Market Comments – October 23, 2015

NY futures ended a volatile week under pressure, with December falling 92 points to close at 62.52 cents/lb.

A weather-induced rally pushed the market temporarily over the 64 cents resistance area on Wednesday, triggering additional spec short covering and fresh buying, but when the rains in West Texas turned out to be less severe than anticipated, sellers regained control and a sharp correction ensued.

Most stations in West Texas reported about 2-3 inches of rain since yesterday, but the storm has been a fast mover and no further rain is in the forecast for the next seven days. Sunny and relatively warm weather should allow bolls to dry out quickly, with harvest to resume in a few days.

The latest available CFTC report, which contains positions as of October 13, confirmed that the market’s advance in October was sponsored by spec buying, as speculators added 2.1 million bales to their net long position in the two weeks between September 29 and October 13, while the trade sold into the rally, increasing its net short by 2.0 million bales. Index funds accounted for the difference, reducing their net long by 0.1 million bales.

Interestingly, the trade’s net short position of 9.37 million bales is more than twice as big as last year, when the trade was just 4.19 million bales net short in mid-October. This relatively large net short position combined with the fact that not much cash cotton has been changing hands yet may have hindered the trade from selling more actively into this recent advance. However, once the market traded above 64 cents on Wednesday, the trade became a lot more aggressive via bearish options strategies, which helped to cap the advance.

One of the reasons why the trade is carrying a bigger net short position this year is that unfixed on-call sales of 6.7 million bales are 1.9 million bales larger than last October. Merchants are inclined to use rallies to lock in the price on on-call sales by selling futures. This in turn provides some support down the road, as these short futures will have to be bought back when mills fix the price. On-call purchases have the opposite effect, although the unfixed position of 2.1 million bales is actually about 0.6 million bales smaller than a year ago.

Since the trade is a lot shorter in the futures market than last season, it follows that speculators must have more longs. In fact, a year ago speculators were 1.73 million bales net short – a rare occurrence – while this time around they are 2.83 million bales net long. With the spot month closing today at nearly the identical level as a year ago – December closed at 62.68 cents on October 22, 2014 – we wonder what speculators see to justify their more optimistic stance towards cotton?

Granted, the US crop is nearly 3 million bales smaller and ROW ending stocks are expected to drop from 43.9 to 41.7 million bales. But mill demand is still lousy and US export sales are limping about 2.2 million bales behind the pace of last season. Also, from a macro perspective there are a lot of headwinds, from slow global growth to battered emerging market currencies. Only time will tell whether the specs’ more optimistic view is justified. We have our doubts!

US export sales were once again nothing to get too excited about at 106’200 running bales for this marketing year and another 9’300 bales for the 2016/17-season. Total commitments for the current season have now risen to 3.7 million statistical bales, of which only 1.2 million have so far been exported.

The fact that there were 17 markets interested in buying US cotton last week may be an indication that a lack of suitable offers is at least partly to blame for these ‘disappointing’ figures. We therefore believe that sales will start to pick up once the bulk of the crop has been harvested in about 3-4 weeks from now.

So where do we go from here? As the famous saying goes “History doesn’t repeat itself, but it often rhymes”! There are a lot of similarities to last season, with prices currently trading at almost the exact same level as twelve months ago. What followed was a weaker trend into harvest, with December slipping toward 59 cents by mid-November and thereafter we saw the respective spot month trading between 58 and 63 cents in the first quarter, before moving into the mid-60s by the second and third quarter.

We feel that a similar path is possible this season, maybe at a slightly higher level. The AWP is moving up to 48.37 cents next week, which means that the base for US prices is now over 400 points higher than at the beginning of the month. The Pakistan quote is no longer part of the AWP calculation, which is now comprised of one Indian and four West African quotes. Therefore, unless there is major price pressure in these origins, US prices should find decent support near the 60 cents level. We therefore expect the market to trade in a relatively narrow range between 60 and 64 cents going forward.