New York traded sideways this week, as December moved up 65 points to close at 64.67 cents.

Since trading to a low of 62.02 on August 1st, trading has turned a lot more two-sided, as new trade buying has emerged and speculators are no longer selling as aggressively as they have been for so many weeks. Last weekΆs CFTC report showed that the trade bought 5Ά260 contracts net between July 30 and August 5, while speculators and index funds were on the other side.

As a result the trade reduced its net short position in the futures market to just 3.9 million bales, which is exactly ten million bales less than a year ago. In fact, the current trade net short is the lowest since at least 2007, when the CFTC started to report trade and index fund net long positions separately. In the previous seven seasons the trade averaged a net short position of over 10.9 million bales in early August, ranging from 7.7 to 15.2 million bales.

One possible explanation for this unusually low trade net short is that old crop supplies are basically committed and new crop is still mostly in grower hands. The uncertain US crop outlook that prevailed until late May, coupled with the steep inversion that existed between July and December, seems to have hindered forward contracting between growers and merchants. Then, with the market crashing in June and July, growers fell even further behind in selling or hedging their crops.

With old crop all but gone and new crop not readily available, merchants are running much smaller short positions in New York and this situation could persist until growers are finally willing to relinquish their cotton to merchants. At these depressed prices this is not likely to happen anytime soon – not while the crop is still in the field! This means that we could see a bottleneck situation develop in the fourth quarter, as limited supplies in the marketing channels force buyers to pay up in order to free up cotton.

This weekΆs USDA report played right into this scenario, as beginning stocks in the ROW (rest of the world) were lowered by 700Ά000 bales from last month. ROW inventories of 38.55 million bales on August 1, 2014 were 1.12 million bales less than a year ago. The US is singlehandedly responsible for this drop, since its beginning stocks fell by 1.3 million bales to just 2.6 million bales, which ties with the 2011/12-season for the lowest stock number in 22 years.

The USDA report is a tale of two vastly different ROW supply scenarios, as we are transitioning from a rather tight 2013/14-season to a much more accommodative current crop outlook. According to the USDA, the 2014/15-season is expected to produce a ROW surplus of 12.04 million bales, which will only partially be absorbed by Chinese imports of 8.0 million bales. This in turn should raise ROW ending stocks by 4.17 million bales, from 38.55 to 42.72 million bales.

The US accounts for about 75% of this inventory buildup, as its stocks are predicted to increase from 2.6 to 5.6 million bales. In other words, stocks outside the US are not really expected to rise by much, which places a lot more emphasis on the availability of US cotton, especially in the early part of the season. We feel that the market is too optimistic in regards to the speed and price level at which US new crop will become available, especially with the government loan allowing growers to play the wait-and-see game.

Weekly US export sales of 187Ά800 running bales net were seen as disappointing by the market, since they did not quite meet expectations for a 200-250k number. However, instead of assuming that mills werenΆt ready to buy, we should consider the possibility that shippers were reluctant to sell. The fact that there were 22 different markets interested in US cotton demonstrates widespread buying interest and we know of a few instances where decent bids did not get filled because sellers kept insisting on higher prices. Current commitments for the 2014/15-season already amount to 4.75 million statistical bales and since a large portion of these commitments are for shipment between now and December, merchants may not be willing to add more sales as long as growers are holding out.

So where do we go from here? With growers not ready to sell at these levels and with specs not pushing the short side anymore, the path of least resistance seems to be up in the near term. The chart is forming another triangle and a move above 65 cents would probably trigger some spec short covering. Speculators, including non-reportable positions, have about 6.5 million bales in outright shorts and many of these shorts are protected by stops not too far above the current market. We therefore believe that the odds are decent for a short-covering rally to materialize, which would likely run into massive resistance from trade selling in the high 60s. Growers donΆt want to sell at 63/64 cents, but they would definitely do so near 70 cents. We therefore see the market going sideways to slightly higher in the near term, with the bear market taking a break until crop pressure starts to develop towards the end of the year.

Best regards