NY futures closed a volatile week with losses, as May dropped 131 points to close at 75.87 cents/lb.
This week’s trading was dictated by spec buying (mostly short-covering) into trade selling, as speculators felt compelled to reduce their short exposure after the market had broken through key resistance last week, while the trade used the opportunity to bolster its insufficient hedge position.
A look at open interest confirms this, as May O.I. has dropped by nearly 2.8 million bales since March 5, when the spot month was still trading at around 73 cents. While specs were covering and/or rolling their May positions, the trade has added shorts in the back, as July O.I. grew by 1.5 million bales and December O.I. went up by nearly 1.4 million bales. Overall open interest didn’t change by much, as it inched up from 22.4 to 22.6 million bales.
The latest CFTC report for the week of March 13-19, during which May had traded in a relatively narrow window between 74.02 and 76.35 cents, showed a big exchange between spec and trade shorts. While speculators bought 1.07 million bales net and reduced their net short to 1.09 million bales, the trade boosted its net short by 1.03 million bales to 5.95 million bales. Index funds accounted for the remaining 0.04 million bales in net sales to bring their net long down to 7.03 million bales.
What we may have underestimated is how aggressively the trade has been shorting into this recent advance. That specs would cover a sizeable amount once the market broke through resistance was expected, but we felt that the trade would be a more patient scale up seller and thereby give the market more room to possibly push into the low 80s. But as the CFTC report and recent market action have shown, the trade didn’t waste any time to increase its net short position.
Since trade selling has been more active in the back months and December has become somewhat of an anchor due to its bearish new crop outlook, it has put the brakes on May and July via the spread. As pointed out last week, a runaway May or July would only make sense if it could be argued that US cotton is basically sold out and that therefore no carry is needed anymore. But since there is still plenty of unsold cotton around, even a sharp reduction in the certified stock from 131k to 47k bales hasn’t convinced the market that there might be a shortage of cotton anytime soon.
The problem with inversions is that they entice mills to play the ‘stretching game’, by running inventories as tight as possible in order to benefit from cheaper new crop pricing. This is especially true in a season like this, where new crop promises to bring plenty of supply and the economic outlook is full of uncertainty.
The recent inversion of the US yield curve (10-year bond yield moving below the 3-month yield) and the unexpectedly dovish stance by the Federal Reserve have added to the market’s fear that a recession might be on the horizon. The yield inversion was the first since 2007 and over the last sixty years it has been a reliable predictor of slowing economic growth. This seems to have weighed on commodity markets this week.
On a more positive note, US export sales came in at a surprisingly strong 427,400 running bales of Upland and Pima cotton for both marketing years. Participation was widespread with Vietnam, China and Turkey leading the pack. Shipments were strong as well at 388,300 running bales. For the current season we now have commitments of 13.6 million statistical bales, whereof 7.3 million bales have so far been exported. For the following marketing year sales have increased to 2.65 million statistical bales.
So where do we go from here? After rallying to the 78 cents level earlier this week, the market ran into a wall of trade selling and was forced to pull back to the breakout zone near 7600 (former downtrend line which is now support and 100-day moving average at 76.22). We often see markets test support or resistance before resuming a trend and we shall therefore give the market the benefit of doubt.
Tomorrow’s US Planting Intentions report and the end of the first quarter should make for a lively session and determine the next move. However, while the market is on knife’s edge from a technical perspective, near-term fundamentals seem to be supportive, as export enquiry has been quite active in a number of origins. Not only have we seen China in the mix lately, but India is expected to come to the market as an importer this summer due to its tight statistical position.
In other words, unless we see fears of a recession intensify, we feel that the market doesn’t have much downside. If support holds on the weekly chart tomorrow, we could see the market resume its uptrend early next week.
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