Market Comments – April 5, 2018

NY futures ended a volatile week on a high note, as May advanced 111 points to close at 82.57 cents.

On Wednesday the announcement of retaliatory trade sanctions by China prompted a steep selloff, with May crashing through support to an intra-day low of 78.62 cents, before recovering slightly by the end of the session. Volume was very heavy at over 90k contracts, but surprisingly we didn’t see open interest decline by much this morning, as May O.I. was down by only 3,272 contracts, while July O.I was up by 405 contracts.

Since we heard of sizeable mill fixations when the market dropped yesterday, the only explanation for this lower than expected decline in open interest is that specs must have added new shorts when the market broke through technical support. This set the stage for today’s impressive rebound, as wrong-footed specs were forced to cover, chasing the market higher, along with mills who missed their chance to fix yesterday.

What set the ball rolling this morning was a more relaxed view on the China/US trade dispute and another stellar US export sales report. Traders hit the panic button yesterday, after China threatened to retaliate with tariffs on a wide range of goods, including cotton. However, today the market started to downplay the issue, believing that there would be trade negotiations between the US and China over the coming months, while potential tariffs would not be implemented until later this year, if at all.

US export sales were once again beating expectations, which is remarkable since there is not that much cotton left for sale. Total commitments of Upland and Pima cotton rose by 422,200 running bales, with 19 markets buying and 28 destinations receiving shipments of 481,000 running bales. Total sales for the current marketing year have now reached 15.9 million statistical bales, of which 8.65 million bales have so far been exported.

US exports have been on a tear this season and while we will never completely sell out of cotton, we are getting close to it. So far the US has committed 19.25 million bales between exports and domestic mill use until the end of July. Since we started the season with a supply of around 23.55 million bales, it leaves a theoretical balance of 4.3 million bales for sale.

However, export commitments from August onwards are already at 2.95 million statistical bales and domestic mills will need about 0.8-0.9 million from current supplies to tie them over to new crop. We are therefore expecting a slowdown in US export sales from here on forward, simply because merchants will soon have committed most of what they currently own. They could of course continue to sell short, but given the uncertain weather conditions in West Texas we feel that traders are getting more cautious after the experience they had this season with the high percentage of low mike cotton.

Unfixed on-call sales made a little progress last week, as May saw a decrease of  0.35 million bales to 2.32 million bales, while July was basically unchanged at 4.94 million bales. Overall there were still 7.26 million bales of current crop cotton left to fix as of last Friday. However, since there were quite a few fixations made this week, we estimate that the balance is now closer to six million bales. Still a big number, but there is some progress being made.

So where do we go from here? Although the market was able to let off some steam during Wednesday’s break, meaning that mills were able to get some fixations squared away, the dynamics as such haven’t changed. Specs are still around 7.5-8.0 million bales net long and mills still need to fix around 6.0-6.5 million bales. In order for the mills to get out of their positions, they need specs to sell, otherwise prices will eventually be forced higher.

Although financial markets seem to have calmed down when it comes to the US/China trade issue, we still see a lot of economic headwinds out there, like a flattening yield curve or the sharply rising LIBOR rate. It is therefore still possible that speculators decide to play it safe by moving to the sidelines, which would allow the trade to reduce its short position. It all depends who has more urgency to act. On Wednesday the specs wanted to sell, and just a day later they were buyers again, along with the trade.

With the US crop now basically committed, there is no need for the trade to carry a large futures position in current crop, other than shorts against mill fixations. This means that the market will likely get thinner, with spec longs vs. mill fixations dominating the action going forward. If both sides are willing to reduce their positions little by little the market might stay balanced, but these thinner market conditions often lead to increased volatility, especially if one side gets nervous. 


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