Bizarre & enigmatic cotton situation confronts 2013

What concerns us is that hardly anyone in the trade believes that cotton prices have a chance of moving higher, with most traders subscribing to a perpetual sideways trend. Just look at the incredibly low volatility readings of just 20% all the way from March to new crop December! For example, the December 80 calls closed today at just 564 points, even though there are still over 10 months on the clock. This nonchalant attitude raises some red flags, especially when we consider the current spec/hedge position.

According to the latest CFTC report as of December 24, the long side was made up of index traders (66,362 net long), large speculators/hedge funds (27,740 contracts net long), and small speculators (5,793 net longs), while the trade was on the other side with a rather sizable net short of 99,895 contracts.

When we look at the changes in the individual positions over the last six weeks, or since the current uptrend began, we notice that the main feature was a swap of positions from spec shorts to trade shorts. Outright large and small spec shorts covered over 38,000 contracts over the last six weeks, while the trade short position grew by 41,000 contracts.

By comparison outright large and small spec longs increased by just about 6,600 contacts during that time frame. These changes can be viewed as either bullish or bearish. The bears may say that this uptrend was entirely the work of spec short covering and will soon run out of steam, while the bulls will counter that the longs haven’t even started to buy yet and therefore still have a lot of money to spend!

So where do we go from here? Although upside momentum has stalled over the holiday period, the uptrend channel dating back to early November is still intact, albeit barely. Speculators have their sights on the 78.02 cents ceiling that marks a nearly 8-month sideways range, and if this level gets taken out, they will likely enter the market in greater numbers.

However, getting there seems to be a difficult task right now and unless the market finds some sponsors relatively soon, momentum will shift to the downside and the market may once again have to regroup in the low 70’s, like it did several times before.

Longer term we remain friendly for reasons mentioned above. Although there is still plenty of expensive cotton around, especially in China, cheap cotton is not overly abundant as mills will sooner or later find out.

Plexus