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NY futures resume their uptrend this week
Feb '11
NY futures resumed their uptrend this week, as March rallied 1572 points to close at 187.58 cents (synthetic close at 192.25 cents!), while December advanced 1544 points to close at 131.50 cents.

The market seems to have entered the much-dreaded blow-off phase of this historic bull market and it is still anybody's guess as to where and when the top will ultimately be made. Judging by the open interest, which has continued to rise rather than decline, we have to assume that there is still enough fuel left to keep this uptrend going for a while.

Open interest in futures measured 223'405 contracts this morning, the highest reading since November 11, and 157'638 of these contracts were in current crop March, May and July. Tomorrow's March options expiration will probably lead to a significant drop in open interest, since there are nearly 66'000 calls 'in-the-money', which will lead to some offsets. The shorts are hoping that this will set the market up for another big drop, similar to what we experienced three months ago when the December contract collapsed some 40 cents in the wake of its options expiry.

However, what worries us is that according to the latest CFTC report (February 1) the trade has further increased its net short position by 0.4 million bales to a 10.7 million bales net short. This number represents a 'delta-adjusted' net position that includes both futures and options.

As long as the trade carries such a sizeable net short position in a market that is basically sold out of physical cotton, it will be difficult to turn the bullish momentum around. Also, it is quite remarkable to see the market rally so strongly during the ongoing Index Fund roll period, since it is typically associated with some price pressure. It will be interesting to see what will happen next week when the currently abundant liquidity is no longer going to be there.

According to economic theory rising prices should lead to demand rationing, as fewer people are able or willing to pay for a certain product. However, in reality this is not as straightforward as it sounds, because hoarding can delay the anticipated demand destruction and even lead to a short-term boost in demand. There seems to be some evidence of this happening in the cotton market at the moment.

While cotton prices are up by more than 150% since last July, price increases in the downstream sectors have not been nearly as pronounced just yet. Anecdotal evidence suggests that buyers at the wholesale and retail level are therefore stocking up on goods in anticipation of higher prices down the road. Last week the Wall Street Journal ran a story that talked about this kind of behavior and it mentioned a T-shirt buyer who boosted his inventory of 30 boxes to over 2500 boxes.

If this is happening on a widespread basis, it can lead to a distortion of the supply/demand picture. As hoarding moves future consumption into the present, it inflatesdemand at a time when the market is ill equipped to meet it. At the same time it creates a void of demand at some point down the road.

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