Market Comments – October 12, 2017

NY futures ended the week slightly lower, as December dropped 43 points to close at 67.84 cents.
The market has remained stuck in a sideways trend, as December has now settled the last 23 sessions in tight range of less than 200 points, between 67.52 and 69.46 cents. Open interest has been steadily declining over the last four weeks, which is the result of spec selling into scale down trade short covering (mainly mill fixations).  
Since early last month open interest in December has dropped from a high of 14.94 million to 12.55 million bales, a reduction of 2.39 million bales, while total open interest has gone down from 24.64 million to 23.01 million bales. Despite US and global production being quite a bit larger this season than last, open interest in the December contract is 2.18 million bales lower year-on-year, while total open interest is 1.15 million bales less. 
The reason for this smaller participation is the reduced spec net long position, which as of October 3rd was at just 4.97 million bales compared to 8.35 million bales a year ago. Last season this position was on its way to grow to a record 12.38 million bales net long by February, while this time around it seems to be headed in the opposite direction. 
This poses a problem if the trade wants to increase its net short position as crops around the globe finally move in and producers and/or merchants are looking for additional hedges. If specs and the trade are trying to sell the market at the same time, it will inevitably put pressure on prices. 
So far mill fixations have provided enough buying to absorb spec selling, while the rest of the trade has been hesitant to add shorts due to the uncertainty regarding crops, with hurricanes, excessive rain and cooler conditions all leading to doubts about size and quality, particularly in the US and India. 
Although West Texas remains an area of concern for another three weeks or so due to the lateness of the crop and below average temperatures, today’s WASDE report seems to have reassured the trade that overall global and US production will be quite large and there is going to be a lot of cotton that needs to be carried outside of government support. This means that the owners of this excess cotton will increasingly turn to the futures market for a ‘substitute sale’!
Unlike in the previous two months, today’s WASDE report contained no surprises and December closed just about 10-20 points lower from where it had traded before the report was released. The main change was a 643,000-bale reduction in the US crop, with Texas and Georgia each accounting for a 300,000-bale drop. This puts the US crop at 21.12 million bales, which would be 3.95 million bales more than last season. Based on what we have seen in West Texas lately we feel that the crop will eventually slip below 21 million bales, but there will be plenty of cotton nonetheless. 
Globally the USDA raised production by 112,000 bales to 120.86 million bales, as increases in Argentina (+0.35 million bales), Brazil (+0.30) and Greece (+0.10) more than offset losses in the US. However, since global mill use increased by 262,000 bales to 118.01 million bales, global ending stocks came in slightly lower at 92.38 million bales. 
We still believe that the USDA is way off target when it comes to global ending stocks, particularly with its Chinese and Indian numbers. In the case of China we have around 9 million bales less than the government and in India we are some 5 million bales lower. 
This reminds us of the 2010/11-season, when the USDA estimated Chinese ending stocks at 18.6 million bales in its July 2010 report. The USDA subsequently had to lower its number by no less than 8.0 million bales and today the records show Chinese ending stocks for the 2010/11-season at just 10.6 million bales. We have a feeling that we are going to see a similar revision for the current season at some point in the future. This is not a market factor at the moment, but we will likely see increased Chinese imports earlier than thought as a result of it, possibly as early as next spring!
So where do we go from here? Today’s WASDE report has given the trade a green light to increase its short position, while speculators are likely to reduce their net long position further. 
Remember that before all these weather scares the spec net long position was at just 1.33 million bales on July 25, or 3.64 million bales less that in the latest CFTC report. In other words, if speculators were to pull back to their end of July size, it would amount to a lot of selling. Combine this with the trade’s need to increase its short, and it adds up to a lot of potential pressure. 
The only significant support comes from mill fixations, as 13.56 million bales of on-call sales are still unfixed, whereof 6.75 million are on December and March futures. However, as we have seen in the past, once the market starts sliding, mills will pull back their buy orders and allow the market more room to the downside. 
While initially the entire board may come under pressure, since speculators have their positions in the front month, we should eventually see December hold up better relative to the back months due to the extreme tightness in the front. 

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