NY futures moved slightly higher this week, as May advanced 42 points to close at 56.83 cents.
The market has been trying to regroup after last week’s breach of long-term support and price action over the last two sessions leads us to the believe that the tide is finally turning. Even though specs continued to lean on the short side, the market has shown a propensity to rebound, which is setting it up for a move higher. Today’s 117-point bounce from an intraday low of 55.66 cents was quite impressive and will serve as a warning sign to the shorts!
In our last report we commented on the large short position that the specs have amassed since the middle of December, which grew even bigger during the week of February 24 to March 1. According to the CFTC the outright spec short position increased by another 0.84 million bales by March 1st and amounted to a record 10.25 million bales, while the spec net short position reached 3.14 million bales. This is not far from the highest spec net short position ever, which measured 3.5 million bales in April of 2006.
The trade continued to buy into weakness and now carries only a 3.4 million bales net short position, which makes sense based on what we are seeing in the cash market. With most of the unsold US cotton sitting in the loan, the AWP loan mechanism takes over some of the hedging function, while non-US supplies have dwindled to such a degree that not a lot of hedging on May and July futures is required anymore. The trade net short position is likely to start growing again as we enter the Northern Hemisphere planting season, but new hedges will be placed on December and later futures rather than May or July.
Index funds remain the only net long in the market at the moment with 6.5 million bales. Since it is not a market driven position, which changes relatively little in the overall context, we feel that the selling pressure may have run its course. Specs can’t possibly keep selling at the pace they have been, the trade doesn’t have much cotton to hedge anymore and Index fund longs are quite static. In other words, the market may be close to being “sold out”.
Fundamental news was positive this week, supporting our argument for higher prices. First we had the dreaded USDA supply/demand report, which came in quite friendly with the seasonal production gap increasing by 0.77 million bales to 8.99 million bales. This was mainly due to further reductions in the crops of India and Pakistan, which were cut by 1.0 and 0.2 million bales, respectively. ROW ending stocks dropped by 0.74 to 38.82 million bales, their lowest level in six seasons.
When we look at the balance sheet outside of the US and China, we have production at just 63.48 million bales (vs. 72.83 million bales last season), whereas mill use is at 73.61 million bales (vs. 73.72 million bales last season), which results in a production gap of 10.13 million bales. Since China is still going to be a net importer this season, estimated to take in 5.0 million bales, the gap increases to over 15.0 million bales. The US is only going to help out with 9.5 million bales of exports according to the USDA, which means that mills are forced to take the balance from existing inventories. This drawdown in stocks combined with the fact that premium grades are less plentiful this season is the reason why we believe that current crop prices have room to move higher over the coming months.
US export sales provided the second piece of supportive news, as they amounted to 219,100 running bales of Upland and Pima for both crop years combined. Once again we saw broad participation with 18 markets buying and 24 destinations receiving shipments of 262,500 running bales. For the current season we now have total commitments of 7.4 million statistical bales, of which 4.3 million bales have so far been exported. New crop sales have increased to nearly 1.0 million statistical bales.
So where do we go from here? We believe that spec shorts may have sold themselves into a ‘bear trap’. Since the middle of December speculators have sold over 9 million bales net, which has forced the market some 900 points lower in the process. Buyers continue to be on hold for now, waiting for the Chinese cotton policy to be announced, but we believe that most of the bearish impact from such an announcement has already been discounted. We therefore expect the market to rally once the uncertainty is lifted. We remain long May and July and still like the current crop/new crop bull spreads.
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