NY futures finally corrected their overbought conditions this week, with December dropping 1031 points to close at 133.90 cents, while March fell 1003 points to close at 129.15 cents.
Just when longs were about to throw in the towel after the spot month had fallen by nearly 30 cents from the November 10 high of 157.23 cents, the US export sales report of this morning reminded traders that this bull market still has some life in it and that the sell-off may simply have been a necessary correction in an overextended market.
Last week the US sold another 556’700 running bales of Upland and Pima cotton for both marketing years combined, after committing 542’200 running bales the week before. Total commitments now amount to around 12.9 million statistical bales for the current season, of which just 2.4 million bales have so far been shipped. The slow pace of shipments is puzzling, since there are already over 10.6 million bales ginned in the US and we should be shipping 400’000 bales a week instead of just 142’000 bales. Apparently there is a shortage of containers that keeps bales from reaching their destination in greater numbers.
After committing another 1.1 million bales for export over the last two weeks, we calculate the unsold balance in the US at no more than 3.0 to 3.2 million bales, or just about 15% of total supply this season. This number takes into account export commitments for August onwards and also includes what domestic mills are expected to use during the August/October period, since it will most likely have to come out of existing stocks. South Texas may bring some relief in late August/early September, but it won’t change the fact that this crop is already very well committed and that there is not going to be any selling pressure whatsoever from growers or merchants for the remainder of the season.
However, there is a caveat we need to keep in mind despite all this recent exuberance. While the US crop is to a large extent sold at the grower and merchant level, most of these bales have yet to be shipped and consumed. Outstanding export commitments are at an unprecedented 10.5 million statistical bales and it doesn’t seem far-fetched to envision that at least some of the current owners - mostly textile mills - might consider canceling or re-selling a part of the bales they are yet to receive. There seems to be a wide range of economic realities when we look at the mill sector and while some mills may still be able to turn a profit at 150 cents landed, others seem to have a much lower break-even point. We have already heard of some instances where mills have elected to cut their production and are trying to convert some of their cotton holdings into cash. At this point this may only have a small impact on global mill use, but if yarn prices can’t keep pace with cotton over the long run, we could see it happen on a larger scale.
The huge spread between current and ‘red’ December provides another incentive for mills to stretch their supplies as far as out as they can. The spread closed today at 43 cents, after it had widened to a record 57 cents last week. Why pay 150 cents or more now when the price is over 40 cents cheaper 12 months out? Even July at a 15 cents discount offers a huge incentive in that regard. We are sure that mills have their calculators out, trying to figure out how to maximize their returns in this topsy-turvy market.
The December options expiration resulted in a huge drop in total open interest, from 241’826 to 203’619 lots, as specs and the trade both cut their respective long and short positions. This is typically seen as a negative sign, because it signals a loss of momentum in a prevailing trend. A strong trend needs to be confirmed by high volume and rising open interest!
Contrary to popular belief, speculators have only a relatively small stake in the cotton market at the moment. When this bull market began in late July, specs owned 39.4% of all longs and 42.1% of all shorts, while as of last Friday they had 36.8% of all longs and just 25% of all shorts. In absolute terms specs are around 15’000 contracts more long today, while they own 14’000 contracts fewer shorts. This relatively low spec participation has pros and cons in our opinion. On the one hand it makes the cotton market less vulnerable to potential spec liquidation in reaction to weak outside markets. On the other hand it can lead to exacerbated moves when the trade is in charge and decides to change direction in a less liquid market.
So where do we go from here? After several days of free falling, the market seems to have found both technical and fundamental support. On Wednesday, when the market traded limit down, it closed right on an important uptrend line dating back to early October and today it managed to bounce off of it. From a fundamental point of view the A-index vs. March futures spread stretched all the way out to 30 cents yesterday, making the futures market look undervalued. However, we believe that it will be difficult for NY futures to rally back to the recent highs anytime soon. There is plenty of cotton around at the moment and we first need to see what mills are going to do with it.
Next week we should get a better idea of what cash cotton is really worth when the December contract enters its delivery period. It has been five months since the last ‘cash test’ and this one promises to be a lively and entertaining affair.
Best Regards
