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NY cotton futures continue to head south

07
Nov '08

NY futures continued to head south this week, with December dropping another 211 points to close at 42.98 cents, while March fell 249 points to close at 46.69 cents.

The weekly AWP continued to decline and as of tomorrow it will be possible to redeem cotton from the government loan at 38.77 cents, which is 1.35 cents cheaper than last week. With the daily AWP rate likely to drop to around 37.00/37.50 cents tomorrow, the downward spiral in the market will continue for now.

Again, as a rule of thumb the replacement value of certificated stock is more or less determined by the AWP plus delivery charges of around 5 to 6 cents, plus whatever one wants to factor in for the 'equity value' of such loan cotton. Based on this calculation, the December contract is probably priced a bit too cheap at the moment.

Nevertheless, the market is a discounting machine and what it is telling us is "never mind today's calculation, prices will get a whole lot cheaper in the weeks ahead". This may well be true given the depressed state of the world economy and the severe problems our industry is facing.

As a result, there are plenty of willing sellers betting on further declines, while potential buyers remain very selective in anticipation of even greater bargains. As long as this mood prevails, there is no stopping this market and we could easily see another five or ten cents taken off before the tide turns.

However, there has been a bit of a shift in regards to where the selling pressure is coming from. For the past several months we have clearly been under severe pressure from hedge and index fund liquidation and redemption selling, while the trade was a net scale down buyer.

But when we take a closer look at the latest two spec/hedge reports as released by the CFTC and NYBOT, we notice that according to the CFTC report of October 28, index funds actually added 2'461 contracts to their net long position during that week, which was the first time in months that we have seen anything other than liquidation from the index fund sector.

Hedge funds were done liquidating some time ago, since the outright long position of commercial speculators is showing only 20'072 contracts according to the CFTC report, down from nearly 100'000 contracts in March. Therefore, even if hedge funds were forced to liquidate every last bale they currently own, it would only be a fraction compared to what they've already gotten rid of so far.

When we look at the most recent NYBOT report as of Friday, it too tells us that specs are not the driving force in this bear market at the moment, as spec shorts covered 7'340 contracts last week while trade shorts added 6'991 contracts. This indicates that the trade has taken control of this downtrend, as it worries that a deepening recession is leading to massive demand destruction.

A notable difference between hedge fund selling and trade selling is that hedge fundswere basically forced to sell at the market in order to meet margin calls, while the trade is more methodical in its selling. For example, the trade will look at things like the AWP/Futures spread to determine when to sell and it may even buy positions back if this measure gets too narrow.

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