Market Comments – March 7, 2019

NY futures ended a volatile week slightly higher, as May gained 29 points to close at 73.11 cents/lb.

Renewed rumors about an impending US/China trade deal pushed the May contract to a 4-week high on Tuesday, but there wasn’t any follow-through buying to keep the momentum going.  May has now closed the last 51 sessions dating back to December 21st in a 463-point trading range, between 71.11 and 75.74 cents. Today’s settlement price sits right in the middle of this sideways trend.

The latest available CFTC data for the week of February 20-26, during which May traded between 71.85 and 75.16 cents, showed that speculators were net buyers of 0.33 million bales, thereby reducing their net short position to 2.47 million bales. The trade on the other hand extended its net short position by 0.25 million bales to 5.07 million bales, while index funds sold 0.08 million bales to reduce their net long to 7.54 million bales.

Outright spec shorts continued to grow and measured 7.71 million bales, which is approaching extreme levels. Only in 2007, 2015 and 2016 did specs carry a higher outright short position and every time it was followed by impressive short-covering. In early March 2016 the outright spec short position amounted to a record 10.7 million bales and over the following five months specs proceeded to buy around 14 million bales net between short-covering and adding new longs.

Could we see a similar move this time around? The short answer is yes, but it might take a while until a catalyst finally forces specs into action. The two potential triggers that come to mind are a favorable US-China trade deal and/or the market moving above the long-term downtrend line.

There were plenty of rumors about a trade deal being close, which got the market excited earlier in the week. It is quite possible that an agreement on agriculture will be announced over the coming weeks, but as always, the devil will be in the detail. If, as some rumors claim, China were to move away from a quota system and opened its doors to imports at a minimal tariff of let’s say 5% (as has been rumored), then it would have bullish implications for US cotton.

For many years we have operated with two cotton markets – China and the ROW (rest of the world). The Chinese price level has been considerably higher than that of the ROW, with the CC-index typically being some 20-30 cents above the A-index. We currently have the CC-index at around 104 cents, while the A-index is 22 cents below that at 82 cents. Since China has so far controlled how much ROW cotton can flow into China, the local price level has not been affected by imports.

This would change if cotton was allowed to flow unrestricted (apart from a small tariff) into China. Under such a scenario Chinese and ROW prices would probably meet each other somewhere in between, as Chinese prices would be forced lower while ROW prices would appreciate.

While this may be good news for cotton exporters, it could have a negative impact on yarn exporters to China, since they would no longer be shielded by a 20-30 cents price advantage compared to their Chinese counterparts. In other words, if the trade deal lives up to the current expectations, it will have far reaching implications for the cotton and yarn trade.

US export sales were about as expected this morning at 154,800 running bales net for both marketing years, but the market reacted negatively. Shipments weren’t bad either at 387,300 running bales, but we need them to average about 393k in order to make the current export target of 15.0 million statistical bales.

Total commitments are now just shy of 13.0 million statistical bales, of which 6.2 million bales have so far been exported. For the coming season there are around 2.4 million bales on the books.

If we add the 3.2 million bales in domestic mill use to the current export commitments, we arrive at 16.2 million bales sold, which compares to a total supply of 22.7 million bales (4.3 beg stocks and 18.4 crop). This leaves around 6.5 million bales, although around 2.0-2.5 million will be needed for US and foreign commitments from August onwards. In other words, we estimate the current unsold US stock at around 4.0-4.5 million bales.

So where do we go from here? We already talked about the trade’s need to increase its net short position over the coming months. Since the specs and the trade can’t be net sellers at the same time, we need the specs to start covering shorts in order to accommodate the anticipated trade selling.

Speculators do indeed have a rather large outright short position of nearly 8 million bales, but will they give it up anytime soon? The trade hopes for a China deal and/or a cross over the downtrend line (currently running through around 7600) to act as catalysts for spec buying, but at the moment this is still wishful thinking.

However, a China deal may only be weeks away and if the market continued to move sideways for a few more weeks, it would eventually catch the long-term downtrend line. In other words, a bullish trigger may not be that far off, but in the meantime the market is testing the bulls' patience.

Although the market remains in a medium-term sideways trend within a long-term downtrend channel, we see the odds for a breakout to the upside increasing. 

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