NY futures continued to rally during this holiday-shortened week, as December gained another 334 points to close at 74.27 cents.
The market’s parabolic ascent has been truly remarkable, as December has managed to advance by more than 900 points in just twelve sessions, rocketing from an August 17 low of 66.64 to a synthetic high of 75.73 cents on September 5.
Had December been allowed to trade freely on Tuesday, it would have surpassed the contract high of 75.72 cents dating back to March 20. December came close to that mark again the following day, when it posted a high of 75.65 cents. How did the market go from being so depressingly bearish to challenging its contract high within a matter of weeks?
After a surprisingly bearish WASDE report in August the trade made the mistake of ‘dividing the skin while it was still on the bear’. Then suddenly the tropics became active with two monster hurricanes bringing destruction and/or torrential rain to South Texas, the Delta and now potentially the Southeast, introducing a lot of uncertainty in regards to the potential size and quality in those areas, which account for a combined output of some 10.5 million bales or around half of the US crop.
But it was not only the trade that got wrong-footed, as outright spec shorts had increased their position from 2.6 million bales on June 6 to 5.4 million bales on August 22. As the market started rising, spec short-covering provided much of the fuel that propelled values higher and once the market went through the 7200 cents resistance level on Tuesday, it triggered large-scale buy stops.
While spec shorts got out, new spec longs jumped on the bullish bandwagon, which led to this powerful limit move on heavy volume of over 67,000 contracts. With hurricane Irma lurking in the Atlantic, the timid scale-up trade selling was no match for the onslaught of spec buying.
The question is of course whether the impact of these storms justifies a 75 cents market? We still feel that Harvey caused losses in the vicinity of half a million bales in South Texas, between cotton that was destroyed in the field and water damage to modules.
The Delta has seen too much rain and a lack of heat units in recent weeks, which has lowered the yield potential somewhat, with many areas now only looking at an average crop.
The impact of Irma is still unknown at this point, but with the Hurricane threatening Georgia and the Carolinas, we have to brace ourselves for more losses and quality problems. We assume that another 0.3-0.4 million bales could get destroyed and 1.0 million bales may suffer some quality issues. We don’t go for more than that at this point because less than half of the crop is open and plants are still carrying their leaves, which should offer some protection against high winds.
Before these storms arrived the US was looking at record yields with a potential of around 21.0 million bales. Therefore, even if we knocked a million bales off the top we could still end up with a crop near 20 million bales. Now let’s assume that a further 2-3 million bales have some quality issues, which would leave 17-18 million bales of potentially better grades. This would still be more than the size of last season’s crop!
If nothing else happens to the US crop from here on and we get some warmer weather as the current forecast suggests, then we could still end up with a large crop of mostly decent quality. Crops in other parts of the world seem to be doing fine, with India, Pakistan and West Africa still looking at a bigger output than last season.
Therefore, from a global perspective the US setback should be relatively insignificant, at least at this point, and should not affect the supply/demand dynamics by too much. However, traders will likely remain on edge for another 4-5 weeks, until we know more about actual yields and the quality mix of the US crop.
So where do we go from here? Traders are quite nervous at the moment due to all these weather-related threats we had over the last couple of weeks. However, the market has probably gone up far enough for now and if no further production setbacks occur, the trade will eventually emerge as a stronger seller again and cap the market.
However, support is moving up as well as there are currently a record 12.74 million bales in unfixed on-call sales (up 1.27 million bales last week alone!), which will provide a lot of scale-down buying underneath the market. We therefore expect the market to trade in a 69-76 cents range over the coming weeks.
We still feel that December is facing a shortage of high grades until it expires and this should keep the steep inversion over March alive. If the crop moves in without any additional hiccups, then the market will eventually have to build carry into the March/July spread, which is currently too narrow at just 20 points.
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