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Cotton acreage shrinks further
Jun '08
NY futures continued to advance this week, as July added 180 points to close at 71.44 cents, while December gained 312 points to close at 80.07 cents.

Weather worries, volatile outside markets and an improving technical picture were the driving forces behind this week's wild ride in the cotton market. On Monday morning, the December contract rallied over 700 points in synthetic trading before falling back to a gain of 'just' 279 points for the day. Since then we have seen a rather nervous, erratic market in search of its 'fair value'.

We believe that the market is set-up for such volatile trading because there is an imbalance between market driven long and short positions. As we have explained on previous occasions, the fact that index funds occupy such a large portion of the long side can lead to interesting dynamics.
Let's have a more detailed look at this! According to the latest CFTC report of June 10, which includes futures and options, the various market participants owned the following positions:

• Large speculators were 4.8 mio bales outright long and 3.0 mio bales outright short, for a net long position of 1.8 mio bales. In addition to that, they owned spread positions totaling 15.9 mio bales.
• The trade had 12.4 mio bales of outright longs and 24.9 mio bales of outright shorts, for a net short position of 12.5 mio bales.
• Index funds had had a net long position of 10.2 mio bales
• Small speculators, called 'non-reportable', owned 2.3 mio on the long side and 1.8 mio on the short side, for a net long position of 0.5 mio bales.

If we summarize these positions, we have on the one hand a large index fund long position of 10.2 mio bales net, to which we add the 1.8 mio bales net long of large speculators and the 0.5 mio bales net long of small speculators, for a total long exposure of 12.5 mio bales.
On the other side of the balance sheet we have the trade, which has an offsetting 12.5 mio bales net short position.

Now, since we know that index funds do not react to market movements, but only to the flow of money in and out of these index products, we really need to focus on the remaining longs and shorts, which do pay attention to supply/demand forces or to technical indicators.

This gives us just 2.3 mio bales of net longs of large and small speculators, and against that there are 12.5 mio of trade shorts, which is a rather stark imbalance. However, as long as the market outlook of these participants remains bearish, not much is likely to happen, because the longs see no reason to add to their positions, while trade shorts have no reason to cover, other than for liquidity reasons perhaps as we have seen in early March.

However, once these trade shorts change their mind about the market and decide to cover, who will be there to sell? Remember, there are not that many 'market driven' longs to begin with and many of them react to technical signals, which means that in a rising trend they want to buy, not sell.

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