NY futures resumed their uptrend this week, as May rallied 380 points to close at 91.61 cents, while December gained 171 points to close at 79.55 cents.
After meandering sideways for the past six weeks, unable to generate much momentum, the market finally exploded to the upside on heavy fund buying. Volume was brisk with over 23’400 lots trading in May alone and we expect to see a large spike in open interest.
The market seems poised to challenge last year’s ‘three peaks’ on the weekly chart, which loom at 93.93, 92.58 and 93.90 cents. A move above this important resistance area would likely trigger additional fund buying and could make life quite miserable for the many trade shorts that remain.
Cotton was in good company though, as Ag commodities continued to rally this week, with hedge funds covering shorts and/or adding new longs in near frantic fashion. Coffee saw the most spectacular gains, having exploded from 115 cents/lb to over 200 cents/lb in a matter of just five weeks on supply concerns, but cocoa, sugar, wheat, soybeans, and corn all had phenomenal gains as well since late January, often to the detriment of commercial traders who in many cases continue to hold bearish views.
The most recent CFTC report showed that large specs carried the biggest net long position across 13 Ag commodities since the summer of 2012, when drought in the US farm belt propelled many of these commodities to record highs.
However, unlike two years ago the fundamentals are not quite as bullish, although there are notable exceptions such as coffee or lean hogs for example. We believe that it is the large amount of liquidity in the financial system and a lack of attractive investment alternatives that drives these managed funds into the commodity arena.
It is no coincidence that many of these commodities started to take off in late January, after the emerging market scare sent tens of billions of dollars back to the US and Europe.
With stocks getting pricey in the US after two years of phenomenal gains and with the bond market looking uninviting with interest rates as low as they are, fund managers in search of asset diversification and higher returns apparently decided to make a play in Ag commodities.
While hedge funds are piling into the cotton market, the trade isn’t really in a position to put up a good fight at this point. Cotton futures are not really that overextended yet in regards to the physical market, as remaining cash supplies in the US and other ROW origins are tight, while mills still need to cover plenty of cotton in the months ahead.
Even if the futures market continued to rally and leaves cash prices behind, it is doubtful thatthere would be a large amount of tenderable grades left for delivery, considering that this year’s crop produced only around 7.5 million bales of certifiable cotton.
US export sales continued to surprise positively, as report showed that 230’300 running bales of Upland and Pima cotton were sold last week – 182’100 bales for the current marketing year and 48’200 bales for shipment August onwards.
Once again there were 18 markets participating, which shows that there is still broad based demand for US cotton. Total commitments for the current marketing year are now at 9.6 million statistical bales, of which 5.9 million bales have so far been exported.
Talk about additional Chinese imports quotas provided additional fuel for the bulls this week. In addition to the annual Tariff-Rate-Quota (TRQ) of 894’000 tons, there are strong rumors that a 4-by-1 sliding scale quota (four bales of Reserve cotton entitle to one bale of imported cotton) as well as a 500’000 tons processing quota would be released over the next few weeks. If these quotas became reality, it would probably boost Chinese imports beyond the 11.0 million bales estimate of the USDA and render a tight ROW situation even tighter.
So where do we go from here? The fact that hedge funds are taking a liking to the commodity complex in general and to the cotton market in particular is not boding well for trade shorts. This breakout to new highs looks impressive on the chart and will probably attract additional fund buying.
As we have stated repeatedly, we see no easy way out for the many trade shorts that have been fighting this trend for the last 17 cents. On-call sales showed hardly any improvement last week, as there were still 4.67 million bales unfixed on May and July.
Unless speculators somehow get spooked into abandoning their net long or the trade finds a large block of tenderable cotton to put on the board, this story will end as it usually does, with a ferocious short squeeze that inflicts a lot of financial pain to those who don’t get out of harms way in time!
