Market Comments – September 20, 2018

NY futures fell through key support this week, as December dropped 304 points to close at 78.47 cents.

After December had closed 25 consecutive sessions in a tight range of just 311 points, the escalating trade tensions between the US and China finally forced the market through the last line of support, the 200-day moving average, which triggered a wave of sell-stops. Futures volume of 56k, along with 29k options, was the heaviest since August 13, when the market fell over a cliff after the August WASDE report.

Surprisingly Tuesday’s collapse didn’t lead to the expected reduction in open interest. Since the selloff was likely triggered by spec long liquidation, while the trade was covering shorts (fixations) on the way down, we would have expected to see a significant drop in open positions. Instead December open interest was merely down 942 lots, while total open interest actually rose by 405 lots to 255.4k contracts.

This means that while some speculators got stopped out, other specs and/or members of the trade must have established new longs. And on the sell side there might have been new outright spec shorts replacing trade shorts. Paradoxically we saw open interest drop by a little over 3k during yesterday’s rebound session. But the message that open interest seems to convey is that there is no mass exodus of positions as might have been feared and that this was simply a washout that moved the market to a slightly lower trading range.

US export sales continued at a relatively slow pace last week, as new sales of Upland and Pima cotton amounted to 134,400 running bales for both marketing years. The sales were spread among 17 markets, while 21 destinations received shipments totaling 157,600 running bales. For the current season we now have total commitments of 9.5 million statistical bales, of which 1.15 million bales have so far been exported. For the next marketing year we currently have 1.5 million bales on the books, which is around twice as much as we had a year ago.

There was some talk earlier this week that Turkey and possibly some other emerging markets might cancel existing US contracts, which seemed to add to the negative sentiment. However, when we look at outstanding contracts, we notice that Turkey has currently only 217,600 running bales open, which amounts to less than 3% of the total. We don’t think that potential cancellations are the problem, but rather that Turkey might not be able to buy as much cotton as it did as last season, when it imported around 1.8 million running bales of US cotton.

When we analyze what markets have the largest outstanding balance when it comes to US exports, we have China leading the way with 1.86 million running bales, followed by Vietnam with 1.59 million, Mexico 0.87 million, Indonesia 0.80 million, Bangladesh 0.62 million and Pakistan with 0.53 million bales. These six markets combine for 6.27 million bales, or about 78% of the 8.08 million running bales that have yet to be shipped. At this point we don’t expect any of these markets to cancel substantial amounts of US cotton.

Never before did the US have 8.35 million statistical bales in outstanding sales on the books by the middle of September, not even in the historic 2010/11-season, when there were 6.87 million bales open at this date. Usually the US finds itself more in the role of residual supplier than front runner, but due to an increasing number of mills preferring machine picked cotton and buying on-call, the US has been able to leap ahead of its competition.

This means that with total commitments of 12.9 million statistical bales (9.5 export + 3.4 domestic mill use), the US can relax and doesn’t need to engage in a price fight with some of the other exporters, who are now trying to get a piece of the action. Since India, which is the 4th largest exporter after Brazil and the West African group of countries, has a minimum support mechanism that will start to absorb a large amount of new crop cotton if prices were to drop further from here, we don’t see there to be lasting pressure on prices.

In the end it all comes down to demand though, as always! As mentioned last week, if mill use were indeed at 128 million bales as currently projected by the USDA, then every last bale of exportable cotton would be needed and prices would eventually rebound during the second half of the season. However, since we believe, along with a growing number of traders, that this demand number is pie in the sky, the more likely scenario is that supply and demand will be more evenly matched during this season, which should keep prices in relatively stable range.

So where do we go from here? After we saw some weakness in fundamentals recently, the technical side followed suit this week by crashing through key support. For now it looks like this was just a necessary washout that realigned futures prices with reality. The fact that open interest held relatively steady, export business picked up and that there were still 15 million bales to fix as of last Friday gives us some confidence that the market has simply moved to a lower trading range of somewhere between 76-81 cents, rather than the beginning of a cascade in prices.

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