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NY cotton futures continue to edge higher this week
02
Aug '08
NY futures continue to edge higher this week, with December gaining 64 points to close at 74.50 cents, while March added 56 points to close at 79.89 cents.

This week was one of the dullest ever in the cotton futures market, as the average daily trading volume dropped below 8'000 contracts. When measured as a percentage of open interest, it was by far the slowest week on record. But why are both speculators and traders so disengaged from the futures market at the moment?

When we look at speculators, particularly hedge and index funds, they currently feel like they have a big bullseye on their back as they are made into the scapegoats for the huge spike in commodity prices. As we have mentioned last week, many of these money managers are holding their breath as Congress is trying to introduce legislations that could limit the amount these funds are able to invest in the various futures markets.

This week initial efforts to pass anti-speculation legislation failed in both chambers of Congress, but Congressman Peterson stated that Democratic leaders intend to call a new vote in September under a different format. Therefore, as long as this uncertainty regarding new legislation looms, many speculators and index fund investors will likely take a cautious approach to the market.

When we look at the latest CFTC report as of July 22, which includes futures and options, it shows large speculators owning an outright long position of 3.6 mio bales and an outright short position of 3.2 mio bales. This is a significant change from the wild days of early March, when speculators had 9.9 mio bales in longs and just 0.6 mio bales in shorts on their books.

This dramatic change from a 9.3 mio bales net long position to the current flat position of just 0.4 mio bales has been the driving force behind the market's weakness over the last few months and a lot of that had to do with the CFTC investigation and the legislative efforts by Congress. The good news from a bullish perspective is that the worst of this liquidation process seems to be over since long speculators have only 3.6 mio bales left at this point.

Index traders have seen a slight reduction in their overall position as well during that same time period, as they went from a 12.3 mio bales net long at the beginning of March to a 10.5 mio bales net long last week. Some of that reduction was due to a rebalancing in the various indexes and part is the result of investors pulling out some money.

If Congress introduces position limits for these traders, it would definitely put the breaks on how much these index funds can grow in the futures markets and it may force additional redemptions, although it is difficult to come up with a ballpark estimate at this point.

The third group of speculators, which includes smaller entities with non-reportable positions, has also seen a reduction in outright longs since February, from 3.5 to 2.3 mio bales, while outright shorts increased their holdings from 1.2 to 1.6 mio bales as the market headed lower.

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