NY futures advanced further this week, with May gaining 217 points to close at 46.13 cents, while December added 214 points to close at 51.48 cents.
Many traders were surprised by the recent strength in the cotton market, given the ample supply of cotton around the globe and the still relatively gloomy consumption outlook. However, there is another set of "supply" figures we routinely need to look at in futures trading, namely that of buyers and sellers.
The futures market is a zero sum game as there has to be a buyer for every seller, and vice versa. The dynamics of a futures market are quite different from those of the stock market for example, which can function perfectly well with just buyers after the initial public offering by companies. A futures market on the other hand constantly depends on a fresh supply of willing and able buyers and sellers.
Since February 23, when open interest amounted to just 115'066 contracts, an additional 26'708 bets were placed by buyers and sellers. In a nutshell it was speculators getting in on the long side, while the trade increased its short position. There is a different mood discernible in the spec camp today compared to late last year, when everyone rushed for the exit, be it due to forced liquidation, deleveraging or good old-fashioned fear and panic. Thanks to the massive global reflation effort by Central Bankers, commodities are suddenly back in fashion as an investment class, or rather an inflation hedge.
The trade provides most of the selling at this point as it is playing an arbitrage game between the AWP (adjusted world price) and the futures market. The idea is that cotton can be bought in the cash market at the prevailing AWP and in case need be delivered against the futures contract if the price is right. Typically at a spread of about 12-13 cents between the AWP and the spot futures contract such an arbitrage trade becomes feasible. With the AWP increasing only 70 points in the coming week, from 33.83 to 34.53 cents, it made plenty of sense for the trade to sell into this rally and that's why we stalled near 47 cents this morning despite another excellent export sales report of over 400'000 bales and stellar shipments of 300'000 bales.
As we have pointed out in an earlier report, the fact that the US is selling so much cotton may be a catch-22 in regards to prices. The more the US captures on the export market, the fewer bales the rest of the world gets to sell, which should keep competitors' prices at bay and prevent the AWP from rising too rapidly.
Of course there is always the possibility for spec buying to overwhelm trade selling, as we have talked about on numerous occasions. The trade simply does not have enough bullets to enter into a shooting match against the spec sector as last year has clearly shown. After increasing its outright net short position by nearly 2.0 million bales over the last couple of weeks and by taking an equal amount of cotton out of the loan, one has to wonder how much more the trade can afford to short. Speculators certainly have no appetite for the short side at the moment as shorts are covering and new longs are getting established.
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