NY futures had a mixed performance this week, as May dropped 1218 points to close at 196.04 cents, while December was basically unchanged, closing down just 5 points at 132.45 cents.
The futures market is now clearly reflecting the ‘stretching game’ we have been seeing in the physical market over the past few weeks, as mills are trying to avoid paying the relatively high price level for nearby shipments in an effort to save themselves into a much more affordable new crop plateau.
One needs to look no further than the US export sales report to find proof for that, as net sales for the current marketing year have been going backwards for a number of weeks now, while commitments for August onwards are still on a fairly decent growth path. US export sales for the current season decreased by 93’100 running bales net last week, while commitments for next marketing year went up by 166’200 running bales net.
Total commitments for the 2010/11-season are now at 15.4 million statistical bales, and unless these weekly sales figures start to show positive numbers again soon, we may struggle to reach the 15.75 million bales the USDA is currently projecting for this season, which ends on July 31st. Over the last two months there have been nearly 900’000 bales cancelled (most of which were able to find a new home), but one has to wonder how many of the 5.4 million bales in outstanding sales are going to be renegotiated. Also, with Southern Hemisphere crops now becoming available, these returned US bales will face more competition as they try to find new buyers.
Considering that the cash market has been trending lower, the relative strength of the spot futures contract may be surprising to many. Today the May/July spread closed at an inversion of over 18 cents, which was a record based on settlement prices. However, as we have stated repeatedly, there are often different dynamics at work in the futures market that can lead to short-term distortions between cash and futures. Right now we have a situation in which there are still some 49’000 contracts open in the May contract, with only 5 more sessions to go before First Notice Day. The Certified Stock at the moment amounts to around 230’000 bales or the equivalent of just 2’300 contracts.
In other words, open longs and shorts in May amount to about 20 times the deliverable stock and we therefore believe that what we are witnessing at the moment is simply a ‘game of chicken’ between the two sides. Who is going to blink first? The longs are clearly in the stronger position at this juncture, although shorts could of course still try to bring cotton to the board, but that would have to happen rather quickly since time to do so is running out and the quantities involved would probably not be significant. This means that most of these shorts will have no other choice but to buy out of their predicament and many of them seem to do so by rolling into July at these rather painful differences. The fact that overall open interest has only declined by about 3’000 contracts last week indicates that there hasn’t been a lot of outright liquidation.
The tide may still turn once most of the May open interest has been liquidated. At that point the longs will have to ask themselves what they would do with Certified Stock at 195 cents (basis 4134 rule 5), for which there is neither carry on the board nor a buyer in the cash market. In other words, once the ongoing short squeeze is out of the way, the Certified Stock could act like a deadweight and lead to a collapse of the May in its final days. A few brave shorts may still benefit from that, but for the majority of them it will be too late. As always, timing is everything!
Whether a similar game plan makes sense for the July contract remains to be seen. Many of the dynamics are the same, but there are a few factors that could tip the scales the other way. On the one hand July open interest is currently quite high at 73’000 contracts, meaning that there are plenty of potential shorts to squeeze, many of which are tied to the 3.0 million bales in unfixed on-call sales on July. However, if further cancellations of US cotton lead to an increase in certified cotton to let’s say 350’000 to 400’000 bales and if there is indeed a last minute collapse in the May contract, then the July longs may loose their cool and abandon their positions a lot quicker. Also, a lot depends on whether July futures are considered expensive when compared to the cash market and how new crop plantings develop.
So where do we go from here? The realignment process between current and new crop prices will likely continue over the next couple of months. We believe that this will happen via a further weakening of current crop values. However, shorting July at these levels may take a strong stomach and deep pockets because powerful short-covering rallies cannot be ruled out. We still like the fundamentals for December, although the promise of some rain in Texas may pressure new crop values in the near term.
Best Regards
