NY futures continued to move higher this week, as May advanced by 121 points to close at 86.50 cents, while December gained 77 points to close at 85.98 cents.
The marketΆs dynamics havenΆt changed much this week, as we still have an unusually large contingent of trade shorts pitted against an equally formidable spec and index fund position on the long side. The trade has been fighting a losing battle ever since this bull market took off on November 9 at 71.09 cents. However, instead of waving the white flag, the trade seems to be more determined than ever to prove the market wrong, since open interest, after a brief interlude, has started to climb again this week.
May open interest has been up by 6Ά098 contracts since February 26, while July open interest grew by 1Ά901 lots. For the two current crop months combined, open interest currently measures 17.1 million bales, which compares to 14.0 million for the same date last season and 11.0 million two years ago. Only during the infamous bull run of early March 2008 did we have more bets on May and July at 19.5 million bales.
By refusing to reduce its short position, the trade engages in a dangerous game against time. In 3-1/2 months the July contract will enter its notice period, which means that this entire short position in current crop futures will either have to be bought back or needs to get rolled into new crop. Waiting until the last moment is probably not a great idea, because it increases the odds for a short-covering rally. Mills continue to do their part to keep the bull market alive, because they have been buying a large percentage of cotton “on-call” in recent weeks. In doing so, mills assume the risk of the futures short position from the merchant, but the short interest in New York wonΆt be reduced until mills finally decide to fix the price.
US export sales continued to impress last week, as 243Ά400 running bales of Upland and Pima cotton were sold for both marketing years combined, with broad-based participation from 20 different markets. Shipments were even more impressive at 526Ά900 running bales, a marketing year high! For the current season we now have commitments at 11.3 million statistical bales, of which 7.1 million bales have already been exported.
When we look at the current statistical position of the US, we started with total supply at 20.4 million bales, of which 11.3 million have already been committed for export, while domestic mills will consume 3.4 million by the end of July. This leaves theoretically 5.7 million bales for sale, but from that we need to subtract around 0.9 million bales for domestic consumption between August and October and we further estimate that 0.6 million bales of the current 1.0 million bales in export commitments for next marketing year will have to be furnished from existing stocks. This would leave just 4.2 million bales of US cotton available until new crop arrives later this year.
TomorrowΆs USDA report will give traders something to chew on, but we expect the overall theme to remain the same – way too much cotton in China and barely enough in the rest of the world! Traders shouldnΆt focus too much on global ending stocks, because they are of no consequence unless Chinese stocks are made available at world market prices. The main driver will be the balance sheet in the rest of the world, which is likely to tighten further since China has continued to import vast amounts of raw cotton and yarn in recent months.
Of particular interest to us is mill use outside China, which has been in a relatively tight range between 65.1 and 70.7 million bales over the last five seasons. Given the strong increase in yarn exports to China coupled with a slight rebound in the global economy, we should see mill use outside China trend towards 73-75 million bales. China is currently importing around 100Ά000 tons more yarn per month than it did two years ago, and unless consumption has dropped in the rest of the world to offset this increased yarn demand, it follows that mill consumption outside China is trending higher.
So where do we go from here? The futures market is once again running ahead of the cash market by several cents, but we see it as unlikely that there will be a correction of more than 3-4 cents, if that, since there are simply too many trade shorts waiting for an opportunity to get out. Once the cheaper bulk suppliers like Africa and India are out of the picture, it will be up to the US to supply mills with cotton in the second and third quarter, and as we have seen above, the US isnΆt sitting on huge inventories either. In other words, cheap cotton is increasingly hard to come by, which combined with the large trade short in New York adds up to a potentially explosive situation.
December has benefitted from the strength in May and July, although it has started to lag behind over the last five weeks. A short-covering rally in the front may pull December up a few more cents, but growers should seize the opportunity to put some bearish options strategies in place. Once May and July are off the board, December will be on its own, with quite different dynamics! Open interest in December currently amounts to just 26Ά000 contracts, so instead of short-covering driving prices up, we will likely see grower hedging weighing on values as we head into the planting season, especially if this higher price level manages to win back some acreage!
