NY futures moved slightly higher this week, as December added another 60 points to close at 88.83 cents.
Although December’s rally ran out of steam just shy of the 90-cent mark on Wednesday, it has put trade shorts on notice that higher prices might be in store. We are not quite sure what sparked this week’s renewed spec and/or index fund buying, but it seemed to have originated in Asia and then carried over to the US futures market. The increase in volume and the rise in open interest from 25.9 to 26.9 million bales suggest that specs and/or index funds were adding to their net long positions.
Since posting an intra-day low of 81.75 cents about four weeks ago, December has been steadily climbing and is now only a little over four cents shy of its highest close, which was set on June 14 at 92.96 cents. What’s interesting is that it was neither the specs nor the trade that carried the market, but index funds.
The latest available CFTC spec/hedge report as of July 24 - when the market was at 86.70 - shows that the first five cents of the market’s rebound were sponsored by index funds. While index funds bought 0.67 million bales net between July 3rd and July 24th and increased their net long to 8.31 million bales, speculators actually sold 0.49 million bales, thereby reducing their net long to 8.51 million bales. The trade was also a light net seller, adding 0.17 million bales to bring its net short to 16.81 million bales. The next CFTC report is due tomorrow and it will be interesting to see who was behind this week’s strength.
The three main players in the futures market have different motivations. Commodity index fund investors are mainly looking for portfolio diversification and/or an inflation hedge and they are typically operating from a long-term net long position. Speculators and hedge funds may have similar objectives, but they try to profit from momentum and/or trend changes and are much quicker to trade in and out of positions. Like index funds, they are typically net long. The trade uses the futures market primarily for hedging purposes and since it is usually net long in the physical market, it follows that the trade holds a net short position in futures.
At the moment all is relatively calm on the futures front, despite an open interest of nearly 27 million bales. Most of the players are sitting on the sidelines and trading volume has been rather low in recent weeks. However, sooner or later some of these traders will be forced to jump back into action and we are afraid that it might be the trade that will have a greater urgency to act.
Considering that the core of the spec net long position has stayed in the market despite a 14-cent drop from 96 to 82 cents tells us that speculators are not likely to quit their longs anytime soon. The same goes for the index fund long, which is likely to grow in a higher inflation scenario.
The trade on the other hand needs to start worrying about its massive unfixed on-call sales position, which at 15.63 million bales – or 11.26 million bales net if we deduct on-call purchases – is considerably larger than the 10.99 million bales (7.16 net) we had a year ago. Over the last two years the trade has been quite patient with its on-call fixations and the market has rewarded traders for not panicking. But sooner or later mills might run out of luck and get caught in a runaway market, which they will then help to fuel with their fixations.
US export sales remained strong last week, as 328,300 running bales of Upland and Pima cotton were sold for all three marketing years. Shipments continued to lag at 265,300 running bales. Total commitments for the 2017/18-season were at 17.55 million statistical bales, of which 15.70 million statistical bales had been exported as of July 27. With four days of data to go, the final export number will likely be at around 15.85 million bales, or 0.35 million bales shy of the USDA number.
Commitments for the current marketing year (2018/19) have risen to 6.9 million statistical bales, plus an estimated 1.7 million bales that will get carried in from last season, which gives us a total of around 8.6 million statistical bales. For the 2019/20-season there are so far 1.3 million bales on the books.
So where do we go from here? Support looks quite solid in the mid-80s, as the US cotton pipeline will basically be empty by the time new crop arrives, mills have a massive amount of fixations to do, global stocks are decreasing, inflation is increasing, specs and index funds seem to have staying power and demand remains robust. It would therefore take a geopolitical or economic event to flip this market on its head.
The upside is more difficult to assess. As long as there is no problem with one of the major crops, the most likely scenario is that the June highs will not be taken out and that we are going to see a range-bound market somewhere in the mid-to-upper 80s and low 90s. However, the set-up is certainly in place for this market to take off at some point. All that’s needed is a trigger. What comes to mind is a setback on the production side, a further downward adjustment in global stocks by the USDA (India, China) or a sudden agreement between the US and China on tariffs.
For now we go with a range between 85 and 92 cents, but with greater confidence on the support number.
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