NY futures ended the week basically unchanged, as December was down just 4 points to close at 69.76 cents.
The futures market saw relatively little movement this week, as December closed the last five sessions in a tight range of just 127 points, between 68.49 and 69.76 cents. The market continues to be boxed in between mill buying/fixations in the high 60s and producer selling above 70 cents.
The market’s sleepy demeanor belies the fact that open interest in futures currently amounts to a massive 26.07 million bales, which is the highest level ever for this date and is only about 4 million bales below the all-time record of early 2008. When we include the options ‘delta’ position, then open interest is at 34.74 million bales according to last week’s CFTC data. This is the highest amount since April 2011 and 10.68 million bales more than a year ago!
This surge in open interest is not unique to cotton, as other commodities have also seen an increase in spec and index fund longs in recent months. We believe that many money managers see commodities as an undervalued asset class, especially when compared to stocks, bonds and real estate. It doesn’t take much of a reallocation from some of these other assets to have an impact on the much smaller commodity space.
According to the latest CFTC report as of October 18, speculators were 8.9 million bales net long, index funds were 6.7 million bales net long and the trade was on the other side with a 15.6 million bales net short. If our assumption is correct and speculators are indeed digging in on the long side of the cotton market, what does that mean for the trade going forward?
The trade net short position is for the most part made up of shorts against the 8.56 million bales in unfixed on-call sales and a large amount of basis-long positions (long cash cotton/short futures) in a variety of origins, such as the US, Australia, West Africa and Brazil. Over the coming months this 15.6 million bales net short will likely decrease, as mills fix cotton and buy basis-longs from merchants. Some grower selling will add new shorts to the mix, but probably not at the same rate as mills fix and buy.
Let’s therefore assume that because of these actions the trade net short position will decrease by 5 million bales net over the next six months, from the current 15.6 million to 10.6 million. This means that the trade would have to be a net buyer of futures in the amount of 5 million bales. But in order to do so either the specs or index funds would have to sell 5 million bales net, and therein lies the problem!
Despite some weakness in the market over the last couple of months, speculators have been stubbornly hanging around on the long side, while mills are getting increasingly nervous and frustrated about the market’s resilience. In the case of December fixations, mills are also running out of time on their 2.1 million bales in outstanding fixations.
US export sales for the week that ended on October 20 were down considerably due to higher prices that week, as only 136’600 bales of Upland and Pima were added to the tally. There were 16 markets participating in the buying, while 23 destinations received shipments of 135,800 running bales. Total commitments now amount to 6.2 million statistical bales, of which 2.15 million bales have so far been exported.
So where do we go from here? With speculators digging in on the long side, some trade shorts have their backs against the wall as they are running out of time on their Dec fixations. Unless specs somehow get spooked out of their positions, the market is likely to remain on a firm footing as we head into the index roll, options expiration and Dec fixations.
A market devoid of carrying charges suits speculators and index funds, as they are able to roll their longs forward at minimal cost. At the moment there is only about 100 points of carry on the board for the seven-month period between December and July. However, with the US crop coming in fast we believe that merchants will try to rebuild carry by increasing the certified stock, which would not only help them to hold inventory, but would also discourage spec longs.
An interest rate hike by the Fed is another potential catalyst that might flush out some spec longs. At the moment the market has the odds for a 25-point increase in the Fed Funds rate at 70%. The last time the Fed hiked rates late last year, the stock market sold off and speculators moved to a ‘risk off’ position in January, which put pressure on commodity prices.
For now we stick with our call for a trading range between 67-71 cents, but we can’t deny that we feel uneasy about this massive open interest, which has the potential to unleash some big moves to either side!
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