NY futures rallied quite strongly since our last report of two weeks ago, with March gaining 363 points to close at 72.81 cents.
After closing in a 250-point range for about two-and-a-half months, March started to break out from an ascending wedge pattern on November 17. The first upside target was long-term resistance at 7100, which was taken out quite easily, and after that the market was off to the races on aggressive spec buying.
Volume has been quite strong during this rally and open interest in March increased by over 2.6 million bales to 16.8 million bales over the last nine sessions, which shows that there is some conviction behind this move.
Over the last couple of months we already talked about some of the factors that were behind this somewhat surprising move into the low 70s. On the fundamental side we have a massive amount of unfixed on-call sales, which even after the liquidation of December still amounted to 14.17 million bales last week, with 5.47 million bales on March, while May and July account for another 5.69 million bales combined. This translates into a lot of underlying support!
Then there is the strong pace of US export sales, with commitments already at 10.4 million statistical bales, which is second most ever at this date. Since there have been some quality issues in regards to grades and micronaire, merchants have been scrambling to get their sales covered, which in turn has led to a very firm cash basis for premium grades.
Over the last couple of days there were apparently some cancellations of export sales to China, totaling several hundred thousand bales. We presume that shippers took the initiative due to quality issues, although it should have suited Chinese buyers quite well from a price perspective. But China will still make use of all its import quotas, be it in the US or somewhere else, since the price gap to the domestic market is simply too wide.
Speculators are buying the cotton market based on a constructive chart and the general belief that commodities are undervalued in relation to other assets, particularly the stock market. With the S&P 500 racing to a new all-time high today, this argument just got stronger. The same goes for Index Funds, who have been seeing a steady inflow of investor money.
The latest CFTC report showed that as of November 21 speculator added 0.86 million bales to their net long position, which grew to 5.29 million bales, while Index traders added 0.17 million bales to boost their net long to 7.19 million bales. Since then these positions have grown further and we estimate that the spec net long position will be at around 6.2 million bales in tomorrow’s CFTC report. That would still be only about half of the record spec net long position we had in February of this year, which amounted to 12.38 million bales. In other words, the spec net long still has room to grow!
The market has been rallying because speculators are throwing money at the long side and because mills are finding themselves trapped with too many unfixed on-call sales, but there is definitely no shortage of cotton! There might be some quality issues that need to get sorted out, but overall the world is still awash in cotton.
While a lot of cotton has already been committed, only a small amount has so far been exported. Although export sales have reached 10.4 million statistical bales, less than 2.4 million bales have been shipped, which means that there are currently over 8.0 million bales in outstanding sales. That’s the second highest amount after the 2010/11-season and around 3.4 million bales more than a year ago. In other words, mills all over the globe still have to receive a lot of cotton over the course of the season!
So where do we go from here? Over the last couple of years the price of cotton has been closely correlated to the spec net long position. When specs are buying the price is going up and vice versa. The next move will therefore depend on what speculators decide to do. Will they continue to throw money at the cotton market or are they done for now? We’ll have to wait and see!
From a fundamental perspective there is no reason for the price to go any higher right now. There is plenty of cotton to go around and even though there are some quality issues to deal with, we won’t run out of suitable cotton anytime soon. So rather than the market going higher, we might see a slightly higher trading range of 69-74 cents, with the high grade basis staying firm and lower qualities getting more heavily discounted.
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