Market Comments – January 22, 2015

NY futures came under additional pressure this week, as March dropped another 173 points to close at 57.76 cents.

Speculative selling continued to weigh on the market, as March fell through the 58.50 cents support level, trading to levels last seen in September 2009.

Interestingly, overall open interest jumped by more than 10’000 lots this week, suggesting that it wasn’t long liquidation that drove the market lower, but rather additional short selling by speculators into scale down trade buying. March open interest stood at 132’357 contacts this morning, which is the highest level for this date since 2008, while overall open interest of nearly 206’000 contracts was the highest in 16 months.

The cotton market continues to be dominated by negative vibes on the macro front, as deflation fears are spreading and the money crowd is scrambling for save havens. With the US economy currently performing better than its counterparts across the two oceans, the US has seen a large influx of capital, which has boosted the US dollar and put a strong bid under the US bond and stock markets. Today’s announcement by the European Central Bank to print 60 billion Euros per month starting in March has only exacerbated the move into the dollar.

Commodities are not part of the investment equation in a deflationary environment and the sharp drop in crude oil combined with the strengthening US dollar has money managers running for the hills. As a result hedge funds as well as index funds have seen a considerable amount of liquidation and redemptions recently. We need to look no further than the Index Fund position in the cotton market, which at 5.0 million bales net is the lowest since late 2011 and compares to 6.3 million bales a year ago and to a record 12.3 million bales in early 2008.

However, while the macro situation may look volatile and threatening, the US cotton market has been on a tear this season. US basis levels have remained persistently high, with 21s and 31s going for 400-600 on FOT at the moment and even 41s are still trading at an ‘on’ basis. This raises some interesting questions regarding the upcoming March delivery period! From a taker’s point of view it may be cheaper to buy the board than bidding in the cash market, while a potential deliverer is currently not able to turn cash cotton into certified stock without losing money.

When we look at the statistical position of the US, we currently have supply at 18.5 million bales, whereof 12.2 million bales have so far been committed between the 8.4 million bales in export commitments and the 3.8 million bales that go to the domestic industry. This leaves theoretically 6.3 million bales for sale, of which around 5.8 million bales are Upland and 0.5 million are Pima. However, of the 5.8 million bales Upland we need to reserve at least 2.5 million bales to cover domestic and foreign mills between August and October, which brings availability between now and the end of the marketing year down to just around 3.3 million bales.

That’s not a lot of cotton, considering that most mills are still wide open for the second and third quarter. With Brazil and Australia producing a combined 2.9 million fewer bales than a year ago, supply for machine-picked cotton could therefore get quite tight this spring and summer. Furthermore, with US plantings expected to drop by about 11-12% next season, we don’t expect to see a lot of basis pressure on remaining supplies.

So where do we go from here? While the US cotton situation seen in isolation may be painting a friendly picture, it is currently being overshadowed by the negative outlook for commodities stemming from a strong dollar, lower economic growth and fears of another financial meltdown. Crowds do move markets and as long as the crowd is fearful, it is probably wise to play defense and to get some protection in the options market.

Speculators certainly have the power to push cotton prices even lower, but in a month from now, on February 23rd, the March contract will enter its notice period. As explained above, based on the current basis levels in the cash market, it is unlikely that we will see a big jump in the certified stock over the coming weeks, which could set the market up for a short squeeze. Despite all the doom and gloom we therefore have no appetite for the short side at current levels and are prepared for a rather volatile next few weeks as this massive open interest in March gets dealt with.