As a result we have a market that is stuck right in the middle of a 6-month sideways trend, marked by a low of 81.72 and a high of 89.56 in December. While the market hasn’t been able to generate any directional moves lately, the tight nearby supply scenario has forced the Dec/March spread out to an inversion of nearly 200 points.
Even though it may seem like there is not much going on, with December closing the last 27 sessions in a narrow range of less than 300 points, there are nevertheless a number of developments that have the potential to yank the market out of its comfort zone.
There is the certified stock for example, which has all but disappeared in July, dropping from 623’861 bales on July 2nd to just 71’848 bales as of this morning. When we combine this low availability of certified stock, or any cash cotton for that matter, with the massive trade net short position in NY futures, plus the fact that the US crop is late, we have the perfect set-up for a short-covering rally at some point between now and November.
According to the latest CFTC report, the trade net short position amounted to 13.6 million bales as of July 23, which was nearly twice as large as the 7.1 million bales net short of a year ago. Even though the US crop is estimated to be some 4 million bales smaller this season, which means that there are fewer bales to hedge, the trade has been on a tear to short the futures market. Merchants and farmers seem to adopt a ‘better safe than sorry’ attitude, seeking protection against a sudden change in China’s price support policy, which has the potential to turn the cotton market upside down.
For liquidity reasons most of these trade shorts have been put on in the December contract, considering that 85% of open interest belongs to the front month. By comparison, last year it amounted to just 76%, on a smaller position! So we have a rather substantial trade short in December, with hardly any certified stock left and not much cotton in the pipeline to replace it, since current crop cotton is nearly all spoken for and new crop may arrive a little late for delivery.
So far the shorts have kept their cool, waiting for a chance to roll their positions forward at something better than 200 points negative carry. The hope is that the 6.5 million bales net spec longs will blink first and liquidate, be it because of a bearish announcement out of China or some negative news on the macro front. Then there is always the Index fund roll, which will provide 7.0 million bales of liquidity, although that opportunity won’t arrive until late October/early November.
The worry is that in the meantime something spooks these trade shorts into covering. Weather is high on the list of potential catalysts, because it has been rather unusual so far this season, with many records broken on both sides of the spectrum.
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