Although this week’s trading action may have felt like a victory for the bears, the chart reveals that the market has actually moved sideways in the last 15 sessions, with May closing in a tight range between 91 and 94 cents since March 6. This settlement of 92.56 cents sits right in the middle of this narrow band.
Bulls and bears certainly tried hard to sway the market their way, as this week’s wild intraday swings illustrate. Monday’s low of 89.74 cents and Wednesday’s high of 97.35 cents produced a three-day range of 761 points and tripped up scores of nervous longs and shorts in the process. Volume was impressive as well, with a combined 123’600 contracts changing hands between Monday and Wednesday, before cooling off to just 17’400 lots.
Interestingly, despite all this heavy trading we didn’t see much of a change in open interest. Overall open interest actually increased by 389 lots to 184’162 contracts since last Thursday, indicating that there hasn’t been much liquidation yet. There was some position rolling though, as May open interest dropped 6’723 contracts, while July and December saw theirs increase by 4’983 and 1’400 contracts, respectively.
Judging by the open interest we have to assume that the structure between longs and shorts has not materially changed this week. The net long is probably still equally split between index funds and spec longs, while the trade continues to carry a substantial net short, most of which is in current crop futures.
We believe that this set-up is the main reason why the market has not caved in yet, even though it had every reason to do so after the weak session on Monday and then again on Wednesday, when May closed 569 points off its high. In both instances the market rebounded the next session rather than following through to the downside. The large trade short position provides ample support to current crop futures, as merchants continue to scramble out of basis-long positions (selling physicals/buying futures) and mills still had nearly 4.5 million bales to fix on May and July as of March 20.
The US balance sheet got even tighter this week after the USDA released its final ginning report for the current season. There were a total of 12.87 million statistical bales ginned this season, of which 12.23 million bales were Upland and 0.63 million bales were Pima.
This means that compared to last season the Upland crop has dropped by a whopping 4.27 million statistical bales! Based on this report we have to assume that US ending stocks will have to be lowered by 0.3 million to 2.5 million bales, unless the USDA changes its export number.
So far US exports remain on course to meet or exceed the 10.7 million USDA estimate, as last week’s sales and shipments were again above the average needed to achieve this goal. Net new sales for the current marketing year amounted to 79’000 running bales of Upland and Pima, while commitments for August onwards rose by 78’600 running bales.
Once again there were over 20 markets participating in all these transactions. Total commitments for the season now amount to 9.8 million statistical bales, of which 6.8 million have so far been exported.
According to our calculation the unsold balance in the US is currently at just 1.6 million statistical bales. We arrive at this number by taking into account 1.0 million bales for domestic mill use between August and October, and we further assume that 0.8 million of the 1.2 million in export commitments for 2014/15 will be shipped from existing stocks.
Here is another interesting thought - if the US were to ship just 200’000 bales a week and domestic mills continued to use 300’000 bales a month, then every last bale of US cotton would be gone by the end of September! Since the July/Dec inversion discourages the rationing of remaining supplies, the US may actually clean out its cotton warehouses before new crop comes off the field.
So where do we go from here? In trying to make some sense of the market, we need to split it into three separate parts. The first one concerns current crop, with May and July currently trading at a steep inversion to new crop.
This is the result of a) the extremely tight stock situation in the US and most other origins outside China, and b) the market structure that has caught a lot of trade shorts on the wrong foot. Before a price brake can occur, the shorts will probably have to buy their way out first.
The trade of course still hopes for the reverse scenario, whereby prices were to fall first and allow them to escape relatively unscathed. However, for that to happen spec longs would have to get spooked out of their positions and that doesn’t seem likely at this point.
We still believe that May and July are loose cannons that should be avoided if possible, as they are likely to cause further mayhem in the weeks ahead.
The second part focuses on the December contract, which as the transition month between current and new crop needs to be looked at as a ‘hybrid’ in regards to pricing. Since the US is basically going to sell outthis summer and mills have some pent up demand from trying to avoid expensive current crop prices, it will take some time for the supply pipeline to fill up again.
We therefore don’t expect to see much price pressure before the end of the year, which is why December has the potential to move higher and to extend its premium over March and later contracts.
We believe that March 2015 will be the first contract to fully reflect a more ample new crop situation. If new crop supply/demand expectations materialize and China curbs its imports next season as anticipated, then stocks in the ROW will start to grow and thereby put pressure on prices.
US and Chinese futures are already reflecting these expectations. For example, the January 2015 contract at the Zhengzhou Commodity Exchange, the month with the highest open interest, closed at just 16’010 RMB/ton, or around 117 cents/lb. This is about 2’700 RMB/ton (20 cents/lb) less than the spot month and is it also 1’240 RMB/ton (9 cents/lb) below the just revised Reserve auction price of 17’250 RMB/ton.
In summary, both China and the ROW are adjusting to a new price structure next season and this transition will likely take place in several phases.
