Market Comments – November 17, 2016

NY futures continued to advance this week, as March gained 271 points to close at 72.54 cents.
A combination of bullish fundamental and technical factors lifted the March contract to its highest level since August 9. On the fundamental side it was persistent mill fixation buying that forced the expiring December contract more than 500 points higher from Monday’s low of 67.97 cents and thereby moved the Dec/March spread from 41 points carry to an 84-point inversion in the last four sessions.
The latest CFTC on-call report showed that as of November 11 unfixed on-call sales totalled 8.9 million bales, of which 1.35 million bales were in December. This means that mills have made very little progress in getting their December fixations squared away, as only 0.27 million bales were fixed last week. With the market trending higher since then, it has become more and more painful for these remaining mill fixations and with open interest in December at just 18,801 contracts as of this morning, liquidity is quickly dwindling.
There were a couple of other fundamental factors that fuelled the bullish flames this week. The ‘de-monetisation’ move by the Indian government has temporarily paralysed cash transactions, which led to a significant slowdown in arrivals. This in turn led to short covering by merchants and a price spike of over 300 points for Shankar-6. It has also forced markets like Pakistan and Bangladesh to pursue other options for nearby shipment.
In China a similar story led to very erratic trading in the Zhengzhou futures market this week, which reached a high of over 17,000 Yuan/ton (112 cents/lb) on Monday, before settling the period under review at 16,085 Yuan/ton (106 cents/lb). There were logistical constraints that got the market excited, as the flow of cotton from Xinjiang was delayed by inclement weather and preferential treatment for the shipment of perishable crops. However, as in the case of India these supply constraints are temporary, since China definitely has more than enough cotton to feed its mills!
With the trade chasing values higher, it eventually changed the technical picture to bullish and when the market broke out of a 3-month triangle formation on Tuesday, specs jumped on the long side with a vengeance. Volume amounted to a very heavy 47k and 55k in the last two sessions, which we usually only see during index roll or WASDE days. Open interest went up by over 9k in March on Wednesday and probably by a similar amount today, which confirms the market’s strong upside momentum.
Furthermore it was rather impressive how the market shrugged off a 200-point selloff after today’s ‘disappointing’ export sales report and then closed the session near the high of the day. This was the third day in a row that the market closed at or near the session high!
US export sales for the week that ended on November 10 came in below high expectations, but were nevertheless still constructive at 221,200 running bales for Upland and Pima combined. Once again participation was broad based with 19 markets buying and 22 destinations receiving shipments of 110,300 running bales. Total commitments for the season are now at 6.8 million statistical bales, of which 2.55 million have so far been exported.
When we look at the latest snapshot of the US balance sheet, we have beginning stocks at 3.8 million bales and a crop of 16.7 million bales (our estimate!), which would give us a total supply of 20.5 million bales. Of that 3.5 million bales have to be reserved for domestic mill use while exports are so far at 6.8 million bales, which would leave around 10.2 million bales still for sale. Considering that Australia and India have bigger crops this season and West Africa still has a lot of cotton for sale, there should be a plethora of offers to choose from over the coming months.
So where do we go from here? Friendly short-term fundamental and technical factors combined to create a perfect bullish storm this week that jolted the market out of its sleepy sideways mode. However, as pointed out above, supply constraints in India and China are temporary and once these situations normalise, the world will have plenty of cotton to choose from.
Also, speculators were already quite long (8.4 million bales net) going into this latest buying spree and they therefore don’t have that much buying power left. Nevertheless, the market has a lot of momentum right now and additional spec buying plus impending Dec mill fixations have the potential to add a few more cents to this rally and force inversions even wider.
However, once Dec reaches the notice period next week it needs to reconcile with the cash market, at which time we see it difficult for an elevated flat price or the current inversion to be sustained. We would therefore not be surprised to see the market reverse back down and to put some carry back on the board. Since merchants are holding large basis-long positions in various origins it is in their best interest to see to it that the market builds carry, which can be done by flashing some certified stock at the board. With nearly 8 million bales classed at this point, there should be enough cotton available to play the cert stock game!

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