NY futures continued to head lower this week, as July gave back another 208 points to close at 77.16 cents.
With the exception of the recent ‘flash-in-the-pan’ rally, which had lifted July to a synthetic high of 88.40 cents, the market has been range bound for nearly four months now.
Since the end of January the July contract has for the most part traded in a tight range between 7550 and 8000 cents, despite selling 8.3 million bales of Upland cotton in just sixteen weeks from January 26 to May 18. That’s an average of over half a million bales per week and the US might actually sell out of cotton for the first time ever this summer, yet the market seems indifferent.
We believe that there are a number of reasons why the market has been shrugging off these stellar export sales. For one there is still plenty of cotton stored around the globe, even though the bulk of it is located in China and stocks in the ROW are actually quite tight at the moment. But the promise of a big production increase in the 2017/18-season could lift ROW stocks by over 16 percent according to the USDA, which would guarantee ample supplies going forward. Subdued yarn prices and competition from bearish man-made fibers are other reasons why mills have not been willing to jump on the bullish bandwagon.
Although the flat price has not shown much of a reaction to the tightening US balance sheet lately, the July/Dec spread is still inverted by 400 points as a result of it. Whether July will fizzle out in its final days or whether it can muster the strength for another rally remains to be seen and depends to a large degree on what speculators are going to do with their still large net long position.
After the explosive move ten days ago and the crash that immediately followed it looks like specs longs are finally getting out of cotton. They had a great run since the market took off at around 55 cents in March 2016 and subsequently rallied 33 cents or 60 percent to a high of over 88 cents.
Open interest has dropped by 4.0 million bales since May 5 and measured only 10.2 million bales before today’s session. This shows that specs are headed for the exit, which is allowing trade shorts to get out at a reasonable level. With the market closing today just about 30 points above its long-term uptrend line, we are once again approaching critical support and if breached it could trigger aggressive spec long liquidation.
However, the market has held trendline support before and with cash cotton once again finding keen interest in the Far East, it may prove to be difficult to flush out the specs. We heard of sizeable quantities being sold to China, Vietnam and several other markets this week. US cotton is still the preferred choice in most markets and shippers keep pushing sales.
Despite expectations for a net reduction of 100-150k in US export sales last week, today’s report surprised the market and showed net new sales of 259,800 running bales of Upland and Pima cotton for both marketing years. Cancellations of 48,000 bales were actually less than the week before and there were none for China despite rumors to the contrary. One explanation is that buy-backs were being negotiated, but never concluded after the market had collapsed a couple of days later.
Total commitments for current crop are now at 14.7 million statistical bales, of which 11.8 million bales have so far been shipped. Meanwhile sales for August onwards have already reached 3.0 million statistical bales, which is more than double of what we had a year ago.
Our latest estimate of how much US cotton remains for sale at this point is 0.7 million bales, which includes the certified stock of 0.4 million bales. We arrive at this figure by starting with a supply of 21.0 million bales (3.8 beginning stocks + 21.2 million crop), from which we subtract 17.8 million bales for exports and mill use until the end of July.
This leaves 3.2 million bales on August 1, but from this we need to subtract around 0.9 million for domestic mill use between August and October and we further assume that half of the current commitments for August onwards of 3.2 million bales (0.2 carryover so far + 3.0 new marketing year commitments) will be supplied from existing stocks. This would leave just 0.7 million bales uncommitted!
So where do we go from here? The market is approaching critical trendline support and a breach would likely flush out a sizeable number of spec longs. We have seen similar moves in soft commodities like sugar, coffee and cocoa, and would therefore not be surprised if cotton were to follow the same script.
However, while specs may be compelled to sell, the trade still has a lot of short covering to do. The latest on-call report showed that there were still 3.74 million bales in unfixed sales on July as of last Friday. A selloff would therefore be met with plenty of trade buying underneath, both from fixations and the sale of remaining basis-long positions. We could therefore see some choppy trading action, with the market initially spiking lower and then quickly bouncing back. In other words, we expect the market to trade in a range rather than making a big directional move.
Open interest should come down quickly in this environment, since both sides have an interest to get out. The index roll, which won’t start until June 7, will do the rest. Only if there are some procrastinators left late in the game, i.e. after the index roll and options expiration, do we see the possibility for another spike to the upside.
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