NY futures continued to rally this week, as July jumped 270 points to close at 84.82 cents, while December gained 130 points to close at 77.19 cents.
After several failed attempts, the July contract finally managed to break out of its 7-week sideways range and it did so in convincing fashion. July literally exploded to the upside, as it rallied from a low of 80.52 on Monday to a high of 86.80 on Wednesday in heavy volume. It has since given back about two cents but has so far been able to hold above the breakout point.
We believe that there are quite different dynamics at work in the July and the December contracts, so let's take a closer look at what is driving these futures months. July is the last contract of a season that has seen the biggest foreign production gap ever at 23 million bales. Even if the US manages to export 12 million bales, it will only cover a little over half of this huge deficit, while the balance has to be supplied from existing inventories. Due to this tight statistical situation we had a strong physical market all season long, leaving mills with little negotiating power.
Although mills did not hesitate to secure their needs from shippers, many of them left the price open by buying 'on-call', waiting for some breaks in the market to cheapen their deals. While this strategy may have worked well in recent years, it has backfired this season, as unfixed on-call sales have increased from 2.6 million to currently 7.0 million bales since the bull market started back in March 2009. This bigger than usual 'on-call' position, combined with the fact that large basis-long positions were established early in the season, has given the trade a fairly substantial net short position to contend with. According to the latest CFTC report, the trade's net short still amounted to 12.1 million bales last week, of which about two-thirds were in current crop.
As long as this net short position can be rolled forward at more or less full carry it does not really pose a problem, but July seems to be the end of the line in that regard, since it is currently trading at an invert of nearly 800 points to December, which is about 1300 points shy of full carry. Merchants have tried to combat this inversion by boosting the certified stock to about a million bales, but so far the market has been unimpressed.
Rather than waiting for this inversion to collapse, many owners of basis-long positions have decided to aggressively sell their physical longs into the current strength and to get out of short futures. Combined with fixation related buying this is keeping the July contract well supported at the moment. Many traders seem surprised that the certified stock has not been able to put a lid on the market. While it has forced out the May/July spread to more than full carry, it hasn't prevented the board from moving higher.
We believe that it is all a matter of timing. Right now the certified stock doesn't pose a threat to the market because the wide May/July spread is facilitating another roll forward. In other words, the market has just bought itself another two months to deal with the problem. In the meantime we have trade short-covering and new spec buying leading the front end higher. We once again have a situation in which there are more traders wanting or needing to buy the July contract than others willing to sell it. The trade is getting out of shorts and speculators like the long side based on the market's strong technical performance. There will be dips resulting from occasional voids of buying or from momentum players trying to scalp a cent or two on the short side, but the tide will only turn once this massive trade short in July has been greatly reduced. At that point we could very well see the July contract collapse, but it may be another six to eight weeks before that happens.