Market Comments – March 3, 2016

NY futures continued to lose ground, as May dropped another 131 points to close at 56.41 cents.
After breaching long-term support at 57.05 on Monday, the May contract briefly dropped limit down to a low of 54.53 cents, before bouncing back nearly two cents by the end of the session. Volume was extremely heavy that day with nearly 60,000 contracts changing hands. The fact that open interest actually rose by 7,278 contracts tells us that it wasn’t liquidation but new long and short bets that drove these moves.
Members of the trade seem to be at a loss to explain why the market has fallen so precipitously since the middle of December. After all US export sales have been quite decent since then and most exportable origins seem to be well committed at this point, especially in premium grades. So what was behind this big selloff?
The answer is actually quite simple if someone took the time to look at the CFTC “Commitment of Traders” report. What it shows is that basically all of this price pressure has come from massive spec selling. In the ten weeks between December 9 and February 23, speculators (large funds and non-reportables) have sold 84,559 contracts or 8.5 million bales net and since last week this number has probably increased to somewhere in the neighborhood of 9.5 to 10.0 million bales net.
The price action in the futures market between December 9 and February 24 perfectly correlates with this onslaught of spec selling. The May contract has traded from a high of 65.80 on December 9 to a low of 57.16 on February 24, for a total high-to-low move of 864 points during those ten weeks of CFTC data. This week we saw this range stretch to over 1100 points as spec selling continued to hammer the market.
While speculators were selling record amounts, the trade was busy buying back 84,065 or 8.4 million bales net during that same ten-week period. Index funds, which own the sole net long position at this point, bought just 497 contracts during the same time frame.
Interestingly, the above position changes were not really caused by liquidation as one might assume, but were to a large degree the result of position swapping between specs and the trade, which explains why open interest has remained so stubbornly high. Open interest in futures and delta-adjusted options positions, as reported by the CFTC, has dropped by only 11’768 contracts, from 235,880 contracts on Dec 9 to 224,112 contracts on Feb 23. 
It was primarily spec and trade shorts that swapped positions and to a lesser degree spec and trade longs. Outright spec shorts increased by 58,102 contracts, while outright trade shorts covered 74,144 contracts over the last ten weeks. On the long side specs liquidated 26,457 contracts, while trade longs increased by 9,921 contracts.
Outright spec shorts, which have really been the driving force in all this, reached a record 9.4 million bales as of February 23 and they have likely extended their position to well over 10 million bales during this week’s selloff. We cannot stress the importance of this spec selling enough because the market stood no chance to withstand nearly a million bales a week of spec selling on average since mid-December!
This selloff has been counterintuitive, since supplies outside China are the lowest since the 2009/10-season and we should therefore see prices rationing demand, not encouraging offtake. When we look at the US balance sheet for example, we had total supply at 16.6 million bales this season (3.7 beginning stocks + 12.9 crop). Offtake to date is at 11.05 million bales (3.85 domestic + 7.2 export commitments), which leaves just 5.55 million bales for sale until new crop arrives in eight months from now.  
5.55 million bales of US cotton are not a lot, especially when we consider the quality angle. The US produced only 53% of Middling and better grades  this season, which means that most of the better cotton is probably committed by now. 
US export sales for the week ending February 25 were once again above the pace needed to make the current USDA estimate. New commitments of Upland and Pima cotton amounted to 189,500 running bales for the current marketing year as well as 3,600 bales for 2016/17. Once again there was broad participation, with 19 markets buying and 22 destinations receiving shipment of 221,900 running bales.
For the season we now have commitments at 7.2 million bales statistical bales, of which 4.0 million bales have so far been exported. The biggest challenge going forward is not so much finding mills interested in buying US cotton, but being able to meet their quality needs as the unsold balance contains a lot of undesirable grades.
So where do we go from here? The market has been blind-sided by record spec selling since the middle of December, which was tied to macro fears, technical signals and the impending Chinese reserve policy announcement. The latter has probably kept potential buyers at bay, which made it easier for speculators to muscle the market lower.
However, with spec outright as well as spec net short positions at record levels, we believe there is a limit as to how much more they will be able to sell. Not just from a regulatory point of view (the maximum permissible position per entity is 5,000 contracts long or short), but also from a risk management point of view.
Unfortunately the trade started to panic this week and added to the selling pressure by buying bearish options, seemingly not understanding that this entire bear move has been caused by nothing more than spec selling. Nevertheless, we believe that it is just a matter of days before this selling pressure will finally run its course and the market starts to rebound.
Given the tight cash situation, not just in the US, but among other major exporters as well, we could see a rather swift move higher in May and July. December may be another story, as the trade will use strength to put on hedges against new crop. For this reason we continue to like the May/Dec and July/Dec spreads. We are bullish at this point and believe that current crop futures will rebound into the low-to-mid 60s in the not to distant future!


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