Market Comments – February 2, 2017

NY futures extended their rally this week, as March jumped another 272 points to close at 76.91 cents.
The market broke out of an ascending triangle formation on Wednesday, which sparked yet another round of spec buying that propelled the market to an intra-day high of 77.40 cents today. It’s hard to believe that the futures market has rallied over 700 points since Christmas, when March was still trading below 70 cents!
The continued rise in open interest tells us that speculators and the trade continue to dig in, with neither side willing to yield. Over the previous five sessions futures open interest has jumped by 19,101 contracts, from 26.36 million to 28.27 million bales, and it is now approaching the all-time record of 30.27 million bales, which was set on March 3, 2008.
The liquidation of March open interest hasn’t made much progress, since it has only dropped by 2,039 contracts over the last five sessions and still measures a sizeable 15.21 million bales. Runaway prices have precluded mills from hitting their fixation targets and with only 13 sessions to go until First Notice Day on February 22, time is starting to become a factor.
The CFTC on-call report, which was released today after the close, showed that as of last Friday unfixed on-call sales amounted to 11.96 million bales, which was 0.13 million bales more than a week earlier and just shy of the record 12.12 million bales of early November 2010.
Unfixed on-call sales on March still amounted to 3.24 million bales, which was just 0.31 million bales less than the week before. This means that mills have their work cut out to square away all these remaining fixations over the next two-and-a-half weeks. With 3.10 million bales yet to be fixed on May and 3.12 million bales on July, total unfixed on-call sales in current crop remain at a very lofty 9.46 million bales.
US export sales for the week of January 20-26 amounted to a strong 424,400 running bales of Upland and Pima cotton, with 18 markets participating. Shipments reached a marketing year high of 360,500 bales to 25 destinations. Total commitments for the season are now at 10.5 million statistical bales, of which 5.2 million bales have so far been exported.
Despite this stellar export performance the US still has several million bales for sale. Total supply this season amounted to 20.8 million bales (3.8 beginning stocks and 17.0 million crop), of which 3.3 million bales go to domestic mills and 10.5 million have so far been committed for export. This leaves still 7.0 million bales, although about half of that needs to be reserved to stretch supplies to new crop from August to October.
But needless to say that the US is not quite sold out yet and given the elevated price level of NY futures some of that cotton will undoubtedly find its way to the board. Certified stocks continued to increase this week and are now just shy of 200,000 bales. However, while a large certified stock may act as a deterrent at some point, it doesn’t really solve the predicament of the many mills who still need to fix three millions bales over the coming weeks.
Last week we talked about the surprisingly low volatility readings of below 20%, which reflected a nonchalant attitude by traders. This all changed this week, as the ‘fear index’ jumped to 25% and traders started chasing out of the money calls to protect their positions or to jump on the bullish bandwagon.
We already talked about these far out-of-the-money calls that have been bought recently and today someone was willing to pay 125-135 points for 1000 of the July 96 calls and 70 points for 950 of the December 100 (one dollar) calls. Just these two positions have a value of about a million dollars and there were several other large trades done with strikes in the 80s and 90s! It’s easy to dismiss these bullish bets as unrealistic, but the lessons of 2008 and 2011 have shown that anything is possible in the cotton market.
Apart from a constructive chart and an improving balance sheet, inflation expectations may be another reason why some money managers are bullish on cotton. If President Trump follows through on his ‘America First’ agenda and levies import taxes, it will make consumer goods more expensive. The same goes for products made in the US, since the production cost will be higher. Therefore, if the US weans itself off of cheap imports, it will almost certainly lead to higher inflation. 
So where do we go from here? Unfortunately not much has changed since last week, except that mills have five days less to get their March fixations done. The massive open interest and the near record unfixed on-call position should continue to support the market going forward and there is still a strong possibility that the market might spike to 80 cents or beyond on last minute short covering.
Fundamentally we don’t see a bullish market down the road as there is plenty of cotton around the globe to make it comfortably to new crop and the 2017/18-crop should see a further increase in plantings thanks to higher prices.
However, the market remains vulnerable to rallies due to the current position structure, since the trade net short position will have to be reduced considerably over the coming months and that can only happen if speculators are motivated to sell.
The increasing certified stock is seen as a tool that will scare the longs out of their position, but if history is any guidance that’s not necessarily going to work. In February 2008 the certified stock amounted to nearly 600,000 bales and it didn’t prevent the market from exploding to the upside in early March!


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