NY futures rallied this week, as March gained 338 points to close at 86.19 cents, while new crop December advanced 221 points to close at 79.67 cents.
After the market demonstrated its strength by successfully holding support at 82 cents, withstanding heavy selling pressure from index traders between January 8 and 14, the stage was set for a move to the upside. It was therefore not surprising that the market rallied nearly 250 points over the last two sessions, boosted by what appeared to be a combination of spec buying and trade short covering.
There were a couple of reports that added to the bullish mood this week. First we learned that Chinese imports for December amounted to 2.7 million statistical bales (609Ά000 tons), which brings total imports for the first five months of the season to 6.43 million bales. This means that China will only have to import 4.57 million bales over the remaining seven months of the marketing year to arrive at the current USDA estimate of 11.0 million bales. This seems certainly feasible considering that China has recently started to release its annual Tariff Rate Quota (TRQ), which usually amounts to around 4.1 million statistical bales.
The second report that got traders excited were US export sales for the week ending January 9. Even though most traders expected a number above 150Ά000 bales, the fact that net sales increased by 239Ά700 running bales took the market by surprise. Once again there were 17 different countries participating in the buying, with China, Vietnam and Indonesia leading the pack. Total commitments for the season are now at just under 8 million statistical bales, of which 3.5 million bales have so far been shipped.
It is quite obvious that most of these new sales were done ΅on-callΆ, since the latest CFTC report reveals a net increase in unfixed sales of 176Ά500 bales. Total unfixed on-call sales now amount to 5.08 million bales for current crop and 0.53 million bales for 2014/15. By leaving the price on so many contracts open, mills often defeat their own objective and ultimately end up paying higher prices. We believe that the 12 million bales in unfixed on-call sales were one of the main catalysts that propelled prices to historic highs in early 2011 and we seem to experience similar dynamics this time around, albeit on a smaller scale.
Last FridayΆs USDA supply/demand report did not contain any changes in the categories that matter most to international prices, as the ROW production surplus was little changed at 11.31 million bales and Chinese imports were left at 11.0 million bales. In other words, stocks in the ROW are expected to remain at more or less the same level as last summer. From a psychological point of view the report may have been slightly bearish, since the USDA raised the Chinese crop by a million bales, thereby boosting global ending stocks to 97.61 million bales, of which 58.31 million are located in China. However, for traders and mills scrambling to get their hands on cotton for nearby shipment it is inconsequential whether Chinese stocks are currently at 57 or 58 million bales. The disposal of a large portion of these stocks is something that will occupy tradersΆ minds over the coming three to five seasons.
So where do we go from here? We believe that there are certain times when ΅position dynamicsΆ become the most important driver, especially in a relatively tight statistical situation like it currently exists in the US. Sure, one can easily argue that prices are relatively expensive at the moment, but that doesnΆt mean that they canΆt get even pricier.
The problem is that the trade is substantially net short in current crop futures (over 10 million bales) and will either have to roll this short forward to new crop or buy it back over the next five months. Rolling current crop to December is no viable option at the moment, given that we have an inversion between July and December of over six cents. If buying back is the only way to go, the question is ΅who is the trade going to sell it toΆ? Index Funds will provide liquidity to roll short March futures into May and so on, but thatΆs like kicking the can down the road, because a roll doesnΆt equate to net buying.
Speculators are the group thatΆs long, but with the chart painting the picture of a strong and rising market, these specs are in no hurry to abandon their long holdings anytime soon. If anything, speculators are probably inclined to buy additional longs after the market has been able to shrug off an onslaught of index fund selling lately.
Therefore, with the trade having to buy back current crop futures and speculators possibly wanting to add to their long holdings, there is currently no one willing or able to step forward as a strong seller. This means that the market will have to rise in order to attract potential sellers.
New crop is a completely different animal! When current crop prices rally, they pull December futures along to some degree, but we suspect that selling pressure will intensify once the psychologically important 80 cents level is reached. Open interest in new crop futures amounts to only around 14Ά000 contracts at the moment, but with the planting window fast approaching, we should see a lot of hedging in the months ahead.
We may therefore have a situation in which current and new crop futures obey different dynamics and the spread between the two continues to widen. The trade will probably try to throw some certified stock at the problem in the not too distant future, but it remains to be seen whether that will remedy the situation. Although it may force some carry in the market between March, May and July and thereby facilitate the roll, we doubt that it will be able to force the market on its knees. For that to happen the trade will first have to get out of its net short in current crop futures and we are still a long way from that.
Best regards.
