Market Comments – September 27, 2018

NY futures continued to trend lower this week, as December dropped another 75 points to close at 77.72 cents.

After December had settled the previous seven sessions in a very tight band of just 66 points, between 78.47 and 79.13 cents, the market finally broke through the recent low of 77.90 and settled at a new 5-month low today. Participation was lacklustre though, as the average daily volume was just below 20k contracts this week and open interest continued to slip by 2.2k to 248.6k contracts.

The CFTC spec/hedge report as of Tuesday, September 18 (which included the day the market sold off last week) confirmed that outright spec shorts replaced outright trade shorts, while there was surprisingly little movement in outright spec and trade longs.

Although the spec net long position was reduced by 1.15 million bales to 5.39 million bales, most of the reduction came from new spec shorts entering the market, rather than a reduction in existing spec longs. Outright spec longs were down by just 0.19 million bales to 8.57 million bales, while outright spec shorts increased by 0.95 million bales to 3.18 million bales 

The trade covered 1.07 million bales of its net short position, which dropped to 13.50 million bales. This was mostly due to fixations according to the latest on-call report, as unfixed on-call sales dropped by 0.66 million bales to 14.36 million bales as of last Friday 

The strengthening US dollar in the wake of yesterday’s Fed rate hike was probably the main reason behind cotton’s weakness in the last two sessions. A strong greenback has been weighing on commodities for a while now and that probably won’t change anytime soon. For now the US is boosting its interest rate advantage vis-à-vis other large currency pools like the Euro or Yen, while investors are increasingly shying away from potentially toxic emerging market currencies.

But the future doesn’t look bright for the US dollar in our opinion, since debt levels are starting to grow out of control. The US currently runs a 1.0 trillion dollar fiscal deficit and a 0.6 trillion dollar trade deficit. These twin-deficits are likely to grow closer to 2 trillion dollars annually, as spending and interest on the debt are rising. For example, every 1% increase in interest rates adds over 200 billion in debt service to the budget.

In addition to this growing federal debt there is also a lot of red ink when it comes to states, municipalities, corporate and consumer debt, not to speak of underfunded pension liabilities and increasing social security payments. As long as the US economy is in expansion mode and the cost of money remains historically cheap, these debt levels may be manageable. But sooner or later another recession is going to hit, while the cost of money continues to increase due to the enormous debt load that needs to be financed. In such a stagflationary scenario the US dollar will likely take it on the chin. It is difficult to time such an event, but there are already some early warning signs (soft housing market, political tensions, trade war).

US export sales of 135,800 running bales for both marketing years were about the same as last week, while shipments of 143,700 running bales were slightly lower. Total commitments for the season have now reached 9.6 million statistical bales, of which 1.3 million bales have so far been exported. For next marketing year we have so far 1.55 million statistical bales on the books.

As pointed out before, with 13 million statistical bales in commitments (9.6 export and 3.4 domestic) and a large part of the US crop still out in the field, merchants are reluctant to sell additional qualities. The Carolinas suffered massive quantity and quality losses, parts of the Delta have seen unwelcome rain lately and the West Texas crop is still exposed in the field, which means that it will take a while before the outcome of the US crop is known, both in terms of size and quality. For this reason we expect US export sales to remain slow until the crop has been harvested.

So where do we go from here? It is important to point out that the recent weakness in the market was mainly caused by new spec short selling, after the market broke through the 200-day moving average. Although spec longs have been gradually reducing their long exposure since early June, there has been no panic selling on their part yet.

The good news from a bullish perspective is that the spec net long position has already been whittled down to just 5.39 million bales, which is a lot less threatening than the 12.23 million we had four months ago. While specs might continue to be net sellers since the primary trend is down, the 14.36 million bales in unfixed on-call sales should provide plenty of support underneath.

Although the break below 7800 has opened the door for a move to 7600, we still feel that the market is in a new trading range of somewhere between 76-81 cents. 

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