NY futures pulled back this week, as May gave up 90 points to close at 77.27 cents.
It felt like “déjà vu” this week, as the May contract once again drifted into the ‘fixation zone’ below 77 cents and then rebounded. We already saw the same price action last week and it seems that the market is currently stuck in a sideways pattern that doesn’t have much room on either side.
Even another stellar export sales report did not elicit any excitement and it seems as if the market had become numb to these big numbers. For the week that ended on March 16, total commitments of Upland and Pima cotton rose by another 539,500 running bales net for both marketing years, with 19 markets buying and 25 destinations receiving shipments of 394,400 running bales.
Total commitments for the current season are now at 12.8 million statistical bales, of which 8.1 million have so far been exported. Current crop sales are running around 5.1 million bales ahead of last season! For the 2017/18-marketing year there are now 1.7 million statistical bales on the books and we assume that most of these commitments will be shipped from existing stocks.
When we look at the US balance sheet, we started the season with 21.0 million bales (3.8 beginning stocks + 17.2 crop), from which we have to subtract 12.8 for exports and 3.3 million for domestic mill use until the end of July. We further need to reserve about 1.5 million bales for exports from August to October and around 0.9 million bales for domestic mills for the same time frame. This would leave around 2.5 million bales or 12% of total supply still available for sale at this point.
If sales were to continue at the current pace, the US would be completely sold out in five weeks from now! This is unlikely to happen, but from what we hear we will get at least one more good sales report next Thursday.
As we have discussed repeatedly, the bullish case in current crop rests primarily on the premise that spec longs will hold their position at a time when trade shorts are being forced out of theirs, as mills need to fix nearly 8 million bales of on-calls in May and July.
In other words, specs may be inclined to stay in their net long position and they could simply roll it from May to July (at a small roll loss) and then from July to December (at a substantial roll gain). The trade on the other hand cannot roll current crop shorts forward to December, at least not at on a spread. What is likely to happen is that some trade shorts buy back May and July, while others put on new shorts in December against purchases of new crop cotton.
Therefore the shorts in May and July are at the mercy of spec longs. In order for these shorts to get out they need sell-side liquidity, which only spec longs can provide at this point, since there is very little current crop left to hedge by the trade. Until a few weeks ago we felt that the chances for spec longs to get out were very slim, but the odds for a “risk off” move seem to be improving.
Although the majority of traders and analysts are still positive on US and global economic growth, we don’t share that opinion and feel that the US and Europe are headed for a recession. Most developed economies are about to hit a demographic wall, with scores of baby-boomers retiring on much reduced income thanks to the low interest policy by central banks, and increasingly being forced to divest assets like real estate, stocks and bonds. The pension crisis is real and will move more and more into the limelight over the next year or two!
Meanwhile the younger generation is burdened with student loans and a lack of job growth, unable to generate the wherewithal to take over assets from baby-boomers. We therefore feel that asset bubbles are finally beginning to deflate and that consumption will suffer in such an environment. The recent weakness in the commodity complex may already be signaling this development and cotton as an industrial commodity may therefore not be able to buck the trend for much longer.
So where do we go from here? While most of the bullish drivers that have brought prices from about 56 cents to 77 cents since last March are still in place, particularly the large trade short position tied to a massive amount of unfixed on-call sales, we feel that this bull market is living on borrowed time! If specs hold on to their longs, they could still force the market to spike higher over the next three months.
Beyond that we see an increase in global production and slowing demand putting a lid on the market. The planting intentions report next week will set the tone in this regard. We would therefore advise growers to look at some bearish options strategies ahead of next week’s report, preferably in March options. With the cotton pipeline being near empty at the end of the 3rd quarter, December may not be the best month for price protection.
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