NY futures rallied strongly since our last report of December 20, as March gained 358 points to close at 73.78 cents.
The cotton market started 2017 with a bang, as March futures rallied over 300 points in the first three sessions of the new calendar year. In doing so the front month busted out of a 5-month sideways pattern, taking out the 72.75 cents resistance level and posting its highest close since August 8.
Interestingly the big jump in open interest indicates that it was additional spec and index fund buying into new trade selling that forced prices higher. Wednesday’s big move saw March open interest jump by 8,223 contracts, with the 3-day total amounting to 11,543 new longs and shorts. Overall open interest in futures amounted to 25.54 million bales as of this morning, which are 1.15 million bales more than on December 20.
Since the ICE open interest report shows futures positions only, we have to wait for the next CFTC report to see how options have played into all this. Our guess is that options may have mitigated this big jump in total open interest somewhat, but that doesn’t really change the story.
Some analysts are trying to dismiss this rally as nothing more than a flash in the pan that was triggered by a technical signal and they point out that speculators might be soon out of bullets. While we agree that the specs’ firepower may be limited given the record net long position they are carrying, the counterpoint is that the trade is expanding its already massive short position and that it doesn’t have the luxury to sit on it indefinitely.
In other words, while spec longs can simply roll their position down the calendar at basically no additional cost as long as the board has no carry, the trade will have to buy back shorts as mills fix and basis-long positions get sold. We therefore worry that a short-covering rally may still lie ahead of us!
The pace of US exports has been phenomenal this season. With still seven months to go in the marketing year the US has already sold 8.9 million bales and shipped 3.8 million. That compares to 5.3 million in sales and 2.3 million bales in shipments a year ago. The USDA currently has exports at 12.2 million bales, which means that over the next seven months only 3.3 million bales plus some allowance for a carryover have to be sold, which is not a tall order.
A larger US crop, the lack of carry in the market and the expectation of fierce competition from the likes of Australia (crop of 5 million bales!) later in the season have prompted US merchants and coops to push as much US cotton out the door as possible. They have done so by lowering basis levels some 200-250 points since November in order to lure mills into buying large quantities for nearby and extended shipments.
Mills did not want to pay a fixed price at the time but were happy to load up on millions of bales at an attractive basis. Little did they know that by collectively amassing the second largest on-call position on record, they were running the risk to turn their bearish hopes into a bullish nightmare!
The latest on-call report as of December 30 showed that mills continued to add on-call sales over the Christmas period. The latest snapshot showed that 11.03 million bales remain unfixed, of which 3.93 million bales are on March, 2.53 million on May and 2.30 million on July. With only around 30 trading days left for mills to fix their March portion, they have a daunting task ahead of them!
So where do we go from here? Spec longs have sponsored this latest push higher, while scale up grower selling has managed to keep the advance in check. However, mills have so far been conspicuously absent, judging by the rising open interest and the latest on-call report. This means that most of these mill fixations are still ahead of us and this could lead to additional spikes over the coming weeks.
We suspect that there is a large amount of fixation orders waiting at 70-72 cents, hoping that a dip in the market will allow them to finally get out of trouble. However, markets are often not that kind and we therefore have to brace ourselves for the possibility that mills will eventually have to chase prices higher. This has nothing to do with bullish fundamentals, but is the result of a massive trade short that sooner or later needs to get covered. A large percentage of this trade short is tied to mill fixations.
We therefore expect to see a volatile market over the next four weeks with a price range between 71 and 77 cents, although spikes to higher levels cannot be ruled out. Only once March fixations are out of the way do we see a chance for prices to temporarly fall back to 70 cents or lower, only to see the same scenario repeat itself in the May contract.
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