Market Comments – July 5, 2018

NY futures continued to lose ground, as December gave up another 159 points to close at 81.96 cents. 

Not much has changed during this holiday-shortened week, as the market continued to drift lower on some light spec liquidation. Average daily volume was slightly better at nearly 24k thanks to the Planted Acreage Report and end of quarter activity, but it still feels like the summer doldrums. Open interest dropped by 2k to just under 255K, which is still represents a record for this date. 

Markets don’t like uncertainty and right now there is plenty of it between the US/China trade dispute and trying to figure out how Northern Hemisphere crops might turn out. Unless there is a last minute solution, tariffs on USD 34 billion worth of Chinese goods will go into effect tomorrow, with China likely to retaliate immediately with a similar measure. 

Although this represents only a small amount of the trade between the two nations, traders fear that this might be the opening salvo of a potentially long and arduous trade war. It will almost certainly lead to some disruptions and higher cost in the global supply chain and it could rattle financial markets. 

Overpriced financial assets, who are already facing headwinds from rising interest rates, might get pushed over the edge by these dampened spirits on the trade front. As we all know, perception often trumps reality when it comes to markets, and a trade war might just turn into the proverbial needle that pricks financial bubbles.

The USDA Planted Acreage Report came in below the market’s expectation at 13.52 million acres, producing a quick flash-in-the-pan rally all the way up to 8700, which had no legs since neither spec nor trade buyers were willing to pay up. Last year 12.61 million acres got planted and a relatively high 11.10 million acres were harvested.

Texas accounts for 7.4 million of these planted acres, which is 55% of the total. Due to the ongoing drought in Texas we will likely see a much higher abandonment number this season, which could drop harvested acreage for the US into the 10-11 million acres range. However, while Texas is struggling, the crops in the Mid-South and Southeast are on average doing quite well and we would therefore still go with a crop of around 18.5 to 19.0 million bales at this point.

So where do we go from here? The market’s focus is currently on the US/China trade dispute. So far we have seen the stubbornly high open interest as a bullish argument, as spec longs have shown resilience despite spot futures dropping from 96 to 82 cents over the last four weeks.

However, if financial markets were to react negatively to the tariff issue and if there were suddenly signs of an economic slowdown, this large spec net long position could quickly turn into a liability. The market has been unable to claim back the 50-day moving average and is now approaching long-term trendline support near 8100, which is also where the 100-day moving average (81.23) is located. A breach below this important support area would likely trigger substantial sell-stops by the spec sector. 

Trade support from more than 14 million unfixed bales is likely going to slow down the decline, but as we have seen last season, when specs start flushing their positions, trade buying tends to pull back, giving the market plenty of room to overshoot to the downside. 

Until we have more clarity on what the fallout from this seemingly inevitable trade war is going to be, we feel that it is time to play defense! September put options (expiry August 17) offer a good and relatively cheap way to protect against the bottom falling out. 

 

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