NY futures extended their decline this week, with December falling another 351 points to close at 68.55 cents.
The market continued its relentless slide, driven by the same dynamics we talked about last week. The marketΆs weakness stems from a stark imbalance between active buyers and sellers, as bearish fundamentals and a dismal looking chart are prompting the trade as well as speculators to sell the market, while potential buyers are still not ready to catch the falling knife.
While some traders are willing to bite the bullet and begrudgingly place their hedges as the market keeps falling, scores of others continue to wait for that elusive rebound, only to regret their procrastination a day or two later. Since posting a high of 84.63 a little over two months ago - on May 5 - the December contract has fallen over 1600 points without offering potential sellers a bounce of more than a cent or two along the way.
We were rather surprised when we saw the latest CFTC report, which revealed that the trade was actually a net buyer during the week of June 24-July 1, reducing its net short by 1.1 million bales to just 7.0 million bales. In other words, instead of catching up on hedges, the trade was bold enough to lift existing ones. This move clearly backfired as the market resumed its downtrend this week and traders were once again forced to chase after this runaway market.
Seven million bales in net trade shorts are not nearly enough given that there is a US bumper crop in the making, along with other crops around the globe that need price protection. By comparison, last year the trade had 13.0 million bales in net shorts at the same date. We believe that it was primarily producers and to some lesser degree shippers that got caught on the wrong side of this down move.
Due to the Texas drought, the steep July/Dec inversion and a generally constructive price outlook until about six weeks ago, producers did not forward contract or hedge as much cotton as they otherwise would have. When the market started to fall in the wake of abundant rains in West Texas, speculators were first to react and started dumping their net long. Growers and merchants were only slowly adapting to the changed situation and have ever since been trying to catch up to this southbound freight train.
Speculators (΅Managed FundsΆ) reduced their net long position to 1.6 million bales as of July 1, down from 4.7 million on May 20, which was the week before it started to rain in Texas. However, when we look at the spec position as of last week, there were still 4.0 million bales in outright longs, while shorts had increased to 2.3 million bales. Based on the bearish chart we have to assume that most of these longs are headed for the exit, which would explain the tremendous selling pressure we have been witnessing lately.
US export sales picked up considerably last week, but were not nearly enough to counterbalance the onslaught of selling. For the week that ended on July 3, net new sales amounted to 271Ά500 running bales, of which 68Ά100 bales were for prompt shipment and 203Ά400 bales were for August onwards. Shipments of 141Ά200 running bales remained above the pace needed to make the current USDA export estimate. For the 2013/14-season we now have commitments of 11.1 million statistical bales, of which 10.1 million bales have so far been exported. Sales for the coming marketing year currently amount to 2.7 million statistical bales.
When we look at the US balance sheet for the 2014/15-season, we may end up with a total supply of around 20 million bales, assuming beginning stocks of around 2.6 million bales and a potential crop of 17.4 million bales. Subtracting domestic mill use of 3.7 million bales and current export commitments of 2.7 million bales, it would still leave 13.6 million bales available for sale. ThatΆs a lot of cotton, especially if China is no longer as active on the import front as it has been in recent years.
So where do we go from here? As long as growers and merchants have a need to protect their physical long positions and speculators continue to liquidate their long holdings, the market is likely to remain under pressure. Only when we reach a point of equilibrium, where the selling gets matched by more aggressive mill buying and/or renewed speculative interest, does the market have a chance to arrest this brutal decline and to set itself up for a meaningful rebound.
At this point we have no idea at what level the market is going to regain its balance, although from a technical perspective the 66 cents level may offer some support, since it marks the low of June 2012. Also, sellers need to be careful not to get too carried away in all their doom and gloom, since a lot of the bearish arguments have already been discounted by now, while any potentially bullish factors are largely being ignored by traders.
The Indian Monsoon is still disappointing and Northern Hemisphere crops are by no means in the bag just yet. Further more, we are likely to see most of the certified stock disappear over the coming months (85Ά000 bales of de-certs so far in July) and the Dec/March spread has been narrowing by about 60 points since last week. In a market that acts as bearish as ours, we should see a move towards full carry between the various months and not the opposite.
Who knows, tomorrowΆs USDA report may finally give the market an excuse to bounce after dropping over 900 points in the last twelve sessions, since it canΆt possibly be any more bearish than the market is expecting. Therefore any surprise is likely to be on the friendly side, such as tighter US ending stocks this season and perhaps a conservative US crop estimate. However, any rebound would likely be short-lived, since there are still plenty of traders waiting for a chance to sell the market at a higher level.
Best regards
