NY futures ended a volatile week basically unchanged, as March lost just 18 points to close at 63.77 cents.
The March contract traded to a 3-1/2-month high of 65.23 cents on Wednesday, just before the WASDE report was released, as many traders were buying some upside protection against what was expected to be a bullish report. Although the report was seen as supportive, there seemed to be no one left to buy at that point and the market started to correct to the downside.
Heavy spec buying over the Thanksgiving holiday had started to move the market higher. The CFTC report showed that in the 3-1/2 trading days over Thanksgiving, between November 25 and December 1, speculators added no less than 2.09 million bales to their net long position. This meant that speculators doubled their net long exposure from 2.06 to 4.15 million bales in just a matter of days and they have kept on buying more since then!
The trade used this strength to add another 2.0 million bales to its net short position, which increased to a total of 10.5 million bales. Most of these shorts are against the 6.75 million bales in unfixed on-call sales as well as basis-long positions in both US and non-US growths. By comparison, a year ago the trade carried a three times smaller net short position of just 3.5 million bales, despite a more bearish balance sheet.
This has mainly to do with the spec sector, which a year ago was so bearish that it owned a rare net short position of 1.8 million bales, while index funds were also less engaged with a net long of just 5.3 million bales (vs. 6.3 million now). We definitely sense a lot more enthusiasm regarding Ag commodities among speculators these days, although it remains to be seen whether their latest buying spree was just another flash in the pan or something longer lasting.
The large open interest in the March contract of 146,818 contracts as of this morning – a record for this particular date – tells us that both sides are digging in and that this shapes up to be another one of those epic battles between spec longs and trade shorts.
Wednesday’s WASDE report was quite bullish in our opinion, as the global seasonal production deficit continued to widen. World production is now forecast at just 103.7 million bales, which are 15.4 million bales less than last season. On the other hand mill use of 111.4 million bales is still seen 1.0 million bales higher than last season, although some traders doubt the validity of this number given the sluggish demand we are witnessing this season.
When we look at how supply and demand are shaping up outside the US and China, we find that there is quite a significant seasonal shortfall of 8.8 million bales, up from 7.5 million last month. What we are looking at here is the production in all origins minus the US and China, which amounts to just 66.4 million bales this season, whereas mill use in countries other than the US and China adds up to 75.2 million bales. Since China is expected to be a net importer of 5.5 million bales, the shortfall actually grows to 14.2 million bales.
US exports are therefore desperately needed to close this gap, although the estimated 10.0 million bales in exports won’t be enough to avert a significant drawdown of stocks in the ROW. Inventories outside of China are expected to fall to just 39.4 million bales, 3.0 of which are in the US while 36.4 million are located in all the other countries. This compares to 44.1 million bales at the start of this season, of which the US had 3.7 million bales and all the other countries owned 40.4 million bales.
The 39.4 million bales in ROW stocks are the lowest since the 2009/10-season, which at the time set the stage for the epic bull market that followed in late 2010 and early 2011! Therefore, unless China decides to export part of its inventory, we are facing a very tight supply situation going forward. Since there isn’t enough cotton to go around, especially if we factor in the quality angle this season, it really doesn’t matter which origins sell first. In the end all available cotton, especially premium cotton, will be keenly sought after.
Another interesting fact in the WASDE report was that Bangladesh has now surpassed China as the top importer this season, with 5.75 million bales vs. China’s 5.5 million bales. A close third is Vietnam with 5.2 million bales, followed by Turkey with 3.8 million bales. These four markets make up 20.25 million bales combined, or 57% of all imports.
US exports slowed down from the pace of previous weeks, as just 129, 500 running bales of Upland and Pima were sold for both marketing years combined. Shipments continued to be slow at 115,300 running bales. Total commitments for the current marketing year are now at 5.0 million statistical bales, or exactly half of the USDA export estimate, of which 1.9 million have so far been shipped.
So where do we go from here? Speculators initiated the recent rally from 61.50 to over 65.00 cents by aggressively buying the market, while the trade was seen as a heavy seller. In order for the market to continue to move higher, speculators will have to commit additional funds to the long side or the trade will need to cover shorts. Speculators certainly have more room to add longs when looked at from a historical perspective and the statistics may encourage them to do so.
The trade seems to be in no panic to cover shorts just yet, but will likely do so if the market were to dip towards 62 cents, at which time we’d expect to see mill fixations and sales of basis-long positions, both of which would require futures to be bought back. Tomorrow’s CFTC report is likely to show the trade at the largest net short position of the season, after which we would expect the trade short to gradually decline over the remainder of the season, at least in current crop, which should be supportive to the market.
Next Wednesday’s Fed decision on interest rates needs to be watched, because it could lead to wild currency swings. A stronger dollar would weigh against commodities, while a weakening dollar might encourage hedge funds to commit additional funds to the Ag complex.
In the near term we are looking for a pullback towards 62.50-63.00, but we like the market in the longer term and wouldn’t rule out a move towards 70 cents or beyond later in the season.