Market Comments – January 4, 2018

NY futures continued to push higher during the holiday period, with March gaining another 131 points over the last two weeks to close today at 79.25 cents.

Even though the market began 2018 on a weak note due to some tax-related selling and grower profit taking, it didn’t take long for buyers to return and chase futures back towards their contract highs. 

Since November 15, when this latest bull market originated, March futures have moved 1060 points higher over the last 34 sessions. A bull market is usually confirmed by strong volume and rising open interest, which has certainly been the case here. During this bull run open interest in the futures market increased by 5.81 million bales, from 22.48 to 28.29 million bales, while daily volume has averaged just under 32,000 contracts. 

In our last report we have already explained some of the dynamics behind this bullish trend, such as speculators accumulating longs and mills trying to find a way out of their fixation trap. The latest CFTC report, which reflected positions as of December 26, showed a further expansion of the spec net long, which grew by 0.41 million to 10.38 million bales. On the other side of the ledger the trade increased its net short by 0.57 million to 17.54 million bales. 

The latest ‘on-call’ report unfortunately showed no improvement in the mills’ predicament, as there were still 11.78 million bales of current crop unfixed as of December 22, of which 5.31 million were on March alone. The overall unfixed on-call sales position actually rose to a new historic record of 15.32 million bales. 

As these latest position snapshots show, there has been no improvement yet in this standoff between spec longs and trade shorts (mainly mill fixations), and there is no quick solution in sight. As long as the specs hold on to their longs, it will be difficult to generate enough sell-side liquidity for trade shorts to get out. 

The recent breakout of the GSCI index to its highest level in over 2 years may just be the beginning of commodity repricing vis-à-vis other asset classes. Commodities are still at their lowest ratio to the S&P 500 stock index in over 40 years and this has not gone unnoticed in hedge fund circles. We therefore see no reason for spec to abandon their 10.4 million bales net long in the cotton market anytime soon.

The rapid pace of US export sales is another piece in the bullish puzzle, because the more cotton that gets sold, the fewer short futures the trade requires. Over the last few weeks we heard of some sizeable buy-backs of premium grades by US merchants, as some of these qualities are simply not available in sufficient numbers. 

However, while a shipper may be able to get out of a high-grade sale he made several months ago, he still has to get rid of the discounted qualities in his position. With a futures board devoid of carrying charges and potentially falling over a 500-point cliff in June, merchants and coops are trying to dispose of their stocks posthaste and thanks to the steep discounts being offered, mills are happy to receive them. This creates a situation in which US commitments continue to rise despite higher futures prices. 

US export sales are delayed until tomorrow, but as of December 21 total commitments had already reached 11.4 million statistical bales, of which just 3.3 million bales were shipped. Considering that 2 out of every 3 bales in the Lubbock classing office are coming in below 3.5 mike, we feel that sales will remain strong and could reach 16 million bales or more by summer, although it is questionable that this many bales would actually be shipped by the end of July. But from a position point of view the more bales that are sold, either fixed price or on-call (and fixed later), the more supportive it will be for the market. 

So where do we go from here? The trade has been waiting for a meaningful correction for the last six weeks, but the market hasn’t given back much more than a cent or two a couple of times. This is clearly frustrating the shorts and/or mills who still need to fix a lot of cotton, and over the last couple of sessions we have seen some fixations move up to the market. It is this kind of action along with bullish options strategies that keep feeding this bull market!

The bears’ best hope is that merchants will eventually flash some certified stock at the market to remind everyone that prices are getting out of line. But whether that would be enough to shake out spec longs remains to be seen. It may simply force some carry into the market without leading to a reversal of the uptrend. 

Since the shorts are still trapped and specs are long and happy, we may only be in the early stages of this short squeeze and it is therefore impossible to predict when and where the top will finally be in. These situations often end with an explosive move as shorts are being forced out, followed by a crash and burn, similar to what we saw in 2008.

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