NY futures rebounded this week, with May advancing 132 points to close at 81.50 cents, while December inched up 12 points to close at 75.10 cents.
Since climbing above the 80 cents mark on February 25, the market has been meandering sideways in a range of just 590 points between 78.70 to 84.60 cents. Although it has corrected below 80 cents on a couple of occasions, the market has found solid support from trade buying, which has allowed it to rebound quickly. However, so far there has not been enough momentum to take out the March 1 highs of 83.29 (close) and 84.60 (intra-day) and therefore the market remains confined to its sideways trend for now.
What's troubling for the still large contingent of trade shorts is that open interest has been increasing as spec longs have been adding to their positions and there is no indication that they will be getting out of their longs anytime soon. Their bullish appetite seems to be growing as stocks are rallying, oil futures are back above 85 dollars a barrel and the outlook on interest rates and inflation is pointing higher. Open interest in cotton futures stood at 192'841 contracts this morning, which is within a few hundred lots of the highest level since this bull market started back in March 2009.
The latest CFTC spec/hedge report, which includes futures and options, confirms that the increase in open interest has been the result of additional spec and index fund buying, while the trade continued to sell into the rising trend. As of March 23rd, net spec longs amounted to 6.25 million bales and net index fund longs stood at 7.45 million bales, while trade net shorts had increased to 13.7 million bales. Based on the current open interest in futures, we assume that about 75 percent of these positions are still in the May and July contracts. What is puzzling to us is that the trade continues to increase its net short position even though time is beginning to run out. First notice day for the July contract is less than three months away (June 24th) and one has to wonder how this huge short position will be dealt with given the nearly 8 cents inversion between July and December.
The spread between current and new crop futures widened significantly after the USDA released its Prospective Plantings report yesterday morning. Trade shorts were hoping for a bearish report to force the market lower, but instead they got a fairly neutral 10.5 million acres number. Initially the entire board dipped in reaction to the report, but then current crop futures started to rally, while December stayed near unchanged. As the huge jump in open interest (+5'380 contracts) would later reveal, it was renewed spec buying that sponsored the rally.
As traders do the math on supply/demand numbers for 2010/11, they may realize that no matter how big the crop is going to be in the coming season, it will not help those who still need to buy cotton for delivery over the next six or seven months. Also, it will take a substantial rebound in production to close the 13.5 million bales seasonal output gap we currently have. Given the surprisingly strong consumer demand, we believe that this gap will increase to around 15-16 million bales next season. In other words, global production may have to grow from the current 102.2 million bales to around 117-118 million bales to keep stocks from falling any further.