NY futures traded sideways this week, as December closed just 3 points lower at 84.72 cents, while March added 3 points to close at 84.46 cents.

Although the futures market didnΆt move much this week and volume remained relatively subdued, it was interesting to see open interest reversing back up after several weeks of liquidation. Over the last seven sessions open interest jumped by nearly 12Ά000 contracts, with March accounting for most of the increase with over 11Ά000 contracts.

Since speculators typically operate in the more liquid spot month, we have to assume that it was primarily the trade that added long and short positions in March. While additional shorts may be tied to grower hedging and additional on-call business, new longs may be related to a ΅weather playΆ.

With harvest in the Northern Hemisphere about to gain momentum, traders are paying close attention to the latest weather developments. After an irregular growing season, which set most of the US crop 2-3 weeks back and possibly affected fiber characteristics, the last thing this crop needs is a rainy and cold fall. Unfortunately the long-range weather forecast points in that direction and that has traders nervous. Not only are the tropics getting more active, but frontal boundaries are expected to trigger a number of storms from Texas to the Southeast over the coming days. Although certain areas would welcome some rain, they donΆt want to see a pattern of recurring storm systems develop.

There is not much margin for error this year since the US crop is relatively small to begin with - the third lowest in 24 seasons to be exact. Only the 2008/09 and 2009/10 seasons saw smaller outputs at 12.8 and 12.2 million bales, respectively. In other words, all it takes is some adverse weather to create a tight premium-grade situation. The first 203Ά000 bales that have been classed so far - all from Texas - have yielded only 46.7 percent in tenderable grades. Although this percentage is likely to rise over the course of the season, the pool of tenderable grades is not going to be very large. At 60% it would amount to just 7.4 million bales out of an Upland crop of 12.3 million bales!

This makes the market vulnerable to a squeeze down the road and it also has the potential to wreak havoc with basis levels, especially if foreign growths like India or West Africa continue to pressure physical prices. If anything goes wrong with this small US crop, it could hurt the many basis-long positions and unfixed on-call sales out there. By being short the futures market, traders all over the globe essentially bet on a positive outcome for the US crop and any weather related trouble could therefore ignite a short-covering rally. According to the latest CFTC report, the outright trade short position still amounted to 16.3 million bales (net short of 11.6 million bales), while unfixed on-call sales were at 5.9 million bales.

US export sales didnΆt amount to much last week, as only 111Ά100 running bales of Upland and Pima cotton found a home. However, we believe that the uncertainty surrounding the US crop has a lot to do with this modest sales number, as shippers are not willing to commit too many additional high grades at this point. For the season total commitments now amount to 4.1 million statistical bales, whereof 1.2 million have so far been shipped.

One news item that didnΆt get quite the attention it deserves was that China imported 1.26 million bales of cotton in August. The USDA expects China to import 11.0 million bales this season, so this August number was a big first step in that direction. It also means that Chinese imports will have to average just 0.88 million bales a month for the rest of the season to get to the USDA target and to absorb the production surplus in the rest of the world. By comparison, China imported an average of 1.68 million bales a month last season and 2.11 million bales in 2011/12.

So where do we go from here? Not much has changed since last week, as the market is still firmly entrenched in a 7-month sideways trend. Traders obviously donΆt think that prices will move much in the foreseeable future, since implied volatility has dropped to a very low 19% this week. However, as we have tried to convey in this report, the market remains quite vulnerable to weather issues and we therefore expect traders to remain on edge for next six weeks or so. If the US crop escapes unscathed, we could eventually see some pressure emanating from cheaper foreign growths, although Chinese support under 80 cents should prevent prices from dipping too much.

Best Regards