NY futures rallied sharply this week, as March advanced 511 points to close at 82.89 cents.
Ever since closing above its 8-month trading range last Friday, the March contract has been on a tear, with heavy spec buying propelling the spot month all the way up to an intraday high of 84.00 cent today, before some profit-taking set in and forced values back below 83 cents at the close.
This most recent bull run, which started after the release of the USDA report on January 11 and took the market from an intraday low of 74.40 to todayΆs high of 84.00 cents, has been textbook style from a technical point of view, with heavy volume and rising open interest pushing the market to higher highs and higher lows over the last nine sessions.
The jump in open interest over the last five trading days has been nothing short of amazing, as it went from 174Ά938 contracts on January 15 to 197Ά740 contracts as of this morning, an increase of 22Ά802 lots! Specs have been piling in on the long side, while the trade kept adding to its already sizeable net short position. TodayΆs explosive blow-off session, during which nearly 64Ά000 futures changed hands, has likely pushed open interest past the 200Ά000 contract level.
What is somewhat surprising to us is that the trade has been stepping so stubbornly in front of this freight train. Traders seem to have forgotten the expensive lesson of early 2008, when we had a similar set-up before the market exploded to the upside. Fortunately the trade is not quite as short on a net basis as it was five years ago and hopefully it will be better equipped to handle margin calls on what we estimate to be a 13 million bales net short position in New York.
Most traders still seem to be stuck on the idea that an 80-million bale carryover stock is bearish and are unwilling to look at a broader picture that presents both fundamental and technical reasons in support of higher prices. We have already talked at length about our two-market theory, whereby the more expensive Chinese market acts as a magnet that pulls international prices higher over time. And now there is also a technical scenario that points to a firmer market.
When we take a birdΆs-eye view of the market and look at what prices have done over the last couple of years, we had a bear market from March 2011 to May 2012, which transitioned into a sideways trend that lasted for the past eight months, and now prices are breaking out to the upside. This renewed technical strength has brought in a lot of new spec interest over the last couple of weeks, after it was mainly spec short covering that supported the market prior to that.
The trade has increased its net short position from 6.8 million bales in early November, when the market was trading around 70 cents, to an estimated 13 million bales net short today. Most of these shorts are hedging physical long positions of various origins, but a sizeable amount is held against unfixed on-call sales, which amounted to around 5.2 million bales as of last week, of which nearly 4.0 million bales are on March, May and July.
So where do we go from here? We once again have a classical battle between spec longs and trade shorts, and so far the specs are winning! After going from a low of 74.40 to a high of 84.00 cents in just nine sessions, the spot month may be a bit overextended and it would therefore not surprise us to see a pullback towards 80 cents or even slightly below. However, specs are not likely to part with their new long positions anytime soon and the trade is probably going to use pullbacks to get out of some shorts.
Remember, when basis-long positions are sold or mills fix on-call sales, it typically means that futures get bought back at the other end. Since there isnΆt really that much grower cotton to be hedged at this stage of the season, the trade as a whole will more likely be a net buyer than a net seller of futures over the coming months. And because specs are also leaning towards the long side, the path of least resistance is up!
Just a few weeks ago most traders felt that the 80-cent level was out of reach, but an ever-increasing trade short position is now providing the fuel for even loftier heights. Today we got a whiff of what can happen when shorts start to panic into covering, and we probably have not seen the last of it just yet.
Best regards
