NY futures have lost some ground since our last report of two weeks ago, with December dropping 118 points to 71.86 cents since July 28.
Since our last report of two weeks ago the market has traversed a lot of territory, first braking out of a 3-week flag formation that saw it shoot up to a high of 77.98 cents, only to run out of steam and collapse nearly seven cents to a low of 71.00 in a matter of just four sessions before finding its footing again today.
Given the massive open interest and the large spec participation, the market’s volatility is not really surprising! On August 8 total open interest amounted to 248,298 contracts or 24.8 million bales, a number which was only surpassed in the 2007/08-season, when open interest had reached 302,683 contracts. However, back then index funds had a much bigger stake with 12.3 million bales, whereas nowadays they own only half as much or around 6.6 million bales.
Speculators were 9.6 million bales net long last week, not quite near the historic high of 11.6 million bales at the beginning of March 2008, but an impressive figure nonetheless. Speculators have been the driving force in the cotton market over the last eight months! Between early December 2015 and late March 2016 they turned a 6.0 million bales net long position into a 4.5 million bales net short position, which drove the market all the way down into the mid-50s.
Since early April speculators have turned their position around in dramatic fashion, going from 4.5 million bales net short to 9.6 million bales net long as of August 2nd, a swing of 14.1 million bales! As a result, the market has advanced roughly 100 points for every million bales of spec net buying.
According to the Financial Times, commodities have seen the biggest inflow of funds since 2009, as total commodity assets under management have risen to USD 235 billion in July, up from a USD 161 billion at the end of 2015. However, while commodities as a whole have seen a lot of new money pouring in, speculators can be quite fickle and chase after hot performers while quickly dumping laggards. So far cotton has been among the former, but its luck seems to be changing.
As we have pointed out before, both the 2007/08 and the 2010/11 bull markets were initially led by spec buying, but the blow-off phase was in both cases caused by trade short-covering. Therefore, since speculators don’t have that much more room to expand their net long position based on historic norms, it would take trade short covering to keep this uptrend going.
Until last week such a scenario was still in play, as both India’s Gujarat and West Texas were experiencing dry conditions, which had the potential to dramatically reduce supply this season. However, both Gujarat and West Texas have recently received some moisture and more is in the forecast, which has alleviated fears of supply shock and an accompanying short covering rally.
The specs hope that tomorrow’s WASDE report will lend support to the market, as most traders feel the numbers are going to be bullish. Among the expected changes is a downward revision of Indian ending stocks as well as a reduction of the US crop. However, the market may already have factored this in and we may therefore not see much of a reaction. There could be a negative surprise on the consumption side, as these higher prices and a slowing global economy are likely to impact mill use to some degree.
US export sales for the week of July 29 – August 4 amounted to just 128,300 running bales net, which was substantially below the 4-week average. There were 14 markets buying and 21 destinations received shipments of 193,200 running bales. Total export sales for the 2015/16-season that just ended amounted to 9.2 million statistical bales, which matches the current USDA estimate. Total commitments for the current season, including cotton that has been carried over from last season, are so far at 3.7 million statistical bales.
A lot of these new sales continue to be made ‘on-call’, as the latest CFTC report shows. As of August 5 there were 7.41 million bales in unfixed on-call sales, up another 122,700 bales from the previous week.
So where do we go from here? Spec longs got the wind knocked out of them over the last few sessions and are now hoping for the WASDE report and mill fixations to keep the market from caving in further. However, as pointed out above, with the weather situation improving, a trade short covering rally is less and less likely, which could leave the nearly 10 million net spec longs exposed.
Since the uptrend line dating back to late February is still well below the current market at around 67 cents, speculators may stay in their positions for now, but unless there is another problem with one of the major crops, the market is not likely to generate much upside momentum.
The 7.4 million bales in unfixed on-call sales are providing support, which is why we continue to see the market in a trading range of somewhere between 68 and 76 cents in the foreseeable future, although with the improved situation in India and Texas the market seems to be slipping towards the lower end of this range.
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