NY futures continued their slide, with March dropping another 271 points to close at 69.14 cents.
Over the past few years we have seen several amplified moves in the cotton market that were brought about by large swings in the net speculative and index fund positions. Leading up to the price explosion in early 2008 we saw hedge and index funds boost their cumulative net long positions to levels never seen before, which eventually overwhelmed trade shorts in regards to capital demands and forced them into covering at the worst possible time. From a fundamental point of view there was no compelling reason for this spike in cotton prices, which after all proved to be relatively short-lived.
Later in 2008 the financial crisis hit, which forced these same hedge and index funds to liquidate a large portion of their commodity holdings in order to pay for margin calls on highly leveraged and mostly illiquid financial assets. Once again, fundamentals provided little justification for cotton prices to dip below 40 cents at the time.
This huge up-and-down move washed out a lot of positions and dropped open interest in the futures market from 302’683 contracts on March 3, 2008 to just 115’066 contracts on February 23, 2009. However, speculators and index funds returned to the market last spring and steadily increased their net long holdings again and open interest managed to climb back to 192’498 by January 4, 2010, before this latest wave of spec liquidation cut it back to currently 169’924 contracts.
The intensity of the recent spec selling is by no means confined to just cotton and comes from a combination of factors, such as China’s more restrictive monetary policy, Obama’s tougher stance against banks and investment funds, a shift in sentiment on the dollar which have all led to a weakening stock market and a deteriorating technical picture. Unlike in late 2008 though, this has nothing to do with de-leveraging, because hedge funds have currently very little leverage in their portfolios. However, we still can’t find anything wrong with cotton’s fundamental picture.
How long this spec liquidation will last is difficult to ascertain and this move in cotton prices seems to have confused both producers and spinners. From a technical point of view we are on the razor’s edge tonight as we are right at the weekly uptrend line dating back to March 2009. Without mills continuing to buy and fix (there are still 4.9 million bales on-call), it may only be a matter of days before this trendline support is taken out as well and the door for another leg down opens.
From the physical point of view, there is not much that should point to lower prices. We had the biggest export sales report of the season this morning. For the week ending January 21, 2010, sales of Upland and Pima cotton amounted to 497’700 running bales, bringing total commitments for the season to 7.9 million statistical bales, whereof 4.3 million bales have been shipped so far. For the last 14 weeks export sales have averaged 282’900 running bales and if we were to continue on this furious pace we would be completely sold out of US cotton in 25 weeks from now, or by early August. Also, at current levels, December 10 will not be attracting as many acres to cotton for new crop as would have been the case 5 cents higher.
US cotton has been running the show lately with 1.3 million bales sold in the first three weeks of the year. US shippers have pushed sales of US cotton for several reasons. For one they probably wanted to take advantage of the stronger basis that this drop in the futures market has brought about. Another reason was that the AWP (59.01 cents) has been substantially above the loan rate, which means that unsold US cotton is accruing carrying charges whether it is in the loan or not. Therefore, holding cotton only makes sense if the board pays full carryings (just starting to happen now) or if the market outpaces carryings, which is not the case at the moment. With the March/May spread widening thanks to an increasing certified stock (around 500’000 bales including bales under review), merchants seem to become less inclined to make price concessions, which should help to stabilize physical prices. We therefore believe that we will sooner or later have to ration demand via higher prices.
So where do we go from here? There is no telling how much more the specs want to sell further. The last CFTC report showed speculators at 4.5 million bales net long, index funds at 7.5 million net long and the trade at 12.0 million bales net short. Therefore, there are still plenty of spec longs that could potentially get liquidated, especially if technical support around 68.50 (Elliott Wave) and 69.00 (weekly chart) is taken out. However, sooner or later this spec selling will run its course and then there will be no one left to sell, because the trade has no appetite to go futures short at these levels. When that happens there is likely going to be a void of selling into which the market will rebound. We are still bullish going into the second and third quarter but feel that lower futures prices are certainly possible in the short term. We still feel that the best way to play this market at the moment is via the July/Dec spread, since any rebound should be much more pronounced in current crop.
Best Regards