NY futures retreated this week, with May dropping 206 points to close at 80.18 cents, while December was down just 18 points to close at 74.98 cents.
The May contract, which is the most actively traded and therefore most relevant in terms of speculative activity, was unable to generate the necessary momentum to rally past the March 1st high close of 83.29 cents earlier this week and has since come under pressure. It was of no help that July was able to post a new high close of 83.68 cents on Tuesday. The fact that trading volume dropped below 10’000 contracts on Monday and Tuesday was an indication that this latest advance had run out of steam and that the market was ready for another correction.
Wednesday’s breach of an uptrend line dating back to February 5th triggered a series of sell-stops by spec longs. After open interest had risen to nearly 190’000 contracts during the recent rally, we finally saw it drop by 1’643 contracts yesterday as a result of this spec long liquidation and it has probably decreased further today. This rejection near the recent highs has started to form a double top on the chart and we should therefore expect a retest of the 78.70 cents support level in the near future.
Although current crop fundamentals remain supportive and the trade still needs to cover a substantial amount of shorts over the next three months, the near-term fate of the market is once again in the hands of speculators. We have seen rather wild swings in the net speculative position over the last three months that have produced some volatile price moves. On January 4th the net spec long position was around 6.5 million bales, with the spot month trading at 76.00 cents. What followed was an exodus of speculators that brought the net long position down to just 1.8 million bales and caused the market to drop nearly 10 cents to a low of 66.55 on February 5th. Then specs started to jump back in, rebuilding their net long to 6.0 million bales in the process, with the market rallying all the way into the low 80’s. Now we are once again faced with the possibility of spec long liquidation, which could lead to another exacerbated move to the downside.
However, there are several differences compared to three months ago. For starters the US has sold 3.5 million bales for export since the beginning of the year and the statistical situation has tightened considerably, not only in the US but all over the globe. The cash market is clearly reflecting this tightness and the A-index is 745 points higher than on January 4th. The yarn market has improved markedly and mills are generally in decent shape even at this high price level. Also, the global economic outlook is more promising than three months ago and inflation is starting to show up on the radar screen.
Therefore, while the chart may prompt some long liquidation, we don’t think that it will be as widespread as in January. We further believe that the trade will be a more aggressive buyer on weakness, because as of last week it was still sitting on a 13.2 million bales net short position and outstanding fixations in current crop remain exceptionally high at over 3.7 million bales (7.0 million overall). Sooner or later the trade will have to address this massive net short and unfixed on-call position, because rolling it forward won’t be a viable option unless the inversion between current and new crop were to collapse.
Next week we will get a first official look at new crop plantings, when the USDA releases its Prospective Plantings report on March 31st. The consensus is for around 10.3 million acres, but we feel that plantings will ultimately be quite a bit higher because of favorable soil conditions and an optimistic price outlook by many. We would not be surprised to see 10.8 - 11.0 million acres planted this spring, although we don’t expect the USDA number to come in that high just yet.
On a global scale world production may still have a tough time catching up to consumption if we can believe reports coming out of China and India, the world’s two largest cotton producers, which accounted for 54 percent of global output this season. Both countries may increase their plantings only marginally due to strong demand for food crops. If this were true, it would require the rest of the world to increase its plantings by a much more substantial margin. For example, if China and India were to increase their acreage by let’s say 3%, then the rest of the world would have to boost its acreage by some 25 % to arrive at an average global increase that’s big enough to close the seasonal production gap. Yields will of course play an important part in all this as well and based on the moisture profile in the Northern Hemisphere things look quite promising in that regard. Needless to say it will make for an interesting growing season with little margin for error.
So where do we go from here? We feel that there is a good chance that the market will complete the double top formation and retest support near 78-79 cents. At that point much will depend on how committed spec longs remain to their position and how aggressively the trade is going to pursue dips. Given the substantial trade short position we continue to believe that this sell-off is just another correction in an overall bullish trend that has further to go.
Best Regards
