NY futures extended their slide this week, as December dropped another 160 points to close at 66.05 cents.
Just when it looked like the market was finally getting ready for a bounce after trading sideways for the last eight sessions, a new wave of selling forced values another 200 points lower today. We still feel that tradeΆs lack of adequate price protection has been the main driver behind the marketΆs weakness.
Last FridayΆs CFTC report showed that the trade continued to be a net buyer in the futures market for a third week in a row. During the week of July 9-15, the trade bought 0.8 million bales net, bringing the three-week total to 2.6 million bales. In other words, instead of expanding its short position in a falling market, the trade keeps tripping itself up by reducing it. As of last week the trade net short position amounted to just 5.6 million bales, which is not even close to what it should be given the expected size of the US crop as well as some other origins that typically use the US futures market for price protection. By comparison, a year ago the trade net short position amounted to 13.2 million bales!
By getting out of shorts on the way down the trade has obviously been trying to pick bottoms, which clearly backfired and has set the market up for sharp down moves like the one we witnessed today. When the anticipated bounce fails to materialize, traders are often forced to re-enter a short position by selling at the market. That has apparently happened this morning, when a large sell order in December futures triggered a cascade of sell-stops and panic-like selling.
As long as the trade is not adequately hedged while the fundamental and technical outlook are getting more bearish, it is difficult to envision an end to this rout. After the market managed to stabilize near 68 cents for a while, todayΆs decline has once again opened the door for additional losses.
What will it take to finally halt the marketΆs decline? In other words, at what level will sellers refuse to chase the market lower and when will buyers show up in greater numbers? When we look at it from a growersΆ point of view, the current price level is already at or below the cost of production. Since locking in a loss is a tough thing to do, especially while the crop is still in the field, we expect grower selling to slow down considerably from here on down. Furthermore, with the forward AWP (Adjusted World Price) calculating just a couple of cents above the government loan, additional price protection mechanisms are starting to come into play that may reduce the need to sell the futures market.
Large and small speculators have moved from a 6.3 million bales net long position on May 6 to a 0.8 million bales net short position as of last week, a swing of over 7 million bales in a little over two months! They will likely remain net short and possibly add to their positions as long as the trend continues lower. However, this group has the power to act as a potent buyer once the market shows signs of a reversal.
Mills have been steady buyers on the way down as the most recent US export sales reports have shown, but they were still no match for the amount of selling that has hit the market recently. Nevertheless, the 373Ά200 running bales in net new sales last week were quite constructive, especially since there were 19 different markets participating in the buying. Total sales for the current season now amount to 11.1 million statistical bales, of which 10.3 million bales have so far been exported. For the 2014/15 marketing year we now have commitments at 3.4 million statistical bales, which is over 50% more than last season.
There has been a lot of talk about potentially significant defaults and cancellations, but we donΆt subscribe to this pessimistic view. First of all, supplies in the current season are still very tight and mills need the cotton to keep their factories running until new crop brings relief. The US has only a little over 800Ά000 bales of current crop cotton to ship and while there may be some cancellations, they wonΆt be in the hundreds of thousands.
As far as new crop goes, we need to remember that most mills have not covered very far ahead so far, which means that even if the first two or three months of new crop coverage are at levels that are 10-15 cents above the current market, the recent crash is providing mills with an opportunity to average the seasonal price down considerably. There will always be some shaky customers looking for an excuse to walk from a contract, but the vast majority of mills shouldnΆt have a problem if their seasonal average ends up being a few cents above the prevailing market price.
So where do we go from here? It is hard to argue with the chart, which continues to point lower, especially since the market broke through the 66.10 low of 2012 today and we are now at levels not seen since late 2009. Speculators are therefore likely to add to their net short until they see a trend reversal in the making.
Although the trade is still not properly hedged at this point, growers and merchants may become more hesitant to chase the market lower, since many of them are not prepared to book losses at this point and prefer to postpone the day of reckoning. However, as we have seen today, there are always traders who cannot stomach the pain any longer and are compelled to sell at the market. Nevertheless, the December contract has now moved nearly 20 cents lower without any meaningful correction and some caution is therefore warranted. With cotton prices catching up to polyester and with the US government loan and Indian MSP coming into play, the market may have gone far enough for now.
Best regards
