New York futures ended a volatile week slightly lower, as March dropped 130 points to close at 86.03 cents, while new crop December fell 271 points to close at 76.60 cents.
An escalating emerging markets crisis introduced additional uncertainty to an already complex cotton situation this past week, resulting in erratic up and down price action as traders tried to figure out the market’s next move. Bulls and bears both have some strong arguments at the moment, and it will be interesting to see who will emerge as the stronger side in this tug of war.
The bullish case is mainly built on a tight statistical situation in current crop and a relatively large trade net short position (10.4 million as of last week) that may get squeezed – similar to what happened a year ago. Although Chinese imports have slowed this season compared to the previous two, they seem strong enough to once again absorb the entire production surplus in the rest of the world (ROW) and possibly more. That means ROW inventories are likely to remain rather tight as we head into the second half of the season.
After another two weeks of stellar U.S. export sales in which over 1.0 million running bales were sold (most of which were on-call), our calculations show that unsold U.S. supplies – including beginning stocks – are probably at no more than 4.4 million statistical bales. Since many mills are not well covered for the second and third quarter – and with only a limited amount of machine-picked cotton available from other origins – it makes perfect sense for the U.S. to price itself out of the market in order to ration remaining supplies.
This has already happened to a certain degree, at least when looked at from a fixed price point of view. But mills have been trying to outsmart the market by buying on-call, which has the potential to backfire, as history has shown. Unfixed on-call sales increased by another 0.4 million bales last week and now amount to 6.35 million bales overall, of which 5.67 million bales are in current crop. While outstanding fixations dropped by 83,100 bales in March, they increased by 376,400 bales in May and July as buyers continued to postpone pricing decisions.
Even the emerging markets crisis has a bullish component to it, as growers tend to hold on to their crops to protect themselves against a drop in local currency, which limits ready available supplies and can trigger short-covering rallies.
The bearish camp is pinning its hopes mainly on record global stocks and on a deteriorating macro situation. Speculators large and small have been the main drivers behind this rally that lifted prices from the mid-70s to the high-80s since late November. As of last week, specs were 4.8 million bales net long – up nearly 6.0 million bales in just two months. The bullish case depends to a large degree on speculators staying long. Otherwise, a short-squeeze will prove difficult to play out.
As we have seen, when speculators are spooked by macro jitters, the downside can open up rather quickly.
The big question is whether this emerging market (EM) problem is just temporary or something more serious. It started last week when EM currencies came under pressure and long-term bond yields started to rise. Argentina’s Peso has dropped 20 percent so far this month – the most in 12 years – but it has sparked a global phenomenon, as countries like Turkey, Brazil, Russia or South Africa all saw their currencies under pressure while interest rates spiked.
As if someone had shouted “fire” in a theater, the hot money crowd suddenly rushed for the exit in search of safer havens like the U.S., Germany or the UK, where interest rates actually dropped as a result of this money transfer. The capital flight forced some EM central banks to intervene. While these interventions may work in the short term, they often scare investors even more because they are seen as an admission to a problem. Adding to these concerns are fears of a credit crunch and hard landing in China.
So where do we go from here?
Trade shorts have clearly painted themselves into a corner, and they keep hoping for spec long liquidation to get them out of trouble. However, if the emerging market situation calms down and specs stick with their longs, we could see an explosive short covering rally one of these days. Shorts may stall for time by rolling their positions from March to May and then again from May to July, but there will be a day of reckoning unless a deteriorating macro picture flushes the specs out first.
Merchants have increased the certified stock to around 150,000 bales. They will probably add more in an effort to stem the advance, but this may simply be good enough to force some carry in the market.
While trade shorts have no other choice but to buy back their contacts between now and June, spec longs have the option to roll their longs into new crop and pick up huge roll gains in the process. In other words, the shorts have to get out, while the longs don’t. That, in a nutshell, is the story that drives current crop prices higher.
New crop is still an entirely different story, as plenty of growers are waiting for an opportunity to put on some hedges against next season’s crop. December ran into heavy resistance at the psychologically-important 80 cents level last week. It has since dropped back below 77 cents, but we would not sell it here and instead wait for another opportunity.
The above is an option and should be taken as such. We cannot accept any responsibility for its accuracy or otherwise.
Source – Plexus