NY futures continued their remarkable ascent this week, with March rallying another 1017 points to close at 146.12 cents, while new crop December gained a respectable 239 points to close 96.75 cents.
Last week we commented on what we believe to be a disproportionately large futures short position by the trade, considering how little cotton is left for sale. To our astonishment the latest spec/hedge report by the CFTC showed a further expansion of open positions last week, as trade longs added 6’782 contracts and trade shorts increased their position by 6’914 contracts.
In other words, instead of getting out of harms way, there are even more players joining this dangerous game called “picking a top”, among them mills with their still more than 10.0 million bales in unfixed on-call sales. While some shorts represent legitimate hedges, many of them are simply based on a speculative view that the market will sooner or later have to collapse.
We can certainly understand the temptation to short the cotton market after its spot price has doubled in less than five months. However, with most of this season’s supply already committed and with mills seemingly still able to operate at these elevated prices, it is anybody’s guess as to where and when the top will ultimately be made.
As we pointed out last week, the mostly trade-related shorts may find themselves in a trap from which it could prove difficult to escape, since many of the longs are either not able (index funds only roll at certain times) or not willing (hedge funds stay with the trend) to sell their current positions. Some March shorts have chosen to roll into May and July at never before seen inversions, willing to sacrifice over 20 cents in roll penalty in the hope of getting the big selloff at some point down the road. Instead they may be condemned to live though the same nightmare again when May and July move into the limelight.
The bears can’t expect much help from the physical market either, since sellers feel absolutely no pressure to dispose of the limited positions they still own. Yesterday the A-index was quoted at a new all-time high of 173.40 as the cash market continues to outperform NY futures.
When we look at the US situation, not only did the USDA lower the US crop to 18.27 million bales in its latest report, but we also continue to see relatively strong export demand despite the limited availability. Last week US export sales amounted to 198’400 running bales for the current season and another 60’000 bales for next marketing year. Total commitments now amount to 14.0 million statistical bales for this season and 1.6 million bales for August onward shipment, most of which will be drawn from existing stocks.
If we add domestic mill use of 3.6 million bales for the current marketing year as well as 1.0 million bales for August to October consumption, we arrive at total commitments of 20.2 million bales, which compares to total supply of 21.2 million bales (2.9 million beginning stocks + 18.3 million bales crop). This means that the US is for all practical purposes sold out!
A true bull market is always demand-driven and that certainly seems to be the case here! Despite a doubling of prices we have yet to see evidence of any significant demand destruction, especially in fast growing markets like China and India. China reported the second-highest yarn output number ever for November, a sign that these higher prices have yet to curb demand.
This week PricewaterhouseCoopers in Hong Kong released a report according to which retail sales in China are expected to double to 4.6 trillion dollars by 2014. For the next four years, average growth of China’s retail sales will be around 13%-14% annually, which compares to an overall 6% increase for the entire Asia-Pacific region.
In the first eleven months of this year retail sales in China grew by 18.4% compared to the corresponding period last year, according to the National Bureau of Statistics. The main drivers behind this strong domestic growth are increased worker incomes and government measures that stimulate domestic consumption.
Car sales are another gauge for China’s phenomenal growth. Between January and November of this year China sold more than 16 million vehicles, which represents a 34% increase over the same period last year. This marks the second year in which Chinese consumers have bought more cars than their US counterparts. US sales totaled ‘just’ 10.4 million units for the first eleven months of this year. Vehicle sales in China are expected to grow to 20 million units in 2011 and one has to assume that if Chinese consumers can afford that many new cars, they will also be able to buy clothes and home textiles in increasing numbers.
So where do we go from here? The market has now moved within striking distance of its record high, which for March is at 151.23 cents on a closing basis and 151.95 cents intra-day. If these highs are taken out, we will likely see additional momentum players come in on the long side, which has the potential to trigger a short-covering rally similar to the one we experienced in early 2008. The bears are of course hoping for the market to stall out at around 150 cents, which could form a double top on the chart and set a sharp correction in motion. Needless to say the market is approaching a critical juncture, but given the circumstances we would feel more nervous being short than long. We still believe that unless a trader has a convincing reason to be in the market – and the necessary money to back up his bet - it would be best to get out of it altogether since it will only get thinner and more volatile as we move through the season.
Best Regards