NY futures performed mixed this week, with July bouncing 1135 points to close at 155.65 cents, while December remained unchanged at 119.19 cents.
The market is currently in an adjustment phase, as it tries to make the transition from a price level that was well over 2 dollars just a couple of months back to a spot price that will be roughly half of that when December takes over as the lead month around the middle of June.
Due to the record inversion there has been strong resistance by mills to pay the current asking prices for nearby shipments. In addition to that we are witnessing some destocking in the downstream sectors, as holders of relatively expensive inventory are trying to clear it out before prices adjust lower. Even though raw cotton supplies are at historically low levels, they are still plentiful compared to mill demand that is basically non-existent at the moment. Everyone, from merchants to mills, is trying to get out of existing inventory in order to reload when prices become a lot more attractive.
In a matter of just three months the market has gone from a wave of panic buying and hoarding to a wave of liquidation. This up and down action has made it difficult to gauge the true level of demand, because it either appears stronger or weaker than it really is. At the moment we need to be careful not to conclude that demand is weak, because we are in the midst of a destocking phase. We believe that global demand at the end-user level is still on a growth path and would not be surprised to see upward revisions in the USDA numbers down the road, especially since prices are becoming more affordable for mills.
Today’s US export sales report confirmed the dismal state the market is currently in, as sales for both marketing years combined showed a net decrease of 7’200 running bales last week. New sales of 89’700 were not enough to offset cancellations of 96’900 running bales, most of them coming from China. Total commitments for the current season now amount to around 15.8 million statistical bales, of which some 12.3 million bales have so far been shipped. Commitments for the 2011/12-season still amount to about 5.8 million bales of Upland and Pima combined.
Considering how quiet it has been in the physical market, the rally in July futures may have come as a surprise to many. However, there are several reasons behind July’s renewed strength. The most obvious is that Allenberg has de-certified just about all of the notices they have received against the May contract so far, more than 218’000 bales at this point. If this pattern were to continue, we could see another 176’000 bales de-certified by next week. The disappearance of the certified stock is making July shorts nervous and some of them have probably decided to get out of harms way.
The less obvious reason for July’s strength may have to do with the massive spread position that large speculators hold. When we look at the latest CFTC report, which includes futures and options positions, we notice that large specs had a 10.0 million bales ‘delta-adjusted’ spread position as of May 10, which by default consisted mainly of July/Dec spreads. While these large specs hold relatively small outright positions in the market at the moment (3.4 million long and 0.8 million short), they have obviously placed huge bets on the price movement between July and December.
Therefore, if speculators who shorted July and bought Dec at differences of 50, 60 or more cents a while back, decided to take profits with the spread at 20 or 25 cents last week, it would have generated buying power in July and selling pressure in December. In a relatively illiquid market with a current open interest of only 150’000 contracts in futures, it does not take a lot of volume to create volatile moves. Over the last nine sessions the July/Dec spread has traded from less than 21 cents to over 38 cents before settling at a little over 36 cents today.
While lifting July, the above-mentioned spreading may have put undue pressure on December, which traded as low as 113.76 cents last Friday before recovering somewhat this week. Although the Delta and Southeast made great strides in getting their crops planted over the last ten days, West Texas is still waiting for rain and as of this writing there is no significant moisture in the forecast, because the dry line is expected to stay well to the east of Lubbock. Even if West Texas did eventually get some rain, the crop would be off to a late start and therefore more susceptible to an early frost or a wet harvest.
Outside markets were supportive for cotton this week, as some of the managed funds seemed to return as buyers of commodities after the big drop two weeks ago, with wheat, corn and soybeans all displaying renewed strength. We continue to believe that demand for Ag commodities will remain robust, even with the US struggling for growth. Analysts are often too black and white in their views about inflation and deflation. While prices of things connected to the local economy (real estate, services etc.) may continue to soften, food and energy are daily necessities without which people cannot live and they need to be seen in the context of global demand. As long as food prices stay firm, cotton will have to maintain a certain price level in order to successfully compete for acreage.
So where do we go from here? Although physical prices are expected to remain under pressure, July futures may continue to defy gravity due to short covering, especially if the certified stock were to disappear. There are still 2.14 million bales in unfixed on-call sales in July, which continue to provide support. July may still collapse in the end, but probably not before most of the remaining shorts have been forced out. We still like December at 120 cents given the pent-up demand that is accumulating from mills postponing their buying and the uncertainty surrounding the Texas crop.
Best Regards
