While March open interest dropped by 61’670 contracts over the last five sessions, the rest of the board picked up 52’150 contracts, which tells us that specs longs and trade shorts continue to hold their line in this standoff.
According to the most recent CFTC report as of February 5, the trade increased its net short exposure to 15.5 million bales, while specs (8.1 million net long) and index funds (7.4 million net long) owned the corresponding positions on the other side.
The trade continued to increase the certified stock to 294’000 bales this week, including bales under review, which may keep the longs on the back burner for now. However, it is important to realize that over the next four months the trade will have to get out of its massive net futures short in current crop, either by buying it back or by rolling it into new crop.
That amounts to a lot of short covering in a limited time frame and spec longs are probably not going to be very accommodating. We estimate that around 13.0 million of the trade’s net short belongs to current crop, while the remaining 2.5 million bales are against new crop.
From a seasonal point of view this large trade short is a bit unusual. Typically the futures short position should be at its peak at harvest and then gradually decline as basis-long positions get sold over the course of the marketing year. This season the opposite has happened, as the trade net short position grew from 5.9 million bales in mid November to the current 15.5 million bales.
Traders may have become stuck on the idea that the market is a great sell above 80 cents and that prices can’t possibly go any higher in the face of these large global ending stocks. Assumptions like these have proven to be costly to traders in recent years, and we wouldn’t be surprised if history were to repeat itself over the coming months.
The market had three reports to look at since last Thursday and they weren’t really what the bears were hoping for. First up was the USDA report last Friday, which showed a familiar picture of increasing stocks in China (up 2.0 million bales) and declining inventories in the rest of the world (down 1.86 million bales).
Although projected ending stocks in China are at a record high of 42.61 million bales, they don’t really matter as much at the moment since they carry a hefty price tag of around 140 cents/lb and are therefore no threat to cotton that is priced in the 80s.
What does matter in regards to the futures market is that stocks outside China are getting tighter every month and are now estimated at just 39.25 million bales by the end of July. This is more or less the same level we had last season (38.85 million bales) and two years ago (38.40 million bales). What is important though is that in the previous two seasons the outlook for production in the rest of the world remained relatively high, whereas we are now looking at a significant decline in acreage next season.
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