NY futures surged higher this week, with March gaining 961 points to close at 135.95 cents, while new crop December was up just 54 points to close 94.36 cents.
A futures market’s primary function is that of a risk management tool for the trade, with spec participation providing the necessary liquidity for these markets to function. However, with close to 90% of the US supply already committed, there isn’t really a lot of cotton left to hedge, yet open interest in old crop futures (March, May and July) continues to be rather large at 160’000 contracts or 16 million bales.
When we look at the latest CFTC numbers, which take options ‘delta’ positions into account as well, the numbers seem frightening to us, especially when it comes to the trade’s position. Below is a brief summary of the latest CFTC report as of November 30. Although these numbers include all marketing years, the vast majority belongs to the current crop (numbers in million bales).
| LONG | SHORT | NET | |
| TRADE | 10.3 | -21.5 | -11.2 |
| INDEX FUNDS | 7.4 | -1.2 | 6.2 |
| SPECS | 6.6 | -1.6 | 5.0 |
| SPEC SPREADING | 9.0 | -9.0 | 0.0 |
| TOTAL | 33.3 | -33.3 | 0.0 |
What you may notice right away is the huge outright trade short position of 21.5 million bales as well as the trade’s net short position of 11.2 million bales. Speculators and index funds have only a relatively small amount of shorts outside of spread positions.
With only about 2.0 to 2.5 million bales of US cotton left for sale at this point (equivalent to 20’000 to 25’000 futures contracts), one has to wonder what’s behind this large trade position, particularly on the short side. Some of these shorts may hedge foreign growths, but the bulk is probably tied to mill fixations, with merchants holding short futures against unfixed on-call sales. As of December 3rd mills still had a total of 9.8 million bales to fix, of which 2.8 million are on March, 1.9 million on May and 3.5 million on July.
What concerns us about this huge unfixed on-call position is that it sooner or later will have to be fixed and the futures against these fixations will have to be bought back. As long as there are willing sellers on the other side there won’t be a problem, but we envision that it will become more and more difficult to find liquidity as we move further into the season. The trade is already shorter than it needs to be considering how little is left for sale and will therefore be a net buyer as we move forward, not a net seller.
Index funds do have a substantial net long position, but they will simply continue to roll it forward – quite profitably so – unless there are redemptions or a need for rebalancing, neither of which is expected to occur in any meaningful way. That leaves speculators as the last hope for the trade to find some much needed sellers, but specs longs are not likely to leave a market that is trending so strongly and offers a huge inversion to roll down to, while potential spec shorts know better than to jump in front of this freight train.
So where do we go from here? While the futures market has so far followed in the wake of the cash market, we are afraid that it might soon take on a life of its own. As we have tried to explain above, there is not much justification for these still large open positions now that the US crop is largely committed and to hedge foreign physical positions with short US futures makes little sense to us at this point. We therefore fear that the futures market could turn into a casino as liquidity dries up further. The shorts may soon run out of chips (be it money or cotton) in this high stakes poker game, which could result in a stampede towards the exit. Baring any major disaster on the political or economic front, we see no reason to approach the cotton market from the short side at the moment!
Best Regards
