NY cotton futures manages to halt decline last week

Plexus Cotton Limited reported that New York (NY) futures found some support this week, as December edged up 56 points close at 72.09 cents.

Just when we thought that the market was once again in the grip of the bears, adverse weather conditions across the cotton belt managed to halt the decline by casting some doubt on the potential size and quality of the US crop.

Nearly all cotton fields from Texas to the Carolinas got wet this week, with the heaviest amounts falling in the Mid-South last weekend, where some locations received up to 5 inches. This rain event came at an inopportune time, because at this stage most fields are defoliated and ready for harvest. In the Mid-South only around 25% had been picked prior to the rain and it is therefore likely that the quality has suffered.

This latest harvest delay has the shorts in December a bit nervous, because most old crop stocks are gone by now, while the certified stock has dropped to a mere 9’000 bales and the first 1.1 million bales of new crop cotton have yielded just 48% in tenderable grades so far.

Therefore, as long as the bulk of the crop remains exposed to weather, the downside for December seems limited. However, we don’t think that the market is turning bullish here; we are simply dealing with a timing issue! Time may run out for the December contract to feel the weight of the crop, but March should eventually come under pressure.

This is why a lot of traders have opted to roll their long December puts into March puts or put spreads this week, resulting in small bounce for December and a narrowing of the spread.

While the initial down move from 76 to 71 cents generated good momentum, with average daily volume spiking to over 20’000 contracts and open interest increasing from 182’000 to 190’000 contracts, the market has since quieted down again, with volume and open interest tapering off in recent sessions.

Maybe the weather is to blame for that, but we feel that neither the specs nor the trade are at this point willing to sell the market aggressively. Speculators seem to have played the technical breakdown last week, but they are usually quick to take profits once downside momentum stalls and as we can glean from the CFTC report, the trade doesn’t appear to be a big seller either, at least not yet.

Looking at the latest CFTC report as of September 25, we were surprised to see that this latest selloff was entirely the work of speculators, while the trade was actually a strong net buyer into the decline. Speculators added 9’007 new shorts and liquidated 2’553 longs, for a total of 11’560 contracts in net sales.

The trade on the other hand covered 3’408 shorts and bought 7’590 new longs, for a total of 10’998 lots in net purchases. Index Funds were also on the buy side, adding 571 contracts in net longs.

While it makes sense for speculators to sell the market from a technical point of view after a 3-month uptrend line was broken, we are somewhat puzzled by the large amount of new trade buying. With the crop about to come off the field, we would have expected the trade to be a net seller by now, but perhaps this hedge selling is still ahead of us!

US export sales for the week ending September 27 were above expectations at 248’000 running bales for both marketing years, with China once again leading the pack with 117’800 running bales. Of note is the fact that 15 markets participated in the buying, which tells us that US cotton is quite competitive at current prices and that other origins may not be as readily available at this point. Total commitments for the season now amount to 5.8 million running bales, of which just 1.5 million have so far been shipped.

So where do we go from here? Crops are still vulnerable at this point and a lot will depend on the weather over the next 3-4 weeks. If there are no more hiccups and quality deterioration remains contained, then we should see a resumption of the downtrend as we head into the end of the year, with values possibly retesting the June lows. However, if we get a wet harvest and quality becomes a bigger issue, then NY futures should find decent support around current levels.

The longer-term picture remains friendly in our opinion, since the current 17-to-1 ratio between Dec’13 cotton and Nov’13 soybeans still portends a large acreage shift out of cotton next season. In other words, while we remain cautiously bearish in the near term, we shall be looking for an opportunity to enter the long side going forward.