Market Comments – October 11, 2018

NY futures closed slightly higher this week, as December gained back 81 points to close at 76.81 cents.

It has been an eventful week with a lot of crosscurrents and so far December has managed to hold above the 7600 support level despite relentless spec pressure.

The latest CFTC spec/hedge report showed that speculators reduced their net long by a rather substantial 1.45 million bales to just 3.59 million bales between September 26 and October 2. Spec selling was a combination of continued long liquidation and new short selling. Large spec accounts that hold long positions continued to decline, from 111 to 104, which compares to 181 accounts in early June.

The trade was on the other side buying 1.33 million bales net and thereby cutting its net short position to 11.47 million bales. Index funds were also light buyers, increasing their net long by 0.12 million bales to 7.88 million bales.

Since early June speculators have liquidated 8.65 million bales net, going from 12.24 million bales to just 3.59 million bales net long. With the spec net long now at a much more manageable level, we should see less selling pressure over the coming weeks, although turmoil in the world’s financial markets might force specs into a net short position. The last time this happened was in early 2016, when speculators went a record 4.49 million bales net short, due to a stock market rout that prompted hedge funds to adopt a “risk off” position.

While turmoil in the global financial markets argues for a defensive posture, since it makes the high mill use number doubtful, we had yet another storm wreaking havoc in the US Southeast this week, which has caused significant damage, both in terms of quantity and quality.

Hurricane Michael hit the Florida Panhandle as a strong Cat 4 storm yesterday and then its track took it right over the main cotton growing areas of SE Alabama, Georgia and the Carolinas. Georgia is the second largest cotton producer in the US with an estimated 2.9 million bales and this storm could not have come at a worse time since almost all of the cotton was open, with only about 20% harvested. The storm still had hurricane force winds as it moved into Georgia and we therefore expect there to be a lot of cotton on the ground or strung out.

Today’s WASDE report was once again a mixed bag. The bulls were happy to see that the USDA finally got rid of Indian ‘phantom stocks’, as it made historical revisions going back to 2002/03 that resulted in a stock reduction of 2.9 million bales. The current ending stocks of 8.98 million bales are 4.35 million bales less than three months ago.

Another bullish factor was the still very high mill use number of 127.76 million bales, which was just slightly lower than last month due to a 200k reduction in Turkey. However, most traders, including ourselves, do not believe this overly optimistic mill use number, especially in view of the recent problems in emerging markets and as of this week in global stock markets.

The bears will point to a slightly higher US crop of 19.76 million bales, despite losses in the Carolinas. Combined with a 200k reduction in exports we now have US ending stocks at 5.0 million bales, up 300k from last month. However, with the devastation from Hurricane Michael we expect US crop and ending stock numbers to decline by around 0.3-0.5 million bales in the next report.

As a result of the Indian stock revision we saw ROW ending stocks drop to 44.58 million bales. But since previous season were revised down as well, ROW ending stocks are still projected to be 1.7 million bales higher than last season and 7.9 million bales more than two years ago. However, the ROW stocks-to-use ratio has improved to 52.29%, which is more or less the same as the 52.11% we had last season.

So where do we go from here? While the US faces losses and quality problems in the Southeast, which accounts for about a quarter of US output, the global economy is confronted with an emerging market crisis, trade disputes and as of yesterday jittery stock markets. While both developments have the potential to move the market, we feel that fear of lower mill use in the wake of all these economic problems carries the greater weight at this point, especially when it comes to speculators, who seem to turn their backs on industrial commodities.  

Therefore, as long as the spec selling continues, it will be difficult for the market to gain much upside momentum. Even though specs are already down to an estimated 3.0 million bales net long by now, it is difficult to gauge how much more selling they are going to do. A lot will depend on how financial markets behave over the coming weeks. If cooler heads prevail and stock markets rebound, we could see the positive mood spill over into commodity markets as well. On the other hand, if the selloff continues and traders increasingly move to a “risk off” position, then cotton will likely continue on its downward trajectory.

However, we still feel that December shorts need to be careful, especially since quality concerns have become more prevalent after Hurricane Michael. With basically the entire Southeast being downgraded in terms of quality, we cannot envision that shippers are going to bring ‘white’ cotton to the board under these circumstances. To the contrary, merchants will probably look at the certified stock as a potential source of supplies! 

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