former downtrend line which is now support and 100-day moving average at 76.22). We often see markets test support or resistance before resuming a trend and we shall therefore give the market the benefit of doubt.
Today’s move above key resistance has set the stage for a spec short-covering rally, especially if the breakout is confirmed on the weekly chart tomorrow. A lot of these spec short positions are under water now and since algorithms play an important role in specs’ decision making, we expect the market to shoot higher over the coming sessions, possibly into the low 80s.
What looked like light spec short-covering pushed the market towards a crucial resistance area on Wednesday, where a 9-month downtrend line, the January high and the 100-day moving average are all clustered together just above 7600. Although the market seems to have failed in its latest attempt, even a sideways move will eventually catch some of these resistance points and this would likely trigger a wave of spec buying.
We already talked about the trade’s need to increase its net short position over the coming months. Since the specs and the trade can’t be net sellers at the same time, we need the specs to start covering shorts in order to accommodate the anticipated trade selling.
We still feel that the trade will eventually have to boost its 5.4 million net short in order to manage risk on the net on-call position as well as physical longs in current crop and soon to be planted new crop. By comparison, a year ago the trade was still 15.05 million bales net short at this juncture and two years ago it amounted to 19.59 million bales.