Market Comments – October 4, 2018

NY futures continued to fall this week, as December dropped another 172 points to close at 76.00 cents/lb.

December continued to stair-step lower, as it was unable to hold last week’s support at 7800 and is now trying to hang on to the 7600 level. With a few exceptions daily volume is still mostly below 20k contracts and open interest has remained relatively stable at 251k, which is about the same as it was in late August, when prices were at 82-83 cents.

The CFTC spec/hedge report as of Tuesday, September 25, showed further reductions in the spec net long and trade net short positions. Specs reduced their net long by 0.36 million bales to 5.04 million bales, while trade shorts covered 0.7 million bales net and were just 12.81 million bales net short overall. Index funds cut their net long holdings by 0.34 million bales to a 7.77 million bales net long. 

In other words, we are seeing reductions across the board, as cotton seems to lose its lustre. Total open interest in Futures and Options (delta-adjusted) has now declined from 44.04 million bales in early June to 34.37 million bales as of last week. A lot of large specs (hedge funds, CTAs) have left the game over the last four months, as reportable spec accounts carrying long positions have dropped from 181 to just 111.

So far specs have gotten out in an orderly fashion, steadily reducing their net long position from 12.24 million bales to just 5.04 million bales since May 29. But this net long liquidation of 7.2 million bales has forced the spot futures contract roughly 20 cents lower since we made a high of 96.40 on May 30. Unfortunately there is no telling when the bleeding will finally stop, as specs continue to exit positions and the trade is still only a cautious scale-down buyer despite 13.99 million bales in unfixed on-call sales.  

Emerging market currencies continued to decline, with the EM currency index slipping 0.6 percent today, which is the weakest showing since August, when the Turkish lira collapsed. Among the biggest movers were the Indonesian rupiah, which fell to a new 20-year low of 15,168 to the dollar (down from 13,570 at the beginning of the year) and the Indian rupee, which traded to an all-time low of 73.70 (down from 63.85 at the beginning of the year). The US dollar continues to gain strength across the board, as capital flight and rising US rates continue to boost the greenback for now.

US export sales were labelled as “disappointing”, as just 116,100 running bales of Upland and Pima were added for both marketing years. What caught traders’ attention was China deferring 90,200 running bales from the current to the next marketing year. Nevertheless, there were still 14 markets buying, while 22 destinations received shipments of 184,100 running bales. For the current season we now have sales of 9.5 million statistical bales, of which 1.5 million bales have so far been shipped. Additionally there are about 1.7 million statistical bales on the books for next marketing year.

So far the US has classed around 1.5 million bales of new crop cotton, plus we had beginning stocks of 4.3 million bales on August 1. From that we need to deduct 1.5 million bales, which have already been exported as well as 0.6 million bales for domestic mill use in August and September. This gives us a current inventory of around 3.7 million statistical bales. Against that we have 8.1 million bales in outstanding export commitments, 2.8 million bales in domestic mill use between now and July, plus an estimated 1.8 million bales that will get shipped to foreign and domestic mills from current crop supplies during the August to October 2019 period.

If we add it all up we get 12.7 million statistical bales in outstanding commitments, or 9.0 million bales more than we currently have in existence. We are not suggesting that this is a problem as such, since there are still around 18 million bales more to come in, but we don’t know the quality of most of this cotton yet. Therefore, merchants are quite reluctant to extend their commitments at this point, especially since we already had some quality issues in the Carolinas and in some pockets of the Mid-South and South Texas. The big unknown is West Texas, where the crop is still out in the field for the most part.

As we have learned from previous seasons, to get a large crop moved in, classed, applied and then shipped out to domestic and foreign mills can turn into quite a logistical scramble. With a record amount of outstanding commitments on the books, there are likely going to be some pipeline bottlenecks between November and February, which is one of the reasons why we are not too negative on December at the current level.

We are just about to end the longest stretch between delivery periods - the five months between the end of June and the end of November – as cotton futures will once again be forced to reconcile with the cash market next month. In other words, given the expected supply bottleneck starting in November, we feel that the shorts need be careful not to get caught in a delivery trap. Based on what we know today, we can’t see how it would be  profitable to ship cotton to the board at 76 cents or less and the more the market slips from here, the greater the odds for strong takers to emerge.

So where do we go from here? Although this listless market seems to suffer ‘death by a thousand cuts’, as speculators are leaving the game and the cash market feels anaemic, we believe that things are going to get a lot more lively as we head into the final weeks of the December contract.

Although we are still waiting for trade support to kick in, we now feel that we are not far from this finally happening. The India MSP level has been slipping a bit due to the weakening rupee, to perhaps 74-75 cents basis NYF, but it is still there. Then there are the 2.8 million bales in unfixed on-call sales on December and the issue of the certified stock, which we have discussed above. All these elements should slowly but surely combine to stronger trade support, while the remaining spec net long position of just 5.0 million bales is a lot less threatening now than it was four months ago. In other words, we are cautiously optimistic that the market can stop the bleeding and it might even give us a bit of a bounce.

What could derail our optimism is a further deterioration in emerging markets accompanied with growing worries about an economic slowdown in the developed world. We shall therefore keep a watchful eye on these developments!

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