NY futures remained under pressure this week, as December dropped by another 52 points to close at 73.47 cents

The market traded without much conviction this week and continued to drift slightly lower, as news on the fundamental and technical front remained devoid of any bullish impetus.

Last Friday’s USDA report dispelled bullish hopes for a quick rebound, as US production was raised by nearly 10% to 18.3 million bales and global output is now expected to reach 116.0 million bales. Although this figure is 13.5 million bales more than last season and 8.9 million bales higher than in 2008/09, it remains about six million bales below the record set four seasons ago.

Interestingly, even though global production is making a big jump this season, it is still expected to fall short of consumption. World mills use for next season is pegged at 119.7 million bales and that would mark the fifth year in a row in which global output fails to meet demand. If we add up the world production numbers since 2006/07, we arrive at a total of 567.5 million bales for all five seasons, while world mill use amounts to 593.3 million bales, or 25.8 million bales more. Oddly, world stocks are projected to drop by only 13.4 million bales over those same five years, from 63.3 million bales in 2006/07 to 49.9 million bales at end of July 2011. The difference of 12.4 million bales is squared away by a statistical slight of hands via the ominous “loss adjustment”, which is basically all in the Chinese numbers. As we tried to elaborate in last week’s report, given the unprecedented bull market were are witnessing in China, one has to wonder whether these loss adjustments are really justified or whether ending stocks in China might indeed be much tighter than suggested by the current statistics.

Regardless of how tight the stock situation is ultimately going to be next summer – and the current inversion of 325 points between July and December 2011 suggests that it will be tight – the market seems to be nearsighted and focused on the arrival of a fairly substantial Northern Hemisphere crop. The trade is typically a net seller of futures at this time of the season, especially when cotton prices are historically high, as growers sell an increasing amount of their expected crop forward at fixed prices and merchants establish basis-long positions by selling futures. Mills are not aggressive in booking forward commitments yet, at least not at high fixed prices, and continue to buy mostly on-call instead. With the arrival of harvest the tide begins to turn, as merchants will have their positions loaded with basis longs and grower selling slows down, while mill buying and on-call fixations gain momentum. At that point the trade will become a net buyer of futures and the market is likely to rebound, especially if the longer-term outlook remains bullish.

However, in order for the trade to be a net seller of futures, speculators need to be willing to take the other side as net buyers. Until the end of June this symbiosis was working quite well as the CFTC spec/hedge reports show. Although the numbers may be a bit distorted due to the July liquidation, they tell us that the trade increased its net futures and options short by 3.0 million bales to 11.7 million bales between June 8 and June 22, while speculators and index funds went net long by the same amount. This happened with prices hovering just below 80 cents. However, at the end of June renewed concerns about the economy prompted hedge funds to cut their commodity holdings. This resulted in speculators and index funds selling 1.9 million bales net between June 22 and July 6, while the trade used this downturn to reduce its net short position by as many bales.

So where do we go from here? The market is clearly lacking momentum at the moment. On Tuesday, when the market rallied 86 points, open interest dropped by 2’904 contracts. Then on Wednesday the market sold off 130 points and open interest dropped by 588 contracts. On both days volume of around 12’000 to 13’000 contracts was lackluster and today it dropped even lower to just 9’000 contracts. In order to have a sustained move either up or down we need to see increasing volume as well as a rise in open interest and we are not getting that right now. From a technical perspective the market is in a short-term downtrend, which combined with jittery outside markets probably means that speculators won’t throw money at the long side anytime soon. On the other hand, speculators were only 2.7 million bales net long on July 6 and we don’t expect them to go net short either.

Based on a bullish fundamental outlook the trade has been buying some of its short futures back at these lower levels, possibly tied to mill buying or merchants going outright long by lifting legs on basis-long positions. The trade will likely continue to be a scale down buyer, which should keep potential spec selling in check. However, if the market were to rally back into the high 70s, the trade would probably become a net seller again and thereby keep any potential advance contained. We therefore see the market range-bound in the foreseeable future, as it will take some force to generate a sustained move and this kind of momentum is nowhere to be seen at this point.

Best Regards