NY futures extended their decline this week, with December falling another 351 points to close at 68.55 cents.
The market continued its relentless slide, driven by the same dynamics we talked about last week. The market’s weakness stems from a stark imbalance between active buyers and sellers, as bearish fundamentals and a dismal looking chart are prompting the trade as well as speculators to sell the market, while potential buyers are still not ready to catch the falling knife.
While some traders are willing to bite the bullet and begrudgingly place their hedges as the market keeps falling, scores of others continue to wait for that elusive rebound, only to regret their procrastination a day or two later. Since posting a high of 84.63 a little over two months ago - on May 5 - the December contract has fallen over 1600 points without offering potential sellers a bounce of more than a cent or two along the way.
We were rather surprised when we saw the latest CFTC report, which revealed that the trade was actually a net buyer during the week of June 24-July 1, reducing its net short by 1.1 million bales to just 7.0 million bales. In other words, instead of catching up on hedges, the trade was bold enough to lift existing ones. This move clearly backfired as the market resumed its downtrend this week and traders were once again forced to chase after this runaway market.
Seven million bales in net trade shorts are not nearly enough given that there is a US bumper crop in the making, along with other crops around the globe that need price protection. By comparison, last year the trade had 13.0 million bales in net shorts at the same date. We believe that it was primarily producers and to some lesser degree shippers that got caught on the wrong side of this down move.
Due to the Texas drought, the steep July/Dec inversion and a generally constructive price outlook until about six weeks ago, producers did not forward contract or hedge as much cotton as they otherwise would have. When the market started to fall in the wake of abundant rains in West Texas, speculators were first to react and started dumping their net long. Growers and merchants were only slowly adapting to the changed situation and have ever since been trying to catch up to this southbound freight train.
Speculators (‘Managed Funds’) reduced their net long position to 1.6 million bales as of July 1, down from 4.7 million on May 20, which was the week before it started to rain in Texas. However, when we look at the spec position as of last week, there were still 4.0 million bales in outright longs, while shorts had increased to 2.3 million bales. Based on the bearish chart we have to assume that most of these longs are headed for the exit, which would explain the tremendous selling pressure we have been witnessing lately.
