Market Comments – February 23, 2018

NY futures rebounded during this holiday-shortened week, as May jumped 270 points to close at 79.47 cents.

The market broke out of a descending flag formation this week and the ensuing new spec buying combined with some trade short-covering propelled the May contract back towards the 80 cents level. This rebound has stopped any further spec net long liquidation for now and it also served as another wake-up call to mills, who were getting a bit too nonchalant with their fixations. 

When we look at what happened with open interest in the two sessions the market rallied, we notice an increase of 6,014 contracts in May and 1,559 contracts in July. This suggests that specs were adding new longs, while the trade increased its short. We therefore have to assume that not much progress has been made on the fixation front and that the trade is getting ready for another showdown with speculators. 

The March liquidation continued in an orderly and speedy manner and as of this morning there were just 1,015 contracts (=101,500 bales) left to be squared away. So far there have been 485 original notices (=48,500 bales) issued, which amounts to roughly half of the current certified stock of 93,388 bales. In other words, the March notice period has quickly turned into a non-event.

The latest CFTC spec/hedge report, which reflects positions as of February 13, showed another large drop in the spec net long position. Specs liquidated another 1.28 million bales net and were just 7.25 million bales net long. That’s 4.8 million bales less than on January 23, or just 3 weeks ago! 

The trade bought back 0.91 million bales, but was still 15.05 million bales net short, while index funds bought 0.36 million bales to increase their net long to 7.80 million bales. That’s the largest index fund position in 5 years and confirms that investors are moving money back into commodities.

On the fundamental front there aren’t many new developments at the moment, other than some doubts about the final size of the US crop and worries about drought conditions in the US Southwest. So far there have been around 19.75 million statistical bales classed, which means that in order to make the US crop estimate of 21.26 million statistical bales, we still need to see another 1.5 million bales. Yesterday there were still 27.5k bales classed, but since we are almost in March now, we wonder whether there still is a backlog of over a million bales out there.

As for next season’s crop, there is currently a drought developing in the Southwest, which raises concerns regarding abandonment and yield in West Texas and Oklahoma. After two bumper crops, will this be the season where yields revert to the mean, or worse? Yields for Upland cotton reached 793 pounds/acre this season and 748 pounds/acre last year in Texas, while in the previous four seasons they were in a range between 610 and 646 pound/acre. It will be an interesting growing season!

Although the US stock market has rebounded over the last two weeks, we are starting to see some cracks appear in the US growth story. With fiscal and trade deficits expected to reach 1.5 trillion dollars annually and with the Fed threatening to reduce its balance sheet, interest rates are headed higher. This could put the brakes on an economy that was just starting to gain some traction. Consumers are not nearly in as great a shape as analysts want us to believe, otherwise the savings rate wouldn’t be at a 10-year low and credit card at an all-time high. 

It all points to “stagflation”, not just in the US, but in other major economies as well. It is difficult to gauge what that would mean for cotton prices, because the ‘stagnation’ part would be bad for consumer spending, while the ‘inflation’ part might still cause prices to rise. 

So where do we go from here? As mentioned last week, we see the current constellation in the spec/hedge position as supportive to prices. The trade still has to fix around 7 million bales of on-call sales on May and July, among other shorts that need to be bought back until the middle of June, but unlike last year the spec net long position is a lot smaller now.

In other words, unless the specs provide the necessary sell-side liquidity, which is doubtful at this point, the trade will find itself in of a bind. This means that prices should remain well supported in the high-70s, with occasional spikes into the low-to-mid 80s. 


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