NY futures traded sideways this week, as March moved up just 28 points to close at 86.31 cents, while new crop December gained 63 points to close at 77.23 cents.
With global financial markets appearing a lot calmer this week, the cotton market was able to maintain its composure as it stayed above an 11-week uptrend line dating back to late November. However, recent consolidation has formed a ΅triangleΆ or ΅flagΆ pattern on the chart, which is setting the stage for the marketΆs next move. Typically these flag formations are simply a pause in a prevailing trend, which in this case is up, and the odds therefore favor a continuation of the trend, not a reversal.
Recent action in the cash market seems to portend a strong market as well, since most mills around the globe arenΆt well covered and are therefore pursuing remaining supplies with a sense of urgency. The most recent US export sales report had once again 20 different markets on the buyers list, as another 179Ά500 running bales were sold for shipment until July, with an additional 36Ά000 bales for August onwards. Total commitments for 2013/14 now amount to 9.2 million statistical bales, of which 4.5 million have so far been exported.
Looking at the statistical position of the US, we estimate supplies at 17.0 million bales this season (beginning stocks 3.9 + crop 13.1) and current commitments at 12.8 million bales (US mill use 3.6 + export sales 9.2), which theoretically leaves around 4.2 million bales still available. However, we need to reserve at least a million bales for domestic mill use between August and October, which reduces remaining supplies to 3.2 million bales. Some of that is already committed for export for August onwards shipment (we estimate 0.4 million bales at this point), which lowers the uncommitted number to less than 3 million bales. Since thatΆs all that remains until the fourth quarter, it is not surprising that so many mills from all over the globe are keen to secure a share of whatΆs left.
Typically one would expect some rationing to take place in a situation like this, but there is a very compelling reason why this may not be happening this season. The nearly 10 cents inversion between July and December creates plenty of incentive for merchants and growers to push every last bale out the door before prices reset at some point this summer. Mills would like to resist these higher prices, but they are short covered and realize that supplies are tight, so they are in no position to play the ΅stretch gameΆ in early February. There is way too much time left until new crop and mills need to keep their factories running.
In other words, we may have a situation in which sellers keep pushing sales and mills remain willing buyers, no matter how tight inventories get in the process. With both sellers and buyer having an incentive to keep the business going, prices may not even move that much for a while. But the tighter supplies gets, the more dangerous it becomes for traders who are short, especially in the futures market.
The futures market is a zero sum game, which means that for every long there is a short. Since index funds occupy a large block of the long position (5.8 million bales), which they roll forward on only four occasions every year, any short that wants to get out has to either find another short to replace it, or a long willing to exit. Since there is hardly any cotton left to hedge on March, May and July, we donΆt expect too many new sellers to enter the game. This means that existing shorts will have to rely primarily on longs letting them out.
This week we actually saw some orderly long and short liquidation, as futures open interest dropped by nearly 10Ά000 lots without much movement in the price. This is akin to letting some steam out of a pressure cooker, but there is still a long way to go. What continues to worry us is the large amount of unfixed on-call sales. Although open on-call sales dropped by 3Ά686 lots in March, they went up by 2Ά628 lots in May and July. There were still 5.56 million bales of on-call sales open in current crop, whereas unfixed on-call purchases amounted to just 0.8 million bales.
So where do we go from here? The market still looks well supported at the moment, both from a fundamental as well as a technical point of view. Supplies in the ROW are getting tighter by the week and there is no price pressure eminent in any of the major origins. MondayΆs USDA report may show some bullish numbers for a change, as higher US exports should bring US ending stocks down to 2.6-2.7 million bales. Also, the current supply tightness in the ROW leads us to believe that global consumption has been understated and we therefore expect to see an upward revision one of these days.
The chart still shows an uptrend that is alive and well, although we need to watch how this flagging pattern gets resolved. A breakout to the upside would likely invite additional spec buying and make life difficult for the shorts, while a breakout to the downside would trigger sell stops and thereby provide shorts with an opportunity to get out of trouble.
Markets that are driven by a tight supply situation usually donΆt end on a whim, but rather with some fireworks brought about by a short squeeze. So far we have seen nothing of the sort, as the trade net short position is still close to 10 million bales and unfixed on-call sales remain stubbornly high. Only once most of this large trade short has been liquidated will there be some confidence that a top is in place.
Best regards
