NY futures resumed their uptrend this week, as March rallied 1572 points to close at 187.58 cents (synthetic close at 192.25 cents!), while December advanced 1544 points to close at 131.50 cents.

The market seems to have entered the much-dreaded blow-off phase of this historic bull market and it is still anybody’s guess as to where and when the top will ultimately be made. Judging by the open interest, which has continued to rise rather than decline, we have to assume that there is still enough fuel left to keep this uptrend going for a while.

Open interest in futures measured 223’405 contracts this morning, the highest reading since November 11, and 157’638 of these contracts were in current crop March, May and July. Tomorrow’s March options expiration will probably lead to a significant drop in open interest, since there are nearly 66’000 calls ‘in-the-money’, which will lead to some offsets. The shorts are hoping that this will set the market up for another big drop, similar to what we experienced three months ago when the December contract collapsed some 40 cents in the wake of its options expiry.

However, what worries us is that according to the latest CFTC report (February 1) the trade has further increased its net short position by 0.4 million bales to a 10.7 million bales net short. This number represents a ‘delta-adjusted’ net position that includes both futures and options. As long as the trade carries such a sizeable net short position in a market that is basically sold out of physical cotton, it will be difficult to turn the bullish momentum around. Also, it is quite remarkable to see the market rally so strongly during the ongoing Index Fund roll period, since it is typically associated with some price pressure. It will be interesting to see what will happen next week when the currently abundant liquidity is no longer going to be there.

According to economic theory rising prices should lead to demand rationing, as fewer people are able or willing to pay for a certain product. However, in reality this is not as straightforward as it sounds, because hoarding can delay the anticipated demand destruction and even lead to a short-term boost in demand. There seems to be some evidence of this happening in the cotton market at the moment.

While cotton prices are up by more than 150% since last July, price increases in the downstream sectors have not been nearly as pronounced just yet. Anecdotal evidence suggests that buyers at the wholesale and retail level are therefore stocking up on goods in anticipation of higher prices down the road. Last week the Wall Street Journal ran a story that talked about this kind of behavior and it mentioned a T-shirt buyer who boosted his inventory of 30 boxes to over 2500 boxes. If this is happening on a widespread basis, it can lead to a distortion of the supply/demand picture. As hoarding moves future consumption into the present, it inflates demand at a time when the market is ill equipped to meet it. At the same time it creates a void of demand at some point down the road.

The strength we have been seeing in the physical market seems to support this stockpiling theory, since there is no evidence of any significant demand destruction yet. US export sales continue at a brisk pace despite the high price level, with 326’500 running bales of Upland and Pima for both marketing years finding a home last week. Once again there were over 20 different markets participating in the buying. According to our calculation the US is now nearing the point of being completely sold out of current crop cotton.

The A-index (209.75 cents) and the CC-Index (around 199 cents) continue to trend higher as well, reflecting strong fundamentals in the physical market. Meanwhile, the September futures contract at the Zhengzhou Futures Exchange is trading at around 232 cents, which is over a dollar higher than the December contract in New York. While several weeks ago many traders were still of the opinion that current crop prices would sooner or later have to collapse, it now looks like new crop prices might be trading up to current crop levels.

Last Friday the NCC announced planting intentions of 12.5 million acres, up 14% from last season. Even if this figure grows to over 13 million acres by planting time, we have to allow for greater abandonment and lower yields due to the ongoing La Nina pattern, which is likely to cause growers some headaches this spring and summer. In other words, despite increased plantings the US crop may not reach more than 20 million bales next season. The world’s largest cotton producer, China, may also find it difficult to boost its output by any significant margin. China’s eastern agricultural region is currently experiencing one of its worst droughts in decades and the Chinese leadership may therefore incentivize the production of food crops, which could come at the expense of cotton.

So where do we go from here? As of last Friday unfixed on-call sales in current crop still amounted to 7.36 million bales, of which 1.6 million were on March alone. As time is running out for these mills and any other short that may have missed the chance to get out, there is likely to be some last-minute panic short-covering that could propel the market even higher. There was definitely some evidence of that today, as March closed up more than 1100 points synthetically. In order for the market to reverse, hedge funds and other speculators on the long side would have to be willing to sell, which is not likely as long as the market displays such strong bullish signals (strong trend, high volume and increasing open interest). Maybe a big drop in open interest as a result of the March options expiration could trigger some profit taking, but we wouldn’t bet on it just yet.

Best Regards