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NY December futures slide by 227 points
02
Jul '10
NY futures were on the defensive this week, with December dropping 227 points to close at 76.45 cents.

We saw a familiar pattern this week, as renewed concerns about the economy prompted hedge funds to once again take some chips off the table. However, this time around the mood among traders is decidedly more negative than on previous occasions, since key support in the S&P 500 was violated and news on the economic front is rather worrisome, especially in the housing sector.

Even though very little current crop cotton remains for sale and we are going to end this season with the tightest ending stocks in many years, the July contract has not been able to rally past its 87.10 high of April 26 and December has yet to crack the psychological 80 cents barrier. In fact, December closed just 24 points higher than where it was at the end of 2009 and only 85 points higher than where the spot month traded at that time. Why has the market made so little progress despite all the bullish factors that have come into play since then?

Probably the most logical explanation is that the 'futures' market has its name for a reason, because it functions as a discounting mechanism of expectations about the future. In other words, six months ago the market may have rallied in anticipation of the current tightness, thereby already discounting what has now turned into reality.

Also, by acting as an early warning system, it has allowed market participants to take the necessary precautions to stay out of trouble. Mills made sure that they secured their needs early on, many of them by buying on-call. These buyers may have gotten a bit lucky in the end, since their fixations coincided with a period of heavy spec long liquidation, which has prevented a potential short squeeze.

Using the same logic, the market may currently be in the process of discounting what lies ahead several months from now. And what it is seeing is a promising US crop that has the potential to surpass the current USDA estimate by some 2 million bales, while the economic outlook for the remainder of the year is turning bleak. Therefore, we have a situation in which the trade would like to sell the market near 80 cents, but there is a lack of buyers on the other side.

Until a couple of weeks ago speculators were rebuilding their net long position and provided the necessary liquidity to facilitate trades near 80 cents. However, with the stock market turning sour and economic numbers disappointing, they have since turned into net sellers, which means that there wasn't any buying left near 80 cents. As a result the market has been falling in a vacuum in search of renewed support.

It appears that the trade has finally stepped forward as a net buyer near 75/76 cents, as grower selling diminishes at these levels and mill fixation buying and merchant short-covering starts kicking in. Whether trade buying is sufficiently strong to stop additional spec selling remains to be seenand depends to a large degree on how outside markets behave over the coming weeks. Tomorrow's unemployment report will probably set the tone in that regard.

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