NY futures moved sideways this week, as July dropped 32 points to close at 63.69 cents/lb.
For the last seven sessions the July contract has been confined to an extremely tight closing range of just 46 points, between 63.69 and 64.15 cents, as it was unable to push past resistance, while at the same time staving off several attempts to sell off.
Even though the market hasn’t gone anywhere there has been some churning of positions, as 227,000 contracts changed hands over those seven sessions, while overall open interest remained stationary, moving up just 569 contracts to 190,508 contracts.
The latest CFTC report as of April 19 showed that speculators had bought 2.9 million bales net during the week of April 13-19, with most of it being short-covering (2.43 million bales), while the balance was new spec buying (0.47 million bales).
The new spec position as of April 19 amounted to a 1.3 million bales net long, which was composed of 7.2 million bales in outright longs and 5.9 million bales in outright shorts. This means that on a net basis speculators have bought 5.8 million bales in three weeks, with outright shorts reducing their exposure by 4.7 million bales.
As expected the trade has taken over a lot of these shorts and was 8.55 million net short and 12.9 million bales outright short as of April 19, a position that has likely grown further since then. Although a certain percentage of these shorts are hedging new crop positions in December, the majority is still in the front month.
The fact that shorts have shifted from speculators to the trade has defused a potentially explosive situation, because the trade acts differently than speculators. While spec shorts have no offsetting cash position against it and react to trigger points on the chart, a lot of the trade short is tied to basis-long positions or unfixed on-call sales. The trade is unlikely to chase the market at current levels and will instead wait for dips to fix on-call sales and to offload basis-longs.
It was therefore no surprise that US export sales slowed last week, as just 73,900 running bales of Upland and Pima were sold for both marketing years combined. However, there were still 18 markets buying and 25 markets receiving shipments of 258,700 running bales. Total commitments for the season now stand at 8.4 million statistical bales, of which 6.0 million bales have so far been exported and 2.4 million bales remain open.
Last week we commented on the parabolic rise in Chinese futures prices over the last few weeks due to short covering and massive amounts of new speculative money entering the Chinese cotton market. On April 1, the most actively traded September contract had settled at 10,230 yuan/ton and total volume that day added up to 266,032 contracts. Open interest in the September contract amounted to 524,440 contracts, whereas total open interest stood at 909,740 contracts.
Over the following three weeks the September contract would rise by more than 30% to a high of 13,425 yuan/ton on April 21, with the overall daily trading volume reaching 3,609,722 contracts on April 22. Open interest dropped precipitously during this short covering rally and amounted to just 292,810 contracts in the September contract and 558,322 contracts overall that day.
This week the bullish trend has started to reverse in the Chinese futures market, with the September contract settling today at 12,555 yuan/ton, well below its recent high. Daily trading volume dropped as well, although it was still elevated at 1,539,438 contracts.
To put this massive Chinese trading volume into some perspective, the 3,609,722 lots that were traded on April 22 equate to roughly 39.8 million bales or 398,000 ICE futures contracts. By the way, this calculation has already been adjusted for ‘double counting’ in China, where every transaction is scored as two lots traded.
By comparison, the highest daily turnover on the ICE futures market was at around 10.1 million bales in November 2010!
So where do we go from here? We feel that the market has made a temporary top, since a) cash prices have not followed the lead of futures to the same degree, b) the Chinese futures market seems to be reversing course and c) the outright spec short position is greatly reduced, while the trade short position shows no urgency to cover.
However, while the market may retreat a cent or two, we believe that there is plenty of underlying support by the trade at around 61-62 cents, as mills still need to fix 2.1 million bales on July and merchants have a sizeable amount of basis-longs to unload in an inverted market, which should translate into plenty of buying on dips.
Also, on May 3 the Chinese Reserve will finally launch its auctions. Although the new system may initially go through a trial and error phase, we have no doubt that the government is serious about reducing its massive stockpile and that these additional supplies will cap both domestic and international prices for some time to come.
Our best guess is therefore that the market will move in a trading range between 61 and 65 cents in the foreseeable future.
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