NY futures continued to push higher this week, with December adding another 114 points to close at 66.93 cents/lb.
Since last Wednesday’s key reversal the market has now gained nearly 600 points, which is rather impressive considering what is going on in other commodities and emerging markets.
The latest CFTC report confirmed that it was heavy spec selling that had pushed values to a six-and-a-half month low before the USDA report. During the week of August 3-9 speculators sold a total of 2.0 million bales net, thereby reducing their net long exposure to just 1.8 million bales net. The trade was on the other side, buying back 2.0 million bales net to cut its net short position to 8.4 million bales. Meanwhile index funds maintained their net long of 6.6 million bales.
Interestingly, open interest did not change much despite these large net reductions in spec and trade positions, because speculators took over short positions from the trade, while the trade swapped longs with speculators. In other words, outright short positions of 17.0 million bales (specs 3.9 million/trade 13.1 million bales) were still quite large as we headed into the USDA report and that provided the fuel for the rally.
Speculators have probably been the most aggressive buyers since last week, covering shorts and entering new longs, while the trade was primarily a seller at these higher levels. However, since growers are still not letting a lot of new crop cotton go, the trade doesn’t have the ammunition to counter the all this spec buying. Merchants typically need to be able to accumulate long positions in physicals in order to justify selling additional volume in the futures market, but with the uncertainty surrounding the US crop there is not much cotton in play right now, or only at unrealistically high levels.
From a valuation point of view the futures market is becoming overextended, because at a 1400 on basis it would currently cost over 80 cents to land US high grades in the Far East, which is a level that mills are not prepared to pay today. By comparison, Indian high grades are about 9-10 cents cheaper, which is probably why the CCI has recently been able to sell large chunks of its inventory. So far the CCI has managed to auction off nearly 5.0 million domestic bales out of a total of 8.7 million bales.
It is therefore no surprise that US export sales have been sluggish lately, with net new sales amounting to only 54’000 running bales during the week of August 7-13, split among 16 different markets. Additionally there were another 2’400 bales sold for 2016/17. Shipments of 123’800 running bales were not bad considering that there is not much inventory left to choose from. Total commitments for the current marketing year now amount to 2.7 million statistical bales, of which a little more than 0.2 million have so far been exported. Current sales are lagging those of last season by about 2.2 million bales.
A few weeks back we had talked about the financial problems many emerging markets are facing and unfortunately the situation seems to be getting worse. Last week China joined the currency devaluation game and today Kazakhstan saw its currency drop by more than 20% in one day, while the Turkish Lira fell to a historical record low against the greenback. It looks like emerging market currencies are in a race to the bottom, be it the Russian Ruble, the South African Rand or the Brazilian Real, just to name a few.
We believe this has the potential to spread into another global financial crisis. So far an estimated one trillion US dollars has been pulled out from emerging markets over the last five quarters and this capital flight is not going to end anytime soon. The more money leaves, the more these currencies come under pressure and the more difficult it becomes for some countries to service their debt burdens, which are often pegged in US dollars. Import prices soar and that puts a damper on growth, which in turn puts pressure on asset prices such as stocks and real estate. As a result many of these emerging markets are turning into submerging markets and slip into recession.
This is bad news for cotton consumption! We already mentioned last week that the USDA’s global mill use number of nearly 115 million bales is wishful thinking under these conditions and that we may be lucky to get somewhere around 111 million bales. Just for reference, in the previous four seasons global mill use ranged from 104.1 to 111.8 million bales. We therefore expect a gradual scaling down of global mill over the course of the season, which has bearish implications.
So where do we go from here? The cotton market is torn between a potentially bullish weather scenario and a rather pessimistic outlook on demand.
The odds are indeed high that we will experience a stormy and wet harvest in the US, which has the potential to reduce both size and quality. The Indian crop has been on the dry side as well, which could lead to lower than expected output. However, unless we see production figures drop significantly below current estimates, we are not sure that it matters. Demand will be the key to prices and right now it doesn’t look promising.
Speculators have been the sponsors of the market’s recent strength, but with all the headwinds were are facing on the macro front it may be just a matter of time until the momentum stalls and the market reverts back down. Apart from the weather threat we don’t see anything that points to higher prices.