After the December contract had reached a high of 93.72 cents last Friday, followed by another attempt to a high of 93.54 cents on Monday, the ferocious rally that took the spot month nearly 900 points higher over the course of just nine sessions was finally losing steam.
With momentum oscillators flashing warning signs and with December opening below its steep uptrend line on Monday night, the stage was set for speculators to head for the exit.
What followed was a brutal smash that knocked the December contract down 874 points in just two sessions. Many commentators seemed perplexed by the severity of this decline and were looking for explanations, such as reports of a bigger crop in India or rumors about a resumption of Chinese Reserve auction sales in conjunction with smaller import quotas. However, since this was mostly old news to traders, we have to look elsewhere for the culprit.
We believe that this sell-off was primarily caused by a lack of liquidity! Speculators had sponsored the market's advance after it broke above a triangle formation on August 7, with open interest jumping by around 39'000 contracts over the following nine sessions.
Specs couldn't possibly keep on buying at this pace and were therefore relying on trade short covering to take over at some point during the rally. However, unlike in early 2008, trade shorts stood their ground this time and weren't in any hurry to buy their shorts back, even after the market started to move lower.
Since most speculators obey technical signals in their decision-making, a massive amount of sell orders hit the market when the tide turned on Tuesday, with very little trade buying absorbing it on the other side. This caused the market to fall into a void of buying on Tuesday, locking limit down for a good part of the session and thereby limiting the amount of longs that were able to get out.
Only 19'410 December futures traded on Tuesday, with open interest dropping by just 5'206 contracts! This set the market up for yet another big decline on Wednesday, which proved to be more accommodating in terms of liquidity, as volume increased to 40'828 lots in December, while open interest decreased by a further 13'256 contracts.
The market finally regained its footing on Thursday, as trade buying supported the spot month at around 84 cents. Needless to say that this sell-off left its marks on the chart, as it took just two days to erase the constructive efforts of the last five weeks.
Furthermore, December broke through an uptrend line that dates back to June 3rd and we also completed a triple-top formation on the weekly chart. In other words, spec longs and technical traders are pretty beaten up and have probably not much love left for the cotton market at this point.
