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Watch for Volatility as December Contract Period Ends

Watch for Volatility as December Contract Period Ends

The end is near. Cotton slipped below the 70 cent level and spent most of the past week attempting to regain that mark, as the primary market feature continued to be spread trading in front of the market transition from the December to the March contract.

First notice day (FND) for the December contract is November 23. Thus, there are only a few weeks of trading days before March becomes the lead spot month. I continue to believe that the best remaining pricing opportunity for growers will be within this time frame.

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Call sales for December are twice that of call purchases, and certificated stocks – while increasing some 2,000 plus bales daily – are still low relative to open interest. Week ending open interest in the December contract was near 120,000 contracts, and most of those will have to offset by December’s FND. Therefore, the next few weeks should prove to be active and volatile.

The narrow 67.50-72.00 cent trading range continues in play. But I also continue to feel there will be a small and short lived break above the range. A break above 72.50 cents would portend a test of 75 cents, but I do not feel the market can withstand much above 73 cents. In reality, demand will be all but shut off above 71.50-72.00 cents, but an attempted market squeeze on the December contract could support a test of the 75 cent mark.

My thought is that a grower should be fully priced at 71.50-72.00 cents, except for a relatively few bales they consider nothing more than play pretties.

General economic conditions around the globe continue to present barriers to consumer consumption for durables and nondurables alike, especially apparel purchases. The great consumer engine is absent, and consumption growth (demand) is mired in the economic muck of part-time employment and the failure to rebuild manufacturing activity. This lack in consumption growth, coupled with cotton prices attempting to scale the 73-cent line, has left cotton consumption stagnant. Further, the extended open fall season allowed both the U.S. and now the Indian crop to far exceed expectations and set up a scenario that will pressure prices from the supply side of the price equation.

USDA will release its November world supply demand report and the November U.S. crop production report on November 9. Expectations call for a slightly larger world crop and stagnant consumption, but with a slight improvement in China and flat to slightly-higher ending stocks. Of course, USDA could make historical revisions that could alter the carryover expectation. If that comes to pass, then world carryover could be lowered by whatever revision USDA would make. Note my bias that some USDA carryover projections are too high.

It is exactly this concern of slightly larger world stocks and the possible higher revision in U.S. stocks that causes me to shy away from the bullish side of price activity during the coming months and into the late spring of 2017. Typically, one of the best and proven market strategies has been for growers to price their crop at harvest and purchase a 200-400 point out-of-the-money call option on the July contract. Variations of this have been recommended since the initial development of this strategy under the leadership of the New York Cotton Exchange (ICE) in the late 1980s and early 1990s. Yet, the basic strategy has proven itself numerous times since development. Over the long haul, it is simply near perfect as to rewarding the grower with increasing his selling price and totally eliminating his price risk exposure after harvest.

In attempting to micro manage the strategy for perfection, this may well be the year to simply price the crop no later than harvest (December contract) and not purchase a call option. After two years of declining world stocks and this summer’s return of futures prices in the upper 70s, the risk of lower prices into the winter and spring of 2017 are higher than in past years. Nevertheless, I am not suggesting to avoid the strategy this year. Rather, I am simply offering my opinion that if one wants to attempt to cherry pick the years when the strategy may not add to the grower’s net return, then this may be a year when the strategy fails.

As expected, net export sales of upland and Pima were only 162,600 RB. Remember, prices during the reporting week were generally above 70 cents – the price point that mills have targeted to make the switch to the acid-based petroleum chemical fiber in lieu of cotton. This, too, is a major concern as to why I am of the opinion that the market will fail to move appreciably higher in the absence of a price squeeze on the futures contract.

Triple digit trading days will continue.

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