The Dec/March spread remained at the center of attention, with the difference widening dramatically to nearly 400 points today, after the two months had traded at par just a little over a week ago. We believe that December has now become very attractive to potential takers, be it as an outright purchase at 75 cents or on a spread at full carry.
Considering the stiff basis some prominent merchants have been willing to pay for cash cotton this week, we have to assume that a large portion of the current Certified Stock (264’000 bales including bales under review) is going to disappear over the coming weeks.
There was a flurry of excitement on Wednesday after the market shot up 200 points based on two news items out of China, with March trading as high as 79.45 cents. First it was reported that China’s CNCRC expected the crop to be at just 6.68 million tons or 30.7 million statistical bales, quite a bit lower than the current USDA estimate of 32.5 million bales.
The second story referred to rumors about the Reserve delaying auction sales by several weeks. This caught some local traders with short positions by surprise and led to a sharp rally in the Zhengzhou futures market, which spilled over to the NY futures market during the overnight session.
ZCE futures are currently in a steep inversion, with the January contract trading about 8 cents/lb above the May contract. Prices on the CNCE are showing a similar inversion. However, we need to remember that this is an artificial squeeze since China has more than enough cotton with its massive stockpile and in this context it is insignificant that China’s crop may be slightly lower than expected this season.
What we are currently seeing in many markets around the globe is a nearby shortage of cash cotton, as we are still in the process of refilling a nearly empty supply pipeline. Some traders may have overcommitted for nearby shipments and are finding it difficult to find coverage.
The US is no exception, as merchants have been scrambling to get their hands on cotton, since the crop has been later than usual and logistics are only able to handle so much, with load out dates at warehouses already backed up until January in many cases. Meanwhile, US export commitments keep rising at a torrid pace, as around 1.8 million bales have been sold over the last six weeks!
US export sales for the week ending November 14 amounted to a stellar 331’300 running bales net, with Turkey (117’600 bales) and China (68’100 bales) leading a group of 22 different markets.
Total commitments for the season now stand at 6.3 million statistical bales, whereof 2.1 million bales have so far been shipped. Including the 3.6 million bales that domestic mills consume this season, the US has already committed 9.9 million bales or 73 percent of this year’s US crop, which we estimate to be at 13.6 million bales. And it’s only the middle of November, with eight-and-a-half months to go in the marketing year!
With just 3.7 million bales to go before this year’s crop is committed, the US doesn’t need to be in any great hurry to put additional sales on the books and rather than making itself more attractive to buyers, the US will probably have to start rationing its remaining supply.
This may happen via a weakening basis of non-US growths, as other origins are not nearly as well sold and may therefore have to lower prices in order to capture business, while US prices should stay comparatively firm.
The latest CFTC report as of November 12 showed a large reduction in overall open interest in the wake of December options expiration. Open interest for futures and options positions combined dropped by 79’141 contracts to 211’295 contracts between November 5 and November 12, as specs and trade both cut their outright long and short positions, although there was little change in their respective net exposure.
Speculators large and small extended their net short slightly from 0.5 to 0.8 million bales, while the trade’s net short remained unchanged at 5.6 million bales. On the other side of the ledger we have Index traders, who increased their net long position from 6.0 to 6.4 million bales.
The fact that specs and the trade are both net short is another reason not to get too bearish on US futures right now. With prices as low as they are and given the advanced stage of US export sales, it is unlikely that either group will pile on additional shorts at this point.
Index Funds, who are the lone group on the long side, are not likely to alter their position by much, although they may become light sellers in early January due to the annual rebalancing.
So where do we go from here? We feel that NY futures are currently cheap enough with December at 75 cents. The question is whether March will follow in December’s footsteps as many traders expect or whether it will be able to muster some strength of its own?
A lot will depend on what happens with the Certified Stock! If a sizeable amount of it disappears over the coming weeks, which is likely, then March will have to ‘buy’ its own Certified Stock and for that it would have to move higher in order to attract cotton away from a highly contested cash market. In the near term we could therefore see March move to the upper end of what we still see as a broader 75 to 82 cents range.
Only once the nearby supply constraints are behind us do we see the potential for additional price pressure in the US market, although given the high level of commitments this early in the season we expect the December lows to hold.
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