The latest CFTC report as of July 22 showed an all-too-familiar situation, as the trade continued to reduce its net short position by another 0.4 million bales to just 5.2 million bales, while index and hedge funds were net sellers.
This means that the trade is around 2.5 times less short than a year ago, when it owned 13.4 million bales in net shorts, with a much smaller US crop in the field. By allowing its net short position to decline from 12.0 to 5.2 million bales since May 6, the trade has clearly misjudged the severity of this bear market and is now forced to engage in damage control.
Recent action in the options market hints at sheer panic among traders, as they are desperately trying to put some price protection in place. This in turn has resulted in a vicious downward spiral, as the ensuing selling pressure leads to more of these desperate actions over the following sessions, turning the chart convincingly bearish and keeping any potential buyers away.
While basically all the fundamental, technical and structural reasons behind the market’s freefall are well known by now, we need to be on the lookout for any supporting elements that could alter this overwhelmingly bearish perception. While sellers seem to be determined to get shorter no matter what, we feel that they disregard the unwillingness of producers to let go of their crops, especially in the early part of the season.
With the forward A-index currently quoted at 73.25 cents and probably another 50-75 points lower after today’s sharp drop, the AWP (Adjusted World Price) is now getting very close to the US government loan level.
To refresh our reader’s memories, the AWP is calculated by subtracting roughly 20 cents (19.69 cents this week) from the A-index. Once the AWP calculates below the loan, it turns into a subsidy mechanism, since it allows owners of loan cotton to redeem it at a discount. Even though these loan deficiency payments don’t offer the same incentives as in the past due to much more stringent payment limitations (US$ 125’000 per entity), we still feel that a lot of growers will initially put their cotton in the loan and then adopt a wait-and-see attitude.
This could temporarily withdraw a lot of cash cotton from the market and make it quite difficult for shorts to find coverage. This should soon be felt in a firming of the basis, as sellers are no longer willing to offer cash cotton below a certain level. We believe that it will only be a matter of time until this translates into support in the futures market as well.
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