When tropical storm “Karen’ and typhoon ‘Fitow’ failed to deliver the expected punch to cotton areas in the US and China over the weekend, the market quickly relinquished some of its weather premium when trading resumed this week.
However, after a big turnover on Monday with over 39’000 contracts changing hands, there was not much follow-through selling beyond that, as trading turned relatively quiet over the following three sessions.
We are somewhat surprised by how well open interest has been holding up during this selloff, as just 6’368 contracts were liquidated during this week’s 400-point drop. That’s remarkable since open interest climbed by nearly 43’000 contracts over the previous 19 sessions, during which the market gained 400 points.
This leads us to believe that a large part of these new longs and shorts that were established between September 10 and October 4 belong to the trade, rather than speculators, because the latter would have been much more aggressive in getting out of harms way this week.
Some of these new futures long positions could serve as ‘substitute purchases’ against short sales of both US and non-US growths, since the lateness of Northern Hemisphere crops as well as the uncertainty in regards to quality have made it difficult for merchants to cover their commitments in the cash market.
In other words, this relatively high open interest of over 205’000 contracts is probably due to sizeable trade positions on both sides, as some traders operate with basis-longs, while others are holding basis-shorts, both unable to do much until the crops are finally in.
Harvest can’t arrive fast enough for traders, because the market has been incredibly dull in recent weeks, with volatility falling to levels not seen in years. However, we do believe that trading will turn a lot more lively in November, as there is still plenty of cotton to be marketed all over the globe.
With government organizations like the USDA and CFTC still shut down, the market is currently deprived of important reports, such as WASDE, weekly crop progress, US export sales and ‘Commitment of Traders’, making it difficult to take the pulse of the market.
Fortunately there seems to be a compromise in the making and we are hopeful that all agencies will be operational again next week. In lieu of a USDA estimate, the market seemed to pay close attention to the Informa crop number of 13.7 million bales last Friday, which was quite a bit more optimistic than USDA September estimate of 12.9 million bales.
Since the weather has been surprisingly cooperative over the past couple of weeks and early yield reports seem to hold some promise, the US crop may indeed be above 13.5 million bales, provided the weather continues to play along.
After falling to less than 12’000 bales last week, the Certified Stock is once again on the rise, as it amounted to nearly 56’000 bales (including 38’500 under review) this morning. Rumor has it that this inventory will grow to at least 150’000 to 200’000 bales over the coming weeks, as Glencore is apparently re-tendering some of the cotton they took up in July.
Shippers couldn’t be more pleased that the inversion between December and March has finally disappeared and that the board is starting to build carry, just in time for harvest. However, we are not quite out of the woods just yet with regards to the Dec/March spread, as adverse weather conditions could still rekindle the inversion over the coming weeks, so traders need to be careful not to get too bearish on December, especially in view of the already large open interest of over 126’000 contracts.
So where do we go from here? If the weather remains kind to the main crops in the Northern Hemisphere, we are likely going to see additional price pressure. Traders with basis-short positions will be ready to cover physical commitments as soon as bales become available, which would necessitate the selling of long hedges in New York.
The reduction of basis-long positions on the other hand is a slower process, as it takes time to make sales to mills. We could therefore see some harvest pressure in the weeks ahead and traders need to be mindful of the important 82 cents support level dating back to early February. If the market were to break below the June 3 low of 81.72 cents, it would likely open the door for substantial spec long liquidation and short selling that could force the market below 80 cents, at least temporarily.
If the weather doesn’t cooperate and crops suffer some last minute setbacks over the coming weeks, then the market may challenge resistance levels in the high 80s, although we feel that time is starting to run out for the bulls. We therefore see a sideways to slightly bearish scenario as the more likely in the foreseeable future.
