Market Comments – December 3, 2015

NY futures have pushed higher since our last report of two weeks ago, with March advancing 83 points to close at 63.95 cents.

The futures market posted its second highest close in over three months today, second only to the October 21 settlement price of 64.05 cents. Another strong export sales report, a reversal of the US dollar and a constructive technical picture were behind the market’s latest up move. Last Friday the March contract finally broke above a long-term downtrend line dating back to early July and in the process it also climbed above its 200-day moving average, a resistance level it had previously failed to overcome.

The latest CFTC report showed that it was the trade that bought the futures market quite aggressively during the week of November 18-24, when prices had dipped to around 61.50 cents. The trade bought 1.02 million bales net, reducing its net short position to 8.45 million bales, while speculators did the opposite and cut their net long position by the same amount to 2.06 million bales net. We assume that most of the trade buying was connected to mill fixations and/or the selling of basis-long positions (sell physicals/buy futures).

In our previous letter we laid out our case for strong US exports this season and the most recent export sales reports appear to validate our opinion. In the three weeks between November 6-26, US shippers sold a combined 786,600 running bales of Upland and Pima cotton for both marketing years.

Today’s report showed that a marketing year high of 287,100 running bales of Upland and 2,400 bales of Pima were sold during Thanksgiving week, which came as a bit of a surprise to most traders. Although buying was broad-based with 17 markets participating, Vietnam and Turkey accounted for more than two-thirds of the turnover. Slow shipments were the only blemish in the report, as they continued to lag at only 90,800 bales. For the season we now have total commitments at 4.9 million statistical bales, of which 1.8 million bales have so far been exported.

Quality concerns may have played a role in this increased buying activity by mills. Last week’s quality report showed that only 53% were tenderable, with the season total dropping to 57%. The icy weather that hit West Texas last week seems to have affected the quality of the 20-25% that remained unpicked at the time, which will further reduce the supply of premium grades. Georgia, the second largest cotton producer after Texas, has also seen its share of adverse weather this season, with last week’s tenderable percentage slipping to just 38.5%.

The US dollar index reached a 12-year high on Wednesday, but then sharply reversed when the ECB announcement proved to be less accommodative than had been anticipated. Although Mr. Draghi cut the deposit rate to a historic minus 0.3 percent and extended his bond buying scheme of 60 billon Euros a month until March 2017, the market was unimpressed. Bond and equity markets sold off and the Euro rallied by over 3%, while commodities found support.

It remains to be seen whether today’s market reaction was just a quick correction in a very crowded ‘long dollar’ trade or whether we are in the early stages of a meaningful reversal. A lot will depend on the Fed’s decision on interest rates in mid-December. A rate hike would probably lend renewed strength to the greenback, while abstaining from raising rates would be a strike against the dollar.

Exchange rates have played a major role in commodity markets this year, as most commodities have risen quite considerably when looked at in emerging market currencies, such as the Brazilian Real for example. Since the Real has lost about 43% year-on-year against the dollar, Ag commodities such as soybeans, corn or cotton are actually trading at considerably higher levels in local currency than a year ago. The problem this poses is that it incentivizes production and suppresses demand in many of these emerging markets. A weaker US dollar would therefore be very welcomed by commodity bulls!

The December notice period has come and gone without much fanfare, as only a little over 23,000 bales of certified stock have changed hands, with remaining open interest down to just 21 lots as of this morning. However, it helped to establish that the current price of cash cotton is in the vicinity of 61-62 cents, which begs the question why March should be worth 2-3 cents more than that?

So where do we go from here? It remains to be seen whether the market can garner the strength to take out the October high of 64.50, which would open the door for a move to 66.50. A lot will depend on what happens with the US dollar over the next couple of days. Further weakness in the greenback might embolden speculators to bid for commodities and thereby force the market higher. However, we are not convinced that mills are ready to pay these higher prices just yet. Nevertheless, we feel that the bottom near 61-62 cents is being solidified and that it is slowly but surely going to move higher over time as supplies become less plentiful.