NY futures gained additional ground this week, as December advanced 141 points to close at 97.17 cents, while March added 165 points to close at 96.38 cents.

The futures market has been on a rollercoaster ride this week, with December first climbing to a new high of 103.34 cents on Wednesday, only to collapse by over 600 points since then. A correction had been long overdue after the market’s parabolic rise of 30 cents in just two months, but it was anybody’s guess when and at what level it would occur.

We have previously talked about the dynamics behind a bull market and what signs we need to be looking for in order to spot a potential top in the making. Speculators were sponsoring the early phase of this bull market, as they piled into cotton in an impressive manner during the first 20 cents of the advance. By the time the December contract was trading at 93 cents, open interest had increased by over 70’000 contracts or nearly 50%, as speculators large and small wanted to own a part of this bullish story.

However, over the last couple of weeks we have seen a pronounced slowdown in spec buying and during the last 10 cents of the rally open interest went up by less than 10’000 contracts. Speculators were no longer the driving force and instead we were now seeing a lot of trade-to-trade activity. While some trade shorts were forced to make defensive plays by buying calls or call spreads, others were apparently still able to sell into the rally, because we have yet to see a net reduction in the trade net short position as reported by the CFTC.

Also, for the first time during this rally we saw a sizeable amount of mill fixations, which may have helped to propel the market over the dollar mark. As of last Friday, unfixed on-call sales had dropped by a seemingly uneventful 279 contracts net to 105’153 contracts, or 10.51 million bales. Looking at the details though we notice that December on-call sales dropped by 854 contracts net, while the number for March was down by 1’216 contracts net. This means that there were at least 200’000 bales fixed, but probably a lot more, since these are net numbers. In other words, there may have been 300’000 bales in new sales added on December and March, while 500’000 bales were fixed.

This is certainly plausible when we look at the latest US export sales report, which shows that another 576’700 running bales of Upland and Pima were sold last week, of which 55’300 bales were for the next marketing year. For the current season commitments now amount to around 8.5 million statistical bales, of which only a little more than 1.3 million bales have so far been shipped. This low shipment number is entirely due to a lack of cotton in the pipeline and will rapidly increase once the crop becomes available.

Speaking of the crop, the harvest in the Mid-South and Southeast has been progressing very rapidly under hot and dry conditions and early indications are promising in regards to yield and quality. The early arrival of the US crop is definitely playing a role in this correction. While conditions for the Delta still look fine for next week, the Southeast may not be as lucky since some meteorologists call for very wet and stormy conditions to arrive early next week. Hopefully a large part of the Southeast crop will be in modules by then.

So where do we go from here? The momentum has clearly shifted in the last couple of sessions. Spec longs have not been chasing the market for a while now and trade shorts seem to have weathered margin calls a lot better than we had feared. CFO’s must be feeling quite relieved tonight since they are finally getting some money back from New York. At the moment neither speculators nor the trade have a reason to chase prices higher anymore and with the harvest in the Northern Hemisphere gaining momentum we should see the recent fear and panic subside.

With the chart signaling a reversal, spec longs have started to book profits and will increasingly do so if the market doesn’t turn back up quickly. If speculators are in ‘sell mode’, then where is the support going to come from? The two main sources of support are the 10.5 million bales of unfixed on-call sales and Chinese buying. Mills are likely to use a weaker market to reduce their large number of unfixed on-call sales, which should absorb a decent amount of the spec selling. Then there is China, which is still very much in panic mode after prices on the CNCE and the ZCE futures market have shot up to well over 140 cents on record turnover this week. The Chinese Reserve has been auctioning off another 520’000 tons so far in its latest effort to stem the panic and at some point it will have to come to the world market to refill its strategic stock. We are therefore convinced that there is a sizeable amount of Chinese buying waiting below the market, although what level the Chinese government has in mind is anybody’s guess.

Rather than falling apart we believe that the market is going to transition into a sideways range over the coming weeks and months. With the crop now coming in we believe that there will be plenty of selling near the recent highs, but at the same time we expect to see decent support near 90 cents. Whether the market will eventually be able to take out new highs depends on a lot of factors and it probably won’t happen until the 2nd or 3rd quarter next year. The market first needs to establish how much cotton the world is going to produce and see what kind of a toll these high prices are taking on consumption. In the meantime we expect the market to cool off, volatility to drop and spreads to reflect some carry again.

Best Regards