NY futures ended the week slightly higher, as March gained 35 points to close at 72.69 cents.
The market has shrugged off last week’s bearish news and started to reverse higher again. As expected, scale down fixation orders were massive below 72 cents, which allowed for only a brief dip below that level, leaving a lot of mills frustrated.
Most traders seem to have a difficult time understanding this market, since fundamentals are neutral to slightly bearish, yet the March contract has been moving 700 points higher since the beginning of September. As mentioned before, we don’t think that the current market can be seen as a reflection of cotton fundamentals, but instead represents a tug-of-war between the massive spec long and trade short positions.
The latest CFTC report as of January 10 showed speculators at a record net long of 12.23 million bales, whereas the trade had boosted its net short to 18.56 million bales, with index funds making up the difference with a 6.33 million bales net long. When we look at the trade’s position in greater detail, we have 4.70 million bales on the long side and 23.26 million bales (!) on the short side.
A lot of analysts focus on the record spec net long position, believing that it is unsustainable and that it will eventually have to get liquidated like on previous occasions, thereby pulling the market into the abyss. While this is certainly a possibility, we don’t see any reasons for specs to get out of their position anytime soon. The trend is working for them and with inflation expectations on the rise, it would take an outside event to spook specs into selling.
The more interesting question to us is ‘how is the trade going to get out of its massive net short position’? Unlike speculators the trade doesn’t have time on its side and will have to buy a sizeable portion of its shorts back over the coming weeks and months. Since the futures market is a zero-sum game, which means that for every buyer there has to be a seller, the trade will have to motivate speculators into selling. This will only happen if a) speculators get forced out of their positions on a trend reversal or b) the market rallies and provides enough incentive for specs to cash out.
March open interest of almost 165,000 contracts is at the highest level ever for this date. The only other year that comes close is 2008, when there were 149,000 contracts open on January 18. The 10-year average amounts to just over 113,000 contracts.
Unfixed on-call sales are part of this large open interest in March. As of last Friday there were still 36,665 contracts (3.6 million bales) unfixed on March and we feel that only little progress has been made this week. Overall unfixed on-call sales have risen by another 4,104 contracts (0.41 million bales) and now amount to 11.54 million bales. This number is getting close to the record set in November 2010, when 12.1 million bales were unfixed.
The US export sales report has been delayed until tomorrow due to the Monday's holiday, but if the big increase in on-call sales is any indication, it should show another strong number!
So where do we go from here? From a fundamental point of view there should be plenty of supply to comfortably last into the coming season and new crop plantings seem to be increasing in several places, including the US, India and China. In other words, the mid-to-long term outlook is shaping up to be bearish!
However, that’s no consolation for the many mills that still need to fix 11.5 million bales of cotton, of which 9.1 million are on March, May and July. Since it won’t be easy to flush out spec longs, it may take higher prices to get the job done. We therefore still see the possibility for some spike rallies over the coming weeks and months and believe that waiting until the last moment to fix is not a great strategy. At least mills should opt for some protection in the options market!
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