The fact that open interest has remained so stubbornly high during this break could mean two things: 1) Either massive spec net long liquidation still lies ahead of us, which could force the market substantially lower from here, or 2) Specs as well as outright trade longs are giving the market a lot more rope than we thought, which could eventually swing the pendulum back the other way, as fixations and trade shorts begin to pay up. There are currently 14.13 million bales in unfixed on-call sales on the books for December onwards!
Last week we had our doubts as to the trade’s financial ability to increase its short position further, but so far the trade has been determined to keep the fight going.
The speculative net long position continues to grow and is probably at a new record at this point. The trade net short, as well as the outright short position, are also approaching record levels, second only to the spring of 2008, just before the market went parabolic.
The market’s narrative seems to be that while some July shorts might still get squeezed, this isn’t really about July anymore, but rather a shift towards a more bullish market environment in 2019. China will eventually run out of reserve stocks and is therefore expected to increase its imports considerably. Combine this with some problems on the production side, strong downstream demand and an inflationary outlook, and we have the pieces to a bullish puzzle.
The only thing that has changed is that another week has gone by without mills taking action. Today’s on-call report showed that as of last Friday there were still 4.66 million bales unfixed on July. Meanwhile, total unfixed on-call sales rose to a record 16.48 million bales.
The market is still caught between a large spec net long position and a sizeable trade net short position, with neither side ready to blink just yet. However, as already mentioned, over the next 3-4 weeks mills will have to fix nearly five million bales on July, which has the potential to put upward pressure on the market.
Although the technical picture is flashing some warning signs, not much has changed in the standoff between spec longs and trade shorts. Today’s on-call report showed that as of last Friday there were still 5.51 million bales unfixed on July, down just 0.05 million from the week before. Mills are apparently still hoping for specs to cut and run, similar to what happened in mid-May last year.
Another week has gone by and we are still confronted with the same problem, only a little bigger since open interest has been going up. The shorts may continue to hold off for another week or two in the hope that spec longs will blink first, but they are playing with fire!
From here, we could potentially go a lot higher, unless something were to shock spec longs into abandoning their positions again like last season. But the odds for this to happen are much smaller this time around and the current set up looks ripe for a short squeeze. The bulls may have to be patient as the standoff between spec longs and trade shorts might continue for a few more weeks, but we feel that the trade shorts will ultimately be on the run.
Assuming that speculators are not going to bail out of their net long anytime soon given the more optimistic outlook for commodities, it is difficult to envision how mills will escape their fixation trap. Similar to what happened last season, mills have been kicking the can down the road, but they are now reaching a dead end since rolling to December is not a realistic option.
As we have tried to explain in this report, a year ago the market rallied over 1200 points between now and the middle of May on a less bullish setup. Granted, we are already 900 points higher now, but that doesn’t mean that the market couldn’t get squeezed into the high 80s or low 90s.
Although the market was able to let off some steam during Wednesday’s break, meaning that mills were able to get some fixations squared away, the dynamics as such haven’t changed. Specs are still around 7.5-8.0 million bales net long and mills still need to fix around 6.0-6.5 million bales. In order for the mills to get out of their positions, they need specs to sell, otherwise prices will eventually be forced higher.
Not much has changed this week, as combined open interest in May and July has remained steady and mills are still burdened with a substantial amount of unfixed on-call sales.
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.