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Cotton markets see strong volumes and rising open interest
Jun '08
NY futures continued to add to their recent gains this week, as December advanced 170 points to close at 81.77 cents, while March rallied 212 points to close at 87.26 cents.

Even though West Texas received some much needed rain over the last 10 days, which will buy that crop some time, it was not enough to offset the bullish forces from outside market that are acting in support of cotton.

The CRB index set yet another record today at 463.27, up by over 3 percent this week, as crude oil closed at record highs this afternoon. At the time of this writing more rain is falling in the flood-ravaged areas of the Midwest, which will likely lead to further losses in these crops and keep their prices on a firm footing.

However, while December's advance of nearly 9 cents this month looks impressive, we are missing two key ingredients to validate this rally - strong volume and rising open interest. This week's trading volume of somewhere between 12'000 and 20'000 contracts a day was anemic, while open interest has been declining by about 58'000 contracts since this rally began on June 4th. At today's 215'041 contracts, open interest is only about 13'000 contracts higher than a year ago and significantly below its all-time high of 302'683 contracts on March 3rd.

Even though some of this drop in open interest can be explained by the July liquidation, we feel that it has been short-covering rather than new buying that has been driving this rally. The latest CFTC report, which shows futures and options positions as of June 17, tells us that outright large spec longs increased by only 433 contracts, while large spec shorts covered 13'578 contracts. The trade sold 43'758 contracts of its outright longs and covered 25'421 shorts, while index funds more or less maintained their net long position at 102'595 contracts.

While this lack of volume and rising open interest may look suspicious, it is quite possible that the market squeezes out a few more cents to the upside on additional short-covering. As we have explained last week, we do have a rather large block of longs that belongs to index funds and as we have seen in many of these high-flying commodities, it may be difficult to find enough willing shorts to offset these positions.

Outright spec short positions are relatively small at 3.1 mio bales, so we can't expect much buying power from that end. It is really the trade that owns most of the shorts these days and they seem to hold the key to prices from here on forward, at least until speculators decide to enter the game in bigger numbers again. However, with the witch hunt going on in Washington it could be a while before that happens.

So far the trade has been holding on to a fairly large outright short position, especially with the futures market being priced over 10 cents above equivalent cash prices on a C+F Far East basis. But as US stocks are being worked down over the summer and with a UScrop that is considerably smaller than in previous years, the trade has less of a need to hold a big short in New York.

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