NY futures collapse this week

19 Sep '08

6 min read

While we cannot rule out that this financial turmoil will prompt further withdrawals out of index funds, we firmly believe that the majority of investors in these products, many of whom are pension funds, will remain in the market.

While speculators and index funds have sold a combined 55'000 contracts net since June 30, the trade has bought that many contracts back and now holds a net short position of just 86'000 contracts. This position will further shrink over the next few weeks and months as old crop positions are being liquidated and it is not likely to grow back anytime soon since not much new crop cotton is expected to change hands at these low price levels.

So where do we go from here? As we have already stated, we have no clue as to how much longer this onslaught of selling will last. However, having said that, we firmly believe that once some calm returns to the financial markets, and there are some indications of that happening as we write this letter, the cotton market could set itself up for a huge countertrend rally. There are several factors that point in that direction:

1) From a fundamental point of view, we have finally found a level at which mill business takes place again in some impressive numbers, as the latest export sales report of 475'000 running bales has shown. Also, the US crop is not in the greatest shape and many private estimates peg the crop size at no more than 13 mio bales.

2) From a technical point of view we have tested and so far successfully held the very important 58.00 cents support on the weekly chart and any bounce off of this support over the next few days would be seen as strength.

3) There is enormous potential leverage in the December options position. As of tonight, there were 103'000 open December calls between the 58 and 85 cents strike price, with a delta of just 14'000 contracts, because nearly all of these calls are out of the money. Conversely, there were some 128'000 contracts of mostly in the money December puts all the way up to the 110 strike price, with a very high delta equivalent to 105'000 futures contracts. What that means is that if the market were to start heading north, the Dec calls would quickly gain in delta while the puts would rapidly lose delta. The combined effect could translate into a lot of buying power.

4) Recently the market has been dominated by aggressive speculative selling, while buyers stayed on the sidelines. If the market were to calm down, sellers may back off and buyers return, which could quickly lead to a shift in momentum. Since a lot of these recent sellers were new shorts, there are plenty of buy stops to be found on the way up.

Summing up, while we may not have seen the lows of this move yet, with prices at 60 cents we like the long side a whole lot better from a risk/reward point of view.

Plexus Cotton Limited

More Textiles News - United Kingdom...