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Cotton market facing many uncertainties

17 Dec '11
6 min read

Plexus Cotton Limited reports that New York futures came under renewed pressure this week, as March dropped 576 points to close at 86.29 cents.

The market fell to a 16-month low this week on aggressive trade and technical selling in thin trading. A look at the weekly continuation chart now reveals a well-defined 'bell-shaped' curve, which originated in the summer of 2010 at around 80 cents and saw its pinnacle this spring at 227 cents. In other words, the market has now basically gone full circle and there should be a decent layer of support waiting in the 80-84 cents area.

Typically we would have expected to see heavier trading volume on such a pronounced break in the market. However, with the exception of Monday, when volume briefly spiked to 18'000 lots, the remainder of the week saw turnover of just 11'000 to 14'000 contracts.

Unlike in some other markets, where deleveraging by speculators was blamed for the sharp decline in prices, the cotton market can't use this excuse, because a) speculators don't have a large position to begin with and b) open interest went up this week. The fact that open interest was rising indicates that it was new selling rather than long liquidation that weighed on the market.

Apart from perhaps some new technical selling based on a weak chart, the trade seemed to be the main driver behind this move, as holders of long positions in non-US cotton were buying protection, either by selling futures, buying puts and/or selling calls. With speculators conspicuously absent from the cotton market at the moment, there was simply not enough on the other side to absorb the selling, which caused prices to drop into a vacuum on relatively low volume.

The USDA report of last Friday seemed to be behind this renewed sense of urgency among traders to seek protection against unsold positions, and since forward business in the physical market is still difficult to materialize, the futures and options market seems to be the logical choice.

According to the USDA, the seasonal production gap in the rest of the world (ROW) has now all but disappeared, with ROW production at 107.6 million bales basically matching ROW mill use of 107.7 million bales. This is in stark contrast to a deficit of 13 million bales last season and a 26 million bales shortfall two years ago.

In theory, the rest of the world doesn't need any cotton from the US, but since the US has already managed to sell most of its exportable surplus overseas (10.5 million bales in commitments with another 1.3 million in optional sales), it has transferred the burden of pushing sales to other origins around the globe, which is why we have recently seen so much price pressure from a variety of different growths.

Fortunately the Chinese Reserve has been relieving the pressure somewhat by lifting a sizeable amount of the seasonal surplus off the market. As of today, the Reserve has bought around 7.2 million statistical bales in the domestic market and an estimated 4.5 million bales in the international market. In other words, the Chinese Reserve has now basically absorbed the entire global surplus, which according to USDA numbers amounts to 12.1 million bales.

Plexus Cotton Limited

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