NY futures ended a volatile week slightly lower, as March dropped 130 points to close at 86.03 cents, while new crop December fell 271 points to close at 76.60 cents.
An escalating emerging markets crisis introduced an additional uncertainty factor to an already complex cotton situation this week, resulting in erratic up and down price action as traders tried to figure out the marketΆs next move. Bulls and bears both have some strong arguments at the moment and it will be interesting to see who will emerge as the stronger side in this tug of war.
The bullish case is mainly built on a tight statistical situation in current crop and a relatively large trade net short position (10.4 million as of last week) that may get squeezed, similar to what we saw happening a year ago. Although Chinese imports have slowed down this season compared to the previous two, they nonetheless seem strong enough to once again absorb the entire ROW production surplus and possibly more, which means that ROW inventories are likely to remain rather tight as we head into the second half of the season.
After another two weeks of stellar US export sales, during which over 1.0 million running bales were sold, most of which ΅on-callΆ, our calculations show that unsold US supplies (including beginning stocks) are probably at no more than 4.4 million statistical bales. Since many mills are not well covered for the second and third quarter and with only a limited amount of machine picked cotton available from other origins, it makes perfect sense for the US to price itself out of the market in order to ration remaining supplies.
This has already happened to a certain degree, at least when looked at from a fixed price point of view, but mills have been trying to outsmart the market by buying on-call, which has the potential to backfire as history has shown. Unfixed on-call sales increased by another 0.4 million bales last week and they now amount to 6.35 million bales overall, of which 5.67 million bales are in current crop. While outstanding fixations dropped by 83Ά100 bales in March, they increased by 376Ά400 bales in May and July, as buyers continued to postpone pricing decisions.
Interestingly, even the emerging markets crisis has a bullish component to it, as growers tend to hold on to their crops to protect themselves against a drop in local currency, which limits ready available supplies and can trigger short-covering rallies.
The bearish camp is pinning its hopes mainly on record global stocks and on a deteriorating macro situation. Speculators large and small have been the main drivers behind this rally that lifted prices from the mid-70s to the high-80s since late November. As of last week, specs were 4.8 million bales net long, up nearly 6.0 million bales in just two months! The bullish case depends to a large degree on speculators staying long, otherwise a short-squeeze will prove difficult to play out. As we have seen on Monday, when speculators are spooked by macro jitters, the downside can open up rather quickly.
The big question is whether this emerging market (EM) problem is just temporary or something more serious. It all started last week when EM currencies came under pressure and long-term bond yields started to rise. ArgentinaΆs Peso dropped by 20 percent so far this month, the most in 12 years, but it has been a global phenomenon, as countries like Turkey, Brazil, Russia or South Africa all saw their currencies under pressure, while interest rates spiked.
It was as if someone had shouted ΅fireΆ in theater, as the hot money crowd suddenly rushed for the exit in search of safer havens like the US, Germany or the UK, where interest rates actually dropped as a result of this money transfer. The capital flight forced some EM central banks to intervene and while these interventions may work in the short term, they often scare investors even more, because they are seen as an admission to a problem. Adding to all these concerns are fears of a credit crunch and hard landing in China.
Financial markets are largely a confidence game and once fear starts spreading, things can turn ugly in a hurry. We are reminded of the 1997 Asian crisis, which started with the collapse of the Thai baht and then quickly expanded to other Asian economies, as credit bubbles fueled by hot money started to pop.
So where do we go from here? Trade shorts have clearly painted themselves into a corner and they keep hoping for spec long liquidation to get them out of trouble. However, if the emerging market situation calms down and specs stick with their longs, we could see an explosive short covering rally one of these days. Shorts may stall for time by rolling their positions from March to May and then again from May to July, but there will be a day of reckoning unless a deteriorating macro picture flushes the specs out first. Merchants have been increasing the certified stock to around 150Ά000 bales this week and will probably add some more in an effort to stem the advance, but this may simply be good enough to force some carry in the market.
While trade shorts have no other choice but to buy back their contacts between now and June, spec longs have the option to roll their longs into new crop and pick up huge roll gains in the process. In other words, the shorts have to get out, while the longs donΆt, and that in a nutshell is the story that drives current crop prices higher.
New crop is still an entirely different story, as plenty of growers are waiting for an opportunity to put on some hedges against next seasonΆs crop. December ran into heavy resistance at the psychologically important 80 cents level last week and has since dropped back below 77 cents, but we would not sell it here and instead wait for another opportunity.
Best Regrads
