The liquidation of the March contract proceeded in a speedy and orderly fashion, as open interest was down to just 6’393 contracts or 639’300 bales as of this morning.
With another 3’300 contracts trading, most of which are believed to liquidate existing positions, any last minute fireworks become unlikely as March enters its notice period on Monday.
Remaining open interest won’t be much more than the current certified stock of around 252’000 bales, although it remains to be seen whether the current owners are willing to give it up that easily.
When a futures contract approaches its notice period we often see it converge with the cash market, and this time appears to be no different. With March at around 86 cents, it is definitely in the vicinity of US spot prices, which should spark some interest in the certified stock based on its cash value alone, regardless of whether there is enough carry on the board or not.
Based on the most recent open interest, CFTC and on-call figures, it seems safe to say that the trade has simply postponed the day of reckoning by rolling positions and fixations from March to May.
This week’s pullback is giving traders hope that a momentum shift might flush out some spec longs and thereby lead to a deeper correction, but it doesn’t change the fact that the trade still needs to buy back and/or fix a large amount of contracts before July goes off the board.
Total open interest in the futures market stood at 168’307 contracts as of this morning, of which 104’083 were in May. This is considerably less than a year ago, when total open interest amounted to 196’820 contracts, of which 137’530 belonged to May.
This difference is easily explained by the smaller US crop and the tighter availability of cotton around the globe, since there are fewer bales that need to be hedged. Likewise we have a smaller trade net short position at 10.4 million bales, which is still sizeable, but nevertheless quite a bit less than the 16.1 million bales of a year ago.
Considering these reduced overall positions it is therefore all the more surprising that unfixed on-call sales are so much larger this season. The latest on-call report as of last Friday showed hardly any improvement, as unfixed on-call sales in March, May and July still amounted to 5.49 million bales.
While March saw its balance drop by 2’868 contracts, May and July increased by nearly as much, adding a combined 2’663 contracts.
Unfixed on-call sales in current crop are nearly 2.0 million bales larger than the 3.5 million bales of last year. What this boils down to is that there are a lot more bales to fix in a much less liquid market and this could spell trouble! For now it is quiet on that front, because mills have just escaped from March to May, but sooner or later they will run out of opportunities to roll their way out of harm’s way.
Based on how limited remaining supplies are on a global basis and how much mills still need to cover until new crop, we have to assume that global mill use is a lot stronger than the statistics give it credit for. Currently the USDA estimates ROW stocks at 39.2 million bales at the end of July, slightly higher than the 38.8 million bales of last season.
This is at the higher end of a ten-year range and should comfortably tie mills over to new crop, yet for some reason supplies feel a lot tighter than they should.
In trying to come up with a logical explanation, we suspect that the statistics may not have fully captured the extra demand that has arisen from a) Chinese mills setting up shop in other Asian markets and b) the large increase in yarn exports to China. For example, while statistics may have correctly lowered mill use in China as mills have shifted production elsewhere, they may not have properly accounted for the corresponding increase in these other markets.
Likewise, with India currently exporting the equivalent of around 7 million statistical bales of yarn an annual basis, or about 25% more than a year ago, we feel that this increase may not yet be properly reflected in the balance sheet.
The strength of Chinese cotton and yarn imports continues to surprise traders and is definitely one of the main engines behind this strong market. In January China imported another 292’485 tons of cotton, bringing the total for the first six months of the season to just under 1.7 million tons or 7.8 million statistical bales.
This means that China will have to take in only another 3.2 million bales over the next six months in order to reach the USDA estimate of 11.0 million bales.
Equally impressive is the strong pace of Chinese yarn imports (consisting of yarn containing at least 85% cotton), which in January amounted to 166’277 tons and over the last twelve month has grown to nearly 2.0 million tons or the equivalent of around 9.7 million statistical bales if we allow for a waste factor of six percent. This means that over the last two seasons yarn imports to China have just about doubled!
So where do we go from here? After posting two-year highs in May and July earlier this week, the market has started to pull back. At the moment this is still nothing more than a correction, but we need to watch out for a potential breach of the 3-month uptrend line dating back to November, which currently runs through around 87.10 in May.
A break below would likely trigger sell-stops and flush out some spec longs, although trade buying would readily absorb any selling in the 83-85 cents area.
In the longer term there are still a lot of fixations to be done and shorts to be bought back in May and July, and in the absence of any major spec liquidation it could prove difficult for these shorts to escape unscathed. It would therefore be premature to call an end to this bull run!