Cotton trade is currently under hedged – Plexus

01 Dec '12

5 min read

Speculators are a lot more fickle and given that we are in the middle of a 6-month sideways trend, with specs owning more or less an equal amount of longs and shorts, we could see a reaction in either direction, although the shorts seem be the more trigger-happy lot, while many longs are part of the “commodity super bull” crowd that subscribes to a longer term view.

The trade (merchants, growers and mills) has probably the most weight in determining the market’s next move. At the moment the trade is 6.32 million bales net short, most of which are hedges against unsold long positions in physicals.

However, if we do the math we can easily come to the conclusion that the trade is currently ‘underhedged’. Just in the US alone we have nearly 10 million bales still for sale, if we figure supply at 21.3 million bales (3.3 beginning stocks and a bigger than expected crop of 18.0) minus current commitments of 11.3 million bales (7.8 exports and 3.5 domestic). In addition to that there are various current and new crop positions in other origins that typically use futures and options for downside protection, like Australia or Brazil, just to name a few.

In other words, the 6.32 million bales net short only covers part of the many bales that are still available for sale around the globe. However, traders seem reluctant to add to their short futures positions near 70 cents for a variety of reasons: 1) Cotton is relatively cheap compared to other commodities and will likely lose a substantial amount of acres next season, hence cotton doesn’t really need to get any cheaper. 2) China keeps absorbing supplies from the rest of the world at a higher rate than common sense would dictate. 3) Although global stocks are plentiful, not all stocks are equal, meaning that the amount of cheap inventory is relatively limited, with plenty of buyers waiting to buy it on dips.

So where do we go from here? In light of several good export sales reports and continued interest for US styles as well as other origins, most traders don’t perceive there to be any great downside risk at the moment. As long as China and some of the other importers keep buying at the rate they are, crop pressure is not likely to become burdensome, which may allow the market to stay in its current equilibrium.

However, selling pressure could develop if Chinese import demand suddenly slows down and India becomes more aggressive on the export front, which could prompt US traders to put on additional hedges. On the other hand, continued Chinese buying coupled with an outlook for a substantial drop in acreage may embolden an increasing number of traders to approach the market from the long side as we head into 2013. For now the market seems to remain stuck between these scenarios and it will takeconsiderable force to get it out of its current trading range.

Plexus

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