Market Comments – February 16, 2017

NY futures were unchanged this week, as May edged up just 12 points to close at 76.77 cents.
The market made another attempt to rally this week, with May reaching an intraday high of 78.45 cents on Monday, which was the highest reading in 33 months. However, the market was once again unable to maintain its upside momentum and on Tuesday sellers started to take control.
Today the May contract broke below an intermediate uptrend line, which has been in force since December 29. This opens the door for a retest of the major uptrend line, which runs through around 74 cents at the moment. 
The orderly liquidation of the March contract is probably the main reason behind the market’s fading strength. By rolling its massive net short position into May and July, the trade has for now sidestepped a potential problem. However, looking at the nearly unchanged overall open interest in futures, which as of this morning still measured 27.9 million bales, the trade simply bought itself some time and hope, but it is not out of trouble yet.
Two weeks ago, on February 2nd, March open interest was still at 15.3 million bales, while total open interest measured 27.7 million bales. Since then open interest in March futures has dropped by 11.9 million bales to 3.4 million bales, but total open interest has actually gone up slightly to 27.9 million bales. This shows that there hasn’t been any net liquidation of spec or trade positions, as both sides continue to hold their historically large bets. 
The latest CFTC spec/hedge report as of February 7 showed another big increase in all positions. Speculators added 0.73 million bales to their net long, which amounted to 12.2 million bales, while Index Funds added 0.45 million bales to a new total of 7.1 million bales. Meanwhile the trade increased its net short by 1.2 million bales and carried a 19.3 million bales net short position.
Today’s on-call report showed the first overall reduction in many months, as March fixations outpaced new on-call position in May and July. As of last Friday there were still 1.8 million bales in unfixed on-call sales on March, down 1.1 million on the week. May and July saw their unfixed sales increase to 4.0 and 3.5 million bales, respectively. Total unfixed on-call sales still amounted to 11.9 million bales, of which 9.2 million are in current crop.
US export sales once again surprised to the upside, as another 358,200 running bales of Upland and Pima were sold for both marketing years. We assume that most of the 123,300 running bales of ‘new crop’ will be supplied from current crop inventory. Participation was once again broad based, with 19 markets buying and 24 destinations receiving shipments of 363,300 running bales. Total commitments for the season are now at 11.0 million statistical bales, of which 6.1 million bales have so far been exported.
Today the USDA released its 10-year baseline projection for cotton, which shows a massive expansion of global cotton trade. While cotton exports are expected at 35.1 million bales in the current season, they grow by 35% to 47.4 million bales in 2026/27. This increase is almost entirely due to China, which the USDA believes will see a big jump in imports starting in the 2019/20-season.
The world has been running global production deficits in the last two seasons and that is likely to continue in the foreseeable future. The only reason these production gaps haven’t had more of an impact is because China has plenty of inventory to make up the shortfall. This will change in about 2-3 seasons, when China will increasingly turn to imports. 

What we find odd is that while Chinese imports are expected to rise by about 10 million bales from the current 4.5 million bales to 14.4 million bales, the USDA sees US exports as staying flat between 12.0-12.5 million bales all the way out to 2026/27. In other words, the entire export growth would have to come from other origins such as India, Brazil and West Africa, which is hard to believe. Needless to say that this bullish baseline projection is letting the bears know that they are living on borrowed time!
So where do we go from here? There have been two forces at work in the market over the last couple of weeks. On the one hand we had mill fixations and spec buying push prices higher, while an increasing certified stock has forced carry to widen between current crop months. 
Even though the March/May spread is now at full carry, merchants won’t be allowed to take the certified stock based on a ‘cash and carry’ exemption and due to the rapid and orderly liquidation of the March contract we don’t see any major fireworks ahead in the final days before First Notice Day. 
The most likely course of action is for March to converge with its cash value, which we estimate to be at around 73-74 cents. This is also the level of major trendline support in May. Since mills have rolled out of trouble for now and won’t be fixing their May portions right away, at least not at current levels, we believe that there is a good chance for May to pull back towards 74-75 cents, where fixations are likely to intensify. Although we anticipate a pullback, most of these shorts will eventually have to get out and we could therefore still see another spike in a few weeks from now. 

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