Market Comments – May 17, 2018

NY futures moved slightly higher this week, as July gained 47 points to close at 85.03 cents.

The market continued to trend sideways, as it is still waiting for either the spec longs or trade shorts to make a decisive move. The July contract has closed all but 6 out of the last 59 sessions - dating back to February 23 - in a relatively tight band between 81.00 and 85.00 cents. The only exceptions were the one-day dip on April 4, when the US-China trade dispute threatened to escalate, and last week’s spec-sponsored rally to new contract highs.

Open interest has remained stubbornly high, as there were a total of over 286k contracts open before today’s session, of which 131k were in July. That’s the highest total open interest ever for this date, about 22k more than last season and 98k more than in 2016. What this tells us is that speculators and index funds are still holding on to their net longs and even keep adding more, while trade shorts are still hoping for the market to finally break, like it did last season.

A year ago the market peaked around this time and speculators started to dump their  positions, which dropped the overall open interest from 264k down to just 200k within five weeks. However, we get the feeling that speculators and index funds have more staying power this time around, since the outlook for new crop is a lot more supportive than last year.

There is currently plenty of uncertainty surrounding the three largest production areas around the globe. China’s Xinjiang province experienced some cool and wet conditions over the last couple of weeks, which has helped to boost the Chinese futures market. Opinions still vary widely as to what acreage India will commit to cotton over the coming months, after some areas have experienced seed and insect problems last season.

Then there is Texas, which is a study in contrasts. In 2011, which was a devastating drought year, Texas planted 7.55 million acres, but harvested only 2.85 million acres, producing a crop of just 3.5 million bales. Last season Texas planted 6.9 million acres and harvested 5.5 million acres, producing a crop of 9.27 million bales. In 2011 the yield amounted to a paltry 589 lbs/acre, while last season we got 809 lbs/acre.

So what will it be this season? As we can see from the 2011 example, planted acreage doesn’t mean much if there is a lack of moisture to grow the crop. The last two seasons were exceptional production years for Texas, with yields of 748 and 809 lbs/acre, respectively. In the previous five seasons (2011-2015), the yield ranged between 589 and 646 lbs/acre.

Even though West Texas has been getting some moisture this week from thunderstorm activity and more rain is hitting the ground as of this writing on Thursday afternoon, we can’t lose sight of the fact that West Texas remains in a ‘severe to exceptional’ drought. Therefore, even if West Texas were to receive some more rain over the next couple of weeks that allowed farmers to get the crop going, it will most likely be a difficult growing season. In other words, rather than counting on near record yields again, we have to assume that it will be an average season at best.  

If we were to say that Texas manages to harvest 5 million acres with a yield of 650 lbs/acre, then we would look at a crop of 6.77 million bales, or 2.5 million bales less than last season. Until a couple of years ago, these assumptions would have been considered above average, but we got a bit spoiled by the back-to-back bumper crops we saw over the last two seasons.

While the potential size of the next crop is still up in the air, current and future supplies continue to sell like hot cakes as the latest US export sales report showed this morning. Total sales of Upland and Pima cotton for both marketing years amounted to 384,700 running bales net last week, despite cancellations of 35,000 bales. There were still 19 markets buying, while 27 destinations received shipments of 434,400 running bales.

Total commitments for the season have now reached 17.2 million statistical bales, of which 11.4 million bales have so far been exported. Sales for August onwards are already at 4.3 million statistical bales. As explained last week, we keep selling more and more cotton that has yet to be produced and this is creating a lot of pent up demand for early arrivals. For this reason it is difficult to see December coming under too much pressure, even if the crop were to turn out better than expected.

As the CFTC spec/hedge report showed, it was additional spec buying that rallied the market to new contract highs last week. Specs added over 1.3 million bales during the week that ended on May 8, thereby increasing their net long to 11.23 million bales. With the market since selling off, many of these new spec longs were wrong-footed and had to get out, which has put some pressure on the market and allowed mills to reduce their unfixed on-call sales slightly.

The latest on-call report showed that there were still 4.96 million bales unfixed on July as of last Friday, which is a considerable amount since only about 4 weeks remain to square these fixations away. Additionally, there are already 11.34 million bales in unfixed on-call sales from December onwards, which will act as a strong layer of support below the market.

So where do we go from here? The market is still caught between a large spec net long position and a sizeable trade net short position, with neither side ready to blink just yet.  However, as already mentioned, over the next 3-4 weeks mills will have to fix nearly five million bales on July, which has the potential to put upward pressure on the market.

We feel that unlike last year, speculators will hold on to most of their net long position by rolling it forward to December, rather than getting out of the market. The trade has so far been keeping pace with specs rolling to December, but we feel there is a limit as to how much the trade can replace July shorts with Dec shorts. We therefore expect there to be a point at which net buying will become the stronger force. At best the trade can hope for a continuation of the trading range from let’s say 81-86 cents, but there is still considerable risk for a final blow-off move.

 

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