NY futures extended their rally this week, with March advancing another 261 points to close at 77.94 cents.
The market surged to another contract high this week, as a combination of spec and trade buying continued to chase values higher. Since November 15, which was just five short weeks ago, the March contract has now rallied over 900 points, from a low of 68.62 to today’s high of 78.07! That’s quite remarkable considering that the ROW is harvesting its biggest crop ever at 94.96 million bales, which is quite a bit more than last year’s 83.81 million bales or the 72.15 million bales of two seasons ago.
Although ROW mill use has steadily risen from 77.26 million bales two years ago to currently 80.59 million bales, it remains 14.37 million bales shy of ROW production this season. Even if we account for Chinese imports of 5.3 million bales, we are still left with a 9.07 million bales seasonal surplus.
The USDA is probably still a bit too high with its production numbers, as we see the Indian and US crops around 0.7-0.8 million bales lower each. But there should still be ample supply to last through the season, so why is the market behaving like it is about to run out of cotton? We believe that the current bull run has little to do with the availability of cotton, but is instead the result of mills having accumulated a record amount of unfixed on-call sales.
Today’s “on-call” report showed that mills continued to add to their overall position, which as of last Friday amounted to a record 14.99 million bales in unfixed on-call sales, of which 5.51 million were on March, 3.09 million on May and 3.20 million on July. That’s a combined 11.8 million bales that have to be fixed between now and the middle of June!
These sales represent a short position on NY futures and while mills have remained inactive during the initial phase of this bull run, they are now actively engaging in damage control via buying bullish options strategies. But as mills and other trade shorts are finding out, there is still a lack of willing sellers to accommodate all the buying that they, along with speculators, are trying to do.
The NY futures market is a ‘zero sum’ game, which means that for every buyer there needs to be a seller. There are basically three groups that are active in the futures market, namely speculators, index funds and the trade (growers, merchants and mills).
The latest CFTC report (as of December 12) showed speculators at 8.79 million bales net long, while index funds had a 6.97 million bales net long. On the other side was the trade with 15.75 million bales in net shorts. If the trade wanted to reduce its net short by let’s say 3 million bales, then speculators would have to sell 3 million bales of their net long in order to make this happen. Index funds can be excluded from this equation since they are passive investors.
However, speculators are more likely to buy a strong uptrend than sell into it and as we have seen over the last five weeks, they have indeed added more net longs week after week. Speculators tend to stay in a strong uptrend until there is confirmation of a reversal and at the moment there are no signs of that. This means that the trade has to find sellers within its own group and that can only be done by incentivizing potential sellers via higher prices.
Unfortunately, we are not seeing any progress being made, as both the number of unfixed on-call sales as well as the overall trade net short position keep increasing. Until last week the trade was relatively nonchalant about the market’s advance, but over the last couple of sessions we have been sensing some panic among traders, which has the potential to fuel this market further.
However, unlike a speculative object like Bitcoin the cotton market doesn’t exist in a vacuum and sooner or later these elevated prices will lead to certain actions, like an increase in the certified stock, demand rationing and/or cancellations. Again, we don’t see a shortage of cotton this season with record ROW stocks, which means that there should be plenty of cotton available to throw at the futures market. As of last week the USDA had 13.2 million running bales of Upland cotton classed, of which 74 percent are tenderable.
US export sales were once again stellar, as mills booked 369,600 running bales of Upland and Pima cotton for both marketing years. A lot of those sales consist of discounted cotton, which are attractively priced for mills. There were a total of 21 markets buying, while shipments of 163,300 running bales went to 19 destinations.
For the current season we now have total commitments of 11.2 million statistical bales, of which only 3.0 million bales have so far been exported.
So where do we go from here? Speculators led the initial charge of this bull run and now nervous members of the trade are fueling the flames by engaging in bullish strategies in order to protect their short position. The old saying ‘there is no better buyer than a commercial short’ seems to hold true at the moment and it is therefore difficult to gauge at what point this bull market will finally run out of steam and reverse.
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