NY futures continued to slip this week, as March dropped 173 points to close at 76.62 cents. After falling 637 points in just six sessions from January 22-30, the market has since transitioned into a sideways pattern, closing the last seven sessions in a range of 239 points, between 75.96 and 78.35 cents. Trading action has become a lot more two-sided, with strong support from mill fixations being evident near the 7600 level.
The latest CFTC on-call report showed that mills have indeed taken advantage of this steep drop in the market, as they reduced the unfixed balance in March to just 1.79 million bales as of last Friday. Unfixed on-call sales in May went down to 3.59 million bales, while July saw a small increase to 4.16 million bales.
In total there were still 9.54 million bales unfixed as of last week, which is nearly identical to what we had a year ago, when 9.48 million bales were still open on the same date. March is actually in better shape this season with just 1.79 million bales vs. 2.86 million bales last year, while May and July still have more on the books, with 7.78 million bales this season vs. 6.63 million bales a year ago.
US exports sales gave the market a boost this morning, as a combined 528,600 running bales of Upland and Pima cotton were sold for both marketing years. Participation was once again broad-based with 24 markets buying and 27 destinations receiving a marketing-year high 453,300 running bales in shipments.
With still half a year to go in the marketing year, total commitments have now reached 13.0 million statistical bales, of which 5.2 million bales have so far been exported. Only in 2011 did we have more sales at the halfway mark! For next marketing year there are already 1.8 million statistical bales on the books, which are a million bales more than a year ago. As explained last week, sales will likely remain strong going forward, as merchants are trying to place as many bales as they can before the price resets this summer.
However, while this fierce pace of export sales may give the market a bullish appearance, the slow pace of shipment isn’t! Although shipments finally went into high gear last week, outstanding sales of 7.8 million statistical bales are around 2.8 million bales larger than they were a year ago. This means that there is a lot more cotton that mills still need to receive and spin into yarn over the coming months. Furthermore, Brazil and Australia are expected to harvest about 1.4 million bales more than last season, which adds further to the supply between now and new crop. In other words, while we may see offers dry up due to the advanced pace of sales, there won’t be any shortage of cotton in the system anytime soon!
Today’s WASDE report didn’t do much to the market, with a few minor changes resulting in a slight decline in ROW ending stocks from 38.40 to 38.21 million bales. However, the USDA still refuses to address the elephant in the room, which are its overstated ending stocks in China and India.
It has been a while since we talked about a potential “risk off” move by hedge funds, but the precipitous drop in the US and other major stock markets could spill over to commodities. Until last week stock markets were priced for perfection and volatility was at the lowest reading in history. Hedge funds had placed large levered bets on low volatility, as well as an inverse relationship between equities and bonds. In other words, they believed that if bond prices went down, equities would rise.
However, not only did volatility explode, but we now have a situation in which both bonds and equities are falling. This has led to significant losses and massive margin calls in a matter of days and we are now seeing the unwinding and paring down of these bets. It is impossible to know how big the problem really is, but we have a feeling that some hedge funds and potentially a bank or two could be in serious trouble.
So where do we go from here? The market has a lot of similarities to last season, as price, open interest and the amount of unfixed on-call sales are nearly identical. However, although export sales are ahead of last season, there is more cotton available, both in the US and on a global basis, which should keep a lid on prices.
Last season the market traded range-bound in the mid-to-upper 70s between now and May, then spiked into the mid-80s before finally collapsing in June. We might see a similar playbook this year, although a lot will depend on what the specs do over the next few weeks.
If speculators hold on to most of their remaining net long, then the market will likely be well supported over the coming months and follow in the footsteps of last season. However, if financial markets deteriorate further and hedge funds adopt a ‘risk off’ attitude, then the market will continue to trend lower.
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