NY futures moved sideways in very dull trading this week, as March added 75 points to close at 92.05 cents.
It was more of the same this week, as general price weakness emanating from plentiful international offers continued to be offset by aggressive Chinese Reserve buying. Through its domestic auction program the Reserve has added another 1.1 million statistical bales to its stockpile this week, which means that it has already accumulated around 6.1 million bales since the middle of October, which equates to roughly 18 percent of China’s crop this season. The maximum daily auction target is currently at 577’000 statistical bales and the fact that less cotton was taken up this week, combined with an ever so slight rise in domestic prices, seems to indicate that the support mechanism is working.
Against this backdrop of Chinese support, which has kept the CC-index at a relatively elevated level of around 136 cents when compared to the current A-index of 98.70 cents, mills around the globe have been getting some breathing room lately and are now in many cases able to turn a profit against current replacement cost. However, a lot of mills are still struggling to digest the many high price contracts they have engaged in earlier this year and it is going to take a while until this overhang of expensive cotton has finally been worked through the system.
Recent US export sales reports have been reflecting this tug-of-war in the market between Chinese support and struggling markets elsewhere. The latest report, which was released this morning, showed once again a net gain for China in the amount of 35’400 running bales, while the rest of the world went the other way and cancelled a combined 58’400 running bales, resulting in a net reduction of 23’000 running bales of Upland and Pima cotton. The only positive in the report was the increased pace of shipments, which amounted to 244’800 running bales. Nevertheless, total exports to date still amount ot only 2.1 million statistical bales, leaving a large unshipped balance of around 8.4 million bales, not counting 1.3 million bales in optional sales.
This large amount of outstanding commitments seems to worry the market, because of potential cancellations. However, when we look at who has booked these 8.4 million in outstanding sales, the majority belongs to China (4.8 million bales), followed by Turkey (0.7 million bales) and Mexico (0.4 million bales). These three markets account for about 70 percent of all unshipped sales and they pose a relatively limited default risk in our opinion. Beyond that we have 9 markets that are owed between 0.1 and 0.35 million bales each, which is not a large amount in terms or their respective annual mill use and a lot less than what they had on their books a year ago. In other words, while there probably will be some additional cancellations in the weeks ahead, we don’t think that they are going to add up to a significant amount and that net sales will continue to grow overall.
It is unusual to see the market in such a lackluster state at this time of the year. We believe that a lack of spec participation and risk aversion by the trade are the reasons behind this dull market. When we look at the lastest “Commitment of Traders’ report by the CFTC (as of November 29), we have the spec sector with basically a flat position, since a net long of 0.7 million bales by large speculators (mainly hedge funds) is being more than offset by a 1.0 million bales net short position by small speculators (non-reportables). In other words, speculators have very little skin in the game at the moment.
This leaves Index Funds with a net long position of 5.1 million bales versus the trade with a 4.9 million bales net short position as the two main protagonists in the futures market. As we all know, Index Funds are very passive and positions change only if investors add or withdraw cash, or if there is some rebalancing. With specs mostly on the sidelines and index funds in passive mode, the trade is currently in charge of the market’s fate. The trade is a buyer of futures when existing basis-long positions are sold to mills, but every bounce seems to find ready sellers, because the general tone among traders is not bullish. However, they seem to be respectful of the Chinese Reserve and the fact that the US crop is already well committed, and are therefore reluctant to become too aggressive on the short side.
So where do we go from here? The risk aversion among speculators and traders is not likely to disappear anytime soon. It is quite striking to see that the current open interest in futures and options of 185’257 contracts amounts to just 55 percent of what it was a year ago. Specs seem to have abandoned the cotton market and the trade is playing it safe after it got beaten up badly by a volatile market last season. The uncertainty surrounding the Euro and US debt crises doesn’t help to restore confidence, as everyone seems to be waiting for the next shoe to drop.
As long as the Chinese Reserve continues to take excess supply off the market, prices will likely hold steady, which is why we continue to see the market in a trading range in the foreseeable future.
Best Regards
