Market Comments – May 5, 2016

NY futures retreated this week, as July dropped 190 points to close at 61.79 cents/lb.
After trying for ten sessions to overcome resistance at around 64.50-64.75 cents, the market finally gave up yesterday and posted back-to-back down sessions, as recently established spec longs exited the market and the trade engaged in bearish options strategies. Of importance in this regard was today’s drop below the 200-day moving average, which added to the selling pressure!
The latest CFTC report showed that speculators had gone further net long during the week of April 20-26. Speculators bought longs and covered shorts to the tune of 2.07 million bales net during that week and increased their position to 3.35 million net long overall.
This means that in the six weeks since March 15 speculators bought a total of 7.76 million bales net and in doing so lifted the market by around 750 points. Outright spec longs increased their position by 1.90 million bales to 8.06 million bales, while outright spec shorts covered 5.86 million bales and were just 4.70 million bales short.
The trade was on the other side of this spec buying and increased its overall net short position from 2.47 million bales on March 15 to 10.35 million bales on April 26, an increase of 7.88 million bales. Index funds, which do not react to market moves, changed their position by very little, going from a net long of 6.88 million bales on March 15 to a net long of 6.99 million bales of April 26.
As we had mentioned last week, trade shorts approach the market differently from spec shorts. They are more fundamentally driven, which means that short covering typically takes place when the market moves lower and mills jump into action to buy additional quantities and/or fix open on-call sales. Although an exact level is difficult to pinpoint, we expect trade support to surface at around 61 cents.

The May notice period has shown us that the 62.00-63.00 cents level represents a decent cash value, since less than half of the current certified stock of around 61,000 bales has been tendered. If prices were seen as overvalued, the entire stock would have been thrown at this inverted market.
So far only 22,100 bales of certified stock have changed hands and open interest in May was down to just 5,600 bales as of this morning. Therefore, we would argue that if May found value at current levels, July should too, since there will be even fewer tenderable grades left by the time July enters its delivery period.
US export sales for the week that ended on April 28 were about as expected at 97,500 running bales net of Upland and Pima cotton for both marketing years combined. Participation remained active with 18 markets buying and 25 destinations receiving shipments of 290,500 running bales. Total commitments for the season now amount to 8.45 million statistical bales, of which 6.25 million have so far been shipped and 2.2 million bales remain on the books.
Of note is that there were cancellations of 52,700 running bales in 16 different markets. Rather than assuming that mills didn’t want their US commitments anymore, we believe that this was due to a lack of suitable premium cotton and merchants were therefore forced to roll sales to either US new crop and/or other origins. In regards to the latter Australia comes to mind, since it has an excellent crop and the current basis works for a switch.
On Tuesday the long awaited Chinese reserve auction sales finally got under way and in the first three days over 90,000 tons have been sold, comprised of around 72,000 tons of imported and around 18,000 tons of domestic cotton. The average sales price has been at around 12,400 yuan/ton, which translates to around 87 cents/lb.
While the price is not a threat to the international market at the moment, the fact that this massive stockpile in China is now allowed to enter the marketing channels, possibly for years to come, is seen as a potentially bearish factor since it may displace imported cotton and/or yarn over time.
So where do we go from here?  Spec long liquidation, defensive options strategies by the trade and a stronger US dollar have been weighing on the market over the last couple of sessions and this correction has probably further to go. However, we should see decent support near 61 cents, both from a fundamental and technical perspective. There are nearly 2.3 million bales in unfixed on-call sales on July and there is still a sizeable amount of basis-long positions on July (an estimated 1.6 million in the US alone) that need to be sold fairly quickly, which leads us to believe that there will be a lot of trade buying as the market retreats.

The US dollar plays an important role in all this as well and tomorrow’s US employment report will likely determine the greenback’s next move.
We still see the market in a trading range between 61 and 65 cents over the coming weeks, supported by trade buying and capped by the Chinese reserve ceiling.


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