The CFTC spec/hedge report confirms that it was spec selling into trade buying that brought the market under pressure since the New Year. As of January 5, which includes last Tuesday's big selloff down to current levels, speculators had reduced their net long in futures and options to 5.65 million bales, which is down about 0.8 million bales from the week before.
The trade was on the other side, reducing its net short position by 0.8 million bales to 13.65 million bales. Surprisingly, index funds maintained their position at 8.0 million bales net long despite rumors of significant rebalancing, although it is possible that some of that took place this week only.
So where do we go from here? The market seems to have found a level at which mills are happy to buy and fix sizeable quantities. Even though the bulls may be disappointed with the market's recent performance, the fact that the current price break allows a lot of business to take place is supportive in the longer run. The faster we sell out of cotton, the sooner the record foreign production gap will be exposed. Outside the US, the projected stocks-to-use ratio will be the lowest since the 1994/95 season and we all remember what happened with the market in 1995.
For those who need to refresh their memory, cotton prices topped out at 117.20 cents in April 1995 and there was an inversion between current and new crop of well over 30 cents. We are not suggesting that we will see a repeat of what happened 16 years ago, but we do have similar dynamics in place today, with old crop supplies getting tighter and tighter as we head into the second and third quarter, while increased new crop plantings hold the promise of a more ample supply situation in the coming season. This could very well lead to a pronounced inversion of the May/Dec and July/Dec spreads and we therefore see this as a relatively low risk play to take advantage of a potential supply squeeze as we head towards the end of the current season.
As far as outright prices go, we see the potential for a further setback in the short term as speculators may sell additional quantities in light of the dismal technical performance, but we would welcome any further setbacks as a buying opportunity. Barring any unforeseen events on the macroeconomic front, we believe that cotton prices are destined to move higher, potentially much higher, by the second or third quarter.
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