NY futures rebounded this week, as July rallied 224 points to close at 82.12 cents, while December added 41 points to close at 75.89 cents.

The market once again held near crucial support and has since climbed back to the middle of a seven week trading range. July, which is now the lead month with the highest open interest, has closed no lower than 79.28 cents and no higher than 83.68 cents since February 25 - a range of just 440 points. And judging by the drop in options volatility the market seems to assume that this trading range will remain in force in the foreseeable future.

There is certainly some logic to that, since there is solid support near 78/79 cents, both from a fundamental and a technical point of view, while resistance has been insurmountable so far at around 83/84 cents. At the lower end of this trading range the certified stock, which now counts over 900’000 bales including bales under review, becomes attractive in terms of cash cotton, while it is considered too expensive as we approach the higher end of the range. Physical prices, as measured by the A-index, have been in an even tighter range than futures since February 19, fluctuating between 83.40 and 87.20 cents – a range of just 380 points.

While we could easily see cash prices stay in their current range, we should not automatically assume that the same will hold true for the futures market. The wild swings in recent years have taught us that futures often march to a different tune. We therefore need to be on the lookout for scenarios that could force the market to break out of its sideways range. We still believe that the sizeable trade net short position and the large amount of unfixed on-call sales could act as the catalysts for a breakout to the upside. As the May liquidation period is about to wind down, trading volume will taper off significantly, from the current 40’000 to 50’000 contracts a day to a more typical 8’000 to 15’000 per session, and this may pose a problem for trade shorts.

After the market held crucial support levels, long speculators have since backed away from selling the market and short speculators may be forced to cover some of their positions. We therefore shouldn’t expect any aggressive spec selling in the near future. Index funds have just rolled their longs into July and they are going to sit tight for the next two months, until they will once again jump into action and roll their July longs into December, which at the current inversion would be quite profitable.

Therefore, if the trade needs to get out of shorts, it will first have to find someone to take the other side and that may not be easy. There is of course always someone willing to sell a few lots or even a few hundred lots at the right price, but we are talking about a rather massive net short position here. According to the CFTC report of April 6, the trade still had a net short in futures and options of 13.7 million bales, and even though it may have been reduced somewhat during the recent price brake, it remains huge! Also, it is not true that a lot of these positions belong to new crop as some traders have stated! As of this morning, only 29% of the futures open interest belonged to December and later months, while for call and put options the percentages are 30% and 35%, respectively.

In other words, this is still very much a current crop game and we simply wonder how it will all play out over the next two months. While some trade shorts are still holding out for a collapse of the July/Dec inversion, others are a bit more proactive and are trying to get out of their basis-long positions by selling physical longs and buying short futures back. If this is done in large enough quantities, it may put some pressure on cash prices and lift the futures market, thereby resulting in a weakening of the basis.

US export sales continued at a brisk pace last week, as 330’300 running bales of Upland and Pima were sold for both marketing years, bringing the total for the current season to 10.85 million statistical bales, whereas commitments for August onward shipment now amount to 0.75 million statistical bales. The pace of exports slowed to 197’300 running bales last week, bringing total shipments for the season to 7.3 million statistical bales.

Unfixed on-call sales remain a supporting factor in this market, as 3.1 million bales of current crop and 7.0 million bales overall remained open as of April 9. July alone has 2.46 million bales in unfixed sales, whereas unfixed purchases amount to just 43’400 bales.

So where do we go from here? While cash prices seem to have found their equilibrium, we are not sure that the same can be said of current crop futures. What worries us is that there is such a large trade net short in July futures at a time when liquidity may not be there to accommodate those who want or need to get out. Maybe everything will work out just fine and the market continues to churn in its current range while this short position gets dealt with. But under a different scenario we could easily see short-covering in a thin market lifting values above the 83/84 cents resistance area, triggering renewed spec buying and setting a mechanism in motion in which trade shorts and spec longs are reinforcing each other.

Best Regards