NY futures continued to give up further ground this week, with December losing another 97 points to close at 68.04 cents.
After the market had dropped some 900 points in just seven sessions between August 5 and August 15, it has since transitioned into a narrow sideways pattern, closing the last eight sessions in a tight range of just 122 points, between 69.01 and 67.79 cents.
Even though the market has now broken below a 6-month uptrend line dating back to late February, spec long liquidation has so far been very measured and orderly. Although a more intense flush out of spec longs remains a possibility, it appears that the market has found some equilibrium near the 68 cents level.
When markets break below support it often leads to heavy selling pressure into a void of buying. However, this doesn’t seem to be the case here, as there is a considerable amount of trade buying underneath the market that has so far been strong enough to absorb whatever specs have decided to throw at them.
This has allowed speculators to lighten the burden over the past eight sessions without having to concede too much additional ground. Open interest in December, where most spec longs reside, has dropped by over 18,000 contracts since August 15 and nearly 30,000 contracts since its peak on August 5.
However, while some air has come out of the bubble, total open interest remains still relatively high at around 228,000 contracts, of which 157,000 are in December. By comparison, a year ago total open interest was at around 187,000 contracts, of which December occupied 136,000 contracts.
According to the latest available CFTC report, which shows futures and options positions as of August 16, speculators were 8.63 million bales net long, down from 10.01 million the week before. Since then we estimate that speculators have reduced their long exposure to around 7.2-7.4 million bales net long. If that were correct, then speculators would have made great strides in diffusing a potentially implosive situation.
While speculators have seen their paper profits vanish since August 5, to the tune of around 400 million dollars, the trade seems to finally have won a battle against its counterpart! The trade has used the rally into the high 70s to build a substantial net short position that reached 16.74 million bales at its peak earlier this month. Since then some short covering has reduced their net short to an estimated 14.0 - 14.2 million bales as of today.
The fact that mills have for the most part bought cotton on-call when prices were high and therefore postponed their pricing decisions means that there is still a lot of fixation buying ahead of us. Remember, merchants often sell futures when making on-call sales to mills, thereby locking in a fixed sales price on their books, only to buy these futures back once mills issue fixation orders.
Last week’s drop prompted some mills to fix as the latest on-call report as of August 19 shows. Unfixed on-call sales in December dropped by 557,600 bales net, but overall there are still around 6.9 million bales to go, of which 2.8 million bales are on December. This large amount of ‘postponed buying decisions’ is providing a lot of support below the market.
US export sales for the week that ended on August 18 amounted to a strong 332,600 running bales of Upland and Pima for both marketing years combined. There were 17 markets buying, with China taking over 80,000 bales. Shipments were strong as well with 23 destinations receiving 222,600 running bales. For the season we now have commitments of 4.3 million statistical bales (1.5 million bales more than last season), of which a little over 0.5 million bales have so far been shipped.
West Texas saw some beneficial rain this week, with Lubbock getting 0.44 inches and many surrounding areas receiving 1-2 inches. More moisture is currently streaming into the area on Thursday evening. This seems to have capped any attempts to rebound over the last couple of sessions.
So where do we go from here? Speculators still have a considerable long position of over 7 million bales net, but the trade is twice as many bales net short. Index Funds, which are just under 7 million bales net long, are not reacting to price movements.
It is therefore a question of ‘who has more urgency to act’? Specs longs are at or below their break-even point and may want to further reduce their exposure. However, unless they do so in a hurried manner, there seems to be enough trade buying to absorb any selling at the moment.
The trade short, which consists mainly of unfixed on-call sales and merchant basis-long positions, has made a decent amount of money on this down move and doesn’t want to give it back. Since from a fundamental point of view the market seems to have value in the mid-to-high 60s, we might therefore see a more aggressive stance by trade shorts in the days and weeks ahead.
Last week we thought that a spec washout was quite likely given the weak technical picture, but we may have underestimated the trade’s resolve to buy and fix sizeable quantities from current levels on down, which may prevent further price erosion and could even lead to a bounce into the low 70s. We therefore stick to our 68-72 trading range for now!
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