Market Comments – February 25, 2016

NY futures continued to drop this week, as May declined another 94 points to close at 57.76 cents.
The market continued to frustrate the bulls, as May fell to yet another contract low this week. Yesterday’s intra-day low of 57.16 came within striking distance of the weekly continuation low dating back to January 2015, which sits at 57.05 cents. Potential buyers are therefore wary of buying the market here, since a breach of this important support level would spell more trouble. In fact, if the 57 cents level is taken out, we have to go all the way back to 2009 to find lower prices.
2016 has not been kind to the cotton market so far, or any financial asset other than the bond market for that matter. Since the beginning of the year, the May contract has fallen from a high of 64.30 on January 4 to yesterday’s low of 57.16, a drop of over 700 points. As we have explained last week, all of the selling pressure has come from the spec sector and was mainly related to the weakness in financial markets.
Although economic conditions look quite scary at the moment, the last seven years have taught us that central bankers are going to do everything in their power to keep the illusion of a recovery alive. In other words, we expect that a lot more money printing and cheaper interest rates will be announced in the months ahead by the Fed, the ECB and Asian central banks.
As interest rates race towards zero or even negative, we might actually see a weakening dollar over time, since the favorable yield spread to other currencies is probably going to shrink and money starts chasing better returns. There is already over $7 trillion of sovereign debt globally that trades at negative yields and we believe there will eventually be an inflection point at which money will migrate from bonds to stocks, real estate and commodities. Even a small percentage leaving the bond market would have a major impact on these other asset classes.
However, there are several more reasons why the days of this massive spec short position may be numbered. First and foremost we feel that supplies are going to get very tight over the coming months, as many origins are already well committed, yet mills still have a lot to cover beyond April/May shipment.
Even the US, which is in the role of residual supplier this season, has already committed 7.0 million statistical bales for export at this point and premium qualities are becoming harder to get. This is not surprising since the US produced only about 6.4 million running bales of Middling and better grades this season!
US export sales slowed somewhat last week as ‘just’ 140,100 running bales of Upland and Pima for both marketing years were sold. However, combined with the previous week’s 331,000 running bales, US export commitments have risen by roughly half a million statistical bales over the last two weeks alone and we therefore believe that the current USDA estimate of 9.5 million bales is too low! Participation was once again broad based with 18 markets buying and 24 markets receiving shipments of 180,500 running bales, which shows that there is great interest in US cotton.
The problem going forward is that the US may no longer have the qualities that mills want and buyers therefore have to either adjust their expectations or will need to find cotton elsewhere, which is not easy as most exporters are either well committed by now (Brazil, West Africa, India) or relatively expensive (Australia).
From a technical point of view momentum indicators all point to oversold conditions and the board has started to invert this week. This is not supposed to happen in an oversupplied bearish market and speculators will certainly take note of that. Also, there has been a lot of buying of out of the money calls this week, mostly laid up against delta-equivalent short futures, and this could provide bullish leverage if the market ever started to move higher.
So where do we go from here? We believe that the odds favour a rebound, since specs have already loaded up on shorts and the trade doesn’t really want or need to sell May and July at current levels. The problem is that many potential buyers remain sidelined, waiting for China to announce its new policy. However, this event has for the most part been ‘discounted’ by the market and once the announcement is made, we might actually get a ‘sell the rumor – buy the fact’ reaction.
The flattening of the board and the fact that the certified stock is finding takers are signs of support at current levels. If the 57 cents level holds over the coming sessions, it will only be a matter of time until buyers return in greater numbers. We like the long side in May and July at current levels and are neutral on December at this point. For a non-directional play we still like the July/Dec spread.



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