NY futures continued to trend higher this week, as May gained 112 points to close at 83.69 cents.
Since rebounding from last week’s trade war scare, the market’s price action has been quite constructive. The primary trend dating back to late October is still bullish and this week the market moved out of a 5-week downtrend channel, which means that the short-term trend is now aligning with a rising market as well. The growing inversion between May and July adds to the bullish sentiment.
Although the “spec long vs. mill fixation” story hasn’t changed this week, we have seen financial markets calm down regarding a potential trade conflict, which makes it more likely for specs to hold on to their net long position. This is not helping the many trade shorts that remain, who need specs to sell in order to avert a squeeze.
The current situation is reminiscent of last season, when we also had a standoff between spec longs and mill fixations. However, a year ago the May contract was at 74.73 cents on April 12 and there were 150 points carry to July. From there the market would eventually spike to a high of 87.18 cents by May 15, just a little over a month later, before specs finally called it quits and liquidated their 10.85 million bales net long all the way down to just 1.29 million bales between the middle of May and the middle of July.
Mills benefitted greatly from the spec exodus last season and they got lucky again in early February, when specs dumped about 5 million bales and allowed mills to fix in the mid-70s. We therefore can’t blame them for expecting a similar outcome this time around, which is why we still have such a large unfixed on-call balance.
Whether history will repeat itself remains to be seen, both in regards to the price rally that occurred between mid-April and mid-May, as well as the subsequent selloff that forced prices down to 70 cents by the time July entered its notice period.
Statistically we are just as tight in the US as we were a year ago. Although we had a 3.8 million bales larger crop this season, we started with 1.05 million fewer beginning stocks and commitments are currently 3.15 million bales larger than last season (2.25 million until July shipment and 0.9 million from August onwards).
The unfixed on-call position as of last Friday still amounted to 6.52 million bales for current crop, of which 1.59 million were on May and 4.93 million on July. Last season we were in better shape, because we only had 0.75 million on May and 4.46 million bales on July unfixed, for a combined 5.21 million bales.
Then there is the spec net long position, which as of last week was at 8.43 million bales vs. 9.63 million bales a year ago. This means that speculators have room to add to their net long position if they were to get some buy signals. By the same token there is also less to liquidate if the market were to turn south.
Lastly there is the certified stock, which currently amounts to just 73k bales, which compares to 325k last season. Given the lower quality of the current crop due to the 3+ million bales of low mike cotton, it would take considerably higher prices to lure cotton into the certified stock.
US export sales remained surprisingly strong considering that there is not that much left for sale anymore, as net new commitments of Upland and Pima cotton increased by 209,200 running bales. There were 21 markets buying, while 25 markets received shipments of 512,100 running bales. The only fly in the ointment was a 119k cancellation by Pakistan, although it is not clear who initiated it. One possibility is that shippers didn’t have the right quality and were forced to cancel.
Total commitments for the current season are now at 16.1 million statistical bales, of which 9.2 million bales have so far been exported. In addition there are 3.0 million bales on the books for shipment August onwards.
The latest WASDE report didn’t contain any major surprises, other than the fact that the USDA is still carrying phantom stocks in China, India and Pakistan. However, the government did make some balance sheet revisions in Brazil and Australia going back six and two seasons, respectively. Maybe they just haven’t gotten around to cleaning up the big origins yet.
So where do we go from here? As we have tried to explain in this report, a year ago the market rallied over 1200 points between now and the middle of May on a less bullish setup. Granted, we are already 900 points higher now, but that doesn’t mean that the market couldn’t get squeezed into the high 80s or low 90s.
Unless specs somehow decide to liquidate a large part of their net long position, we don’t see an easy way out for mills and other trade shorts. Last year specs got spooked by a very bearish new crop outlook, but with West Texas still dry and global production potentially struggling to keep pace with mill demand, the outlook for next season doesn’t currently lend itself to flush out the spec position. Maybe some outside events will do the trick, but if they don’t, then the market will likely move higher.
Open interest in May should be far enough down on Monday that we don’t expect any fireworks over the next week or two. Like last season, we feel that a potential rally to new highs is more likely to happen in July, since there will be no more room to kick the can further down the road. Rolling to December is simply not an option for mills and trade shorts!
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