NY futures rebounded slightly this week, as March advanced 207 points to close at 92.45 cents, while December gained just 84 points to close at 93.72 cents.
For the past five months, since September 22nd, the March contract has been moving in a relatively narrow trading range of just 1850 points, marked by a high of 102.85 cents and a low of 84.35 cents. New crop December was confined to an even tighter range of just 1474 points, meandering between a high of 97.99 cents and a low of 83.25 cents.
We believe that the market is currently stuck between a set of opposing forces, which keep it from generating any momentum on either side. Acting in support of the market are the restocking purchases by the Chinese Reserve, the relatively strong demand for nearby shipment as mills around the globe are operating with minimal stocks, the comparatively high price of corn and soybean, and the continued debasement of fiat currencies, which has accelerated since December.
On the other side we have an increasingly bearish supply/demand balance sheet that could see global ending stocks rise to their highest level ever, as world cotton production is projected to surpass mill use for a third consecutive season. After a surplus of 1.8 million bales in 2010/11 and a 13.6 million bales surplus in the current season, we are potentially looking to add another 5 or 6 million bales to world ending stocks next season.
Fortunately China has so far been willing and able to lift the extra supply off the world’s shoulders, by absorbing an estimated 16-17 million bales of domestic and imported cotton into its strategic reserve. This has been countervailing the bearish impact these surplus bales would otherwise have had on world prices. However, since it is believed that the capacity of the Reserve is in the neighborhood of 18 to 19 million bales, the world cannot continue to rely on China to mitigate an oversupply situation indefinitely.
Since the Chinese government is likely to continue its support program next season, it is possible that some of these Reserve stocks will be sold to domestic mills in the second and third quarter in order to make room for new auction purchases next season. This in turn would reduce import needs during the summer months. China has been a very active importer so far this season, as already 10.1 million bales (2.2 million tons) have arrived on its shores in the first six months of the season (August to January), but this pace will likely slow down during the second half of the season. If Reserve stocks do indeed get released, we probably won’t see any additional import quotas beyond the ones already authorized.
US export sales were quite strong last week, as net new sales for the current marketing year totaled 108’000 running bales, not counting net new ‘optional origin’ sales of 54’000 running bales. New sales for the 2012/13-season amounted to 65’200 running bales. For the current season total commitments have now reached 11.0 million statistical bales and there are another 1.5 million statistical bales in ‘optional origin’ sales that may come into the picture. Shipments remained strong at 308’700 running bales, bringing the total for the season to 4.7 million bales.
Despite the ongoing March liquidation, which has reduced open interest in the spot month to just 28’500 contracts as of this morning, the overall open interest has hardly changed and still amounts to around 186’000 contracts. This is about 40’000 contracts more than at the end of November. When we look at the CFTC report, which includes options as well, we notice an increase in open interest of around 66’000 contracts since the end of November, from 185’000 to 251’000 contracts. Although some news reports are crediting Hedge Funds as being the driving force behind this increase in open interest, the CFTC report tells a different story.
Since the end of November, it has been Small Speculators (non-reportables) that changed their position the most by adding 14’241 contracts in net new longs, followed by Index Funds with 6’143 contracts net longs and Large Speculators/Hedge Funds with 4’979 contracts net longs, while the Trade was on the other side, increasing its net short position by 25’363 contacts. The trade is currently by far the most potent force in the market, carrying the biggest gross long and short position as well as the largest net position (short 7.4 million bales), followed by Index Funds (long 5.8 million bales), Large Speculators (long 1.2 million bales) and Small Speculators (long 0.4 million bales). Contrary to popular belief, speculators have actually very little skin in the game at the moment, which can be seen as a positive for two reasons. One, there is not much to liquidate should the macro situation change for the worse and two, they still have a lot of potential firepower that they can throw at the long side.
So where do we go from here? We believe that we currently have two different dynamics at work in the futures market. In current crop, the two main positions are the trade net short (most of it being against physical long positions) and the index fund net long. The latter won’t change much as we move forward, but the trade is likely to buy its futures short back as physicals get sold to mills or as on-call cotton gets fixed. This should result in net buying in current crop futures over the coming months. The opposite is true when we look at December. Once growers plant their crops for the coming season, they will want to sell some of their cotton forward. However, since mills are only interested in nearby shipment at the moment, the only vehicle for growers to hedge their crop is to either sell futures or to buy bearish options strategies. Over the last week or so these dynamics have been playing out in the futures market, as current crop has been relatively strong compared to new crop. We may see a continuation of that in the weeks ahead, but we also believe that there is a limit as to how much current crop can strengthen against new crop in a global oversupply situation. We therefore feel that the two opposing scenarios will keep each other in check and that should result in a continuation of the trading range we have been in for the last five months.
Best Regards