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NY cotton futures leap over holiday period
07
Jan '12
Plexus Cotton Limited reports that New York futures made a big move to the upside over the holidays, with March gaining 750 points since December 22 to close at 94.74 cents.

After closing at 85.12 cents on December 14, the market has rallied an impressive 962 points over the last 14 sessions. However, while this move looks quite constructive on the chart, the fact that open interest has been declining sharply on Tuesday and Wednesday should be seen as a warning sign. Typically a powerful uptrend is validated by strong volume and rising open interest, which signals that a trend has momentum.

Surprisingly, open interest increased by only 1'531 contracts since December 14, which is not what we would expect to see in a ten cents move. Even more disappointing is that March open interest decreased by 7'880 lots, with most of this drop happening over the last two sessions.

This indicates that it was primarily short covering and profit taking that fueled the last four cents of the advance. Once the shorts are done covering, the buying will have to come from some other source, otherwise upside momentum will stall.

A lot of the short covering seems to be tied to the selling of physical cotton. When basis-long positions get sold to mills, merchants buy back the futures short that was hedging the physical long position.

Over the last couple of weeks mills have been very active in covering their needs for nearby shipment, taking advantage of relatively attractive prices. The fact that the world's biggest consumer of cotton, China, has engineered an artificially high price plateau (over 135 cents/lb) has created some welcomed breathing room for mills around the world.

The Chinese Reserve has continued to aggressively procure cotton in the domestic market, with today's total now amounting to over 10.5 million statistical bales. If we include an estimated 4.5 million bales of purchases abroad, the Reserve may have already accumulated a total of 15.0 million bales.

According to the latest USDA numbers, China is expected to have an 11.5 million bales production deficit this season, but if we add the 10.5 million bales that the Reserve has extracted from the market so far, we get to a statistical shortfall of 22.0 million bales, assuming there is no change in ending stocks. However, the impact of this shortfall on international prices may not be felt until later in the season, if at all.

If we take a look at how much cotton is currently still available to Chinese mills, we have 11.6 million bales in beginning stocks and 23.0 million bales in new crop that hasn't been taken up by the Reserve.

In addition to that China has already imported around 5.0 million bales since August, some of which belongs to the Reserve. For the purpose of this calculation we assume that 4.0 million of these imports are available to mills.

When we add all these numbers up, we get to almost 39 million bales of free supply. From that we have to deduct mill use of about 3.75 million bales per month, which amounts to roughly 19 million bales since August.

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