NY futures moved sideways this week, with March adding 25 points to close at 71.67 cents.
The market seems to go nowhere in a hurry! Even though the March contract broke out of its long-term triangle formation on Tuesday, it turned out to be just a flash in the pan, as a strengthening US dollar neutralised any further upside momentum. Despite extending its recent trading range slightly, March has now settled the last 16 sessions in a band of just 124 points, between 70.80 and 72.04 cents.
Last Friday’s WASDE report did little to change the market’s stalemate. The numbers were seen as mildly bearish due to an 0.36 million bales upward revision of the US crop, a reduction in US mill use of 0.2 million bales and an increase in ROW ending stocks of 1.09 million bales. However, even though ROW stocks are now estimated at 41.05 million bales, which would be 2.45 million bales more than the 38.6 million bales at the beginning of the season, this inventory level seems to be just enough to prevent another squeeze in the 3rd quarter.
ROW ending stocks haven’t really changed much since the 2010/11-season. In those seven seasons, which include the current one, ROW stocks have been between 38.6 and 44.7 million bales, with an average of 41.4 million bales. Based on last summer’s experience we can probably agree that 38.6 million bales are a bit too tight, while 44.7 million bales may exert some price pressure. The expected 41.05 million bales may therefore be seen as neutral to prices.
When we look at what happened in China over those same seven seasons, we get a much more erratic picture. Stock levels since 2010/11 varied from 10.6 to 66.9 million bales, and the estimated 47.8 million bales at the end of this season are actually the lowest in five years. In other words, China is de-stocking rapidly and this trend is likely to continue over the next couple of seasons.
We need to be careful when trying to forecast prices based on ending stock levels. First of all ROW stocks are more relevant to NY futures prices than global or Chinese stocks, especially with Chinese prices at over a dollar per pound. In other words, even if these Chinese stocks were available to the ROW, they wouldn’t be material since they are currently around 30 cents too expensive.
When looking at ROW stocks and prices, we had inventories higher than they are now in 3 out of the last 5 seasons, yet prices were spending a lot of time trading in the 80s and 90s. Therefore, 41 million bales in ROW ending stocks don’t guarantee a cap on prices!
We already talked at length about the potential impact of the massive unfixed on-call position and every Thursday we watch in bewilderment how this number keeps growing. Today’s report showed that unfixed on-call sales climbed by another 0.54 million bales to 10.31 million bales, of which 8.28 million bales are in current crop (March 4.38 million, May 2.11 million and July 1.79 million bales).
Meanwhile the CFTC report as of December 6 showed that spec longs continued to add to their record net long position. Specs were 11.33 million bales net long, 0.09 million more than in the previous week, while Index funds reduced their net long by 0.3 million bales to 6.52 million bales. The trade covered 0.21 million bales to reduce its net short position to 17.85 million bales.
US exports sales were once again surprisingly strong last week, as another 384,100 running bales of Upland and Pima cotton were sold from December 2-8. Buyers were spread among 19 markets, while 23 destinations received shipments of 235,100 running bales. For the season we now have commitments at 8.2 million statistical bales, of which 3.3 million have so far been shipped.
While the cotton world was relatively quiet this week, the US dollar index made a big move to a 14-year high after the Fed increased interest rates by 0.25% and hinted at additional hikes in 2017. With the 10-year treasury yield having gone from 1.32% in July to 2.58% today, the Fed is clearly behind the curve and is trying to play catch up.
The spread between US and German interest rates has widened to over 200 basis points this week – a 16-year high – as the US is attracting a lot of money at the moment which is fuelling the US dollar rally. However, while it may be smooth sailing for the USD in the near term, we see troubled waters ahead once it becomes clear how much US fiscal and trade deficits are going to increase next year. Therefore, while the dollar may act as a headwind at the moment, this might suddenly change and provide commodities with another reason to push higher.
So where do we go from here? Cotton still seems to be locked into a sideways range for now, with over 10 million in unfixed on-call sales acting like a 3-cents layer of cement underneath the market, which is difficult to get through, while upside momentum is somewhat limited by the record spec long and the unwillingness by the trade to chase values higher.
However, we worry about this large trade short, particularly the big unfixed on-call position. The longer this trade short gets pushed forward, the greater the likelihood of an explosive up move at some point down the road!
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