PLEXUS Market Comments
MARKET COMMENTS – 27 January, 2022
NY futures pulled back this week, with March dropping 125 points to close at 121.63 cents. The July/Dec inversion narrowed slightly from 1786 to 1768 points.
“Risk off” financial markets kept a lid on cotton this week, despite the massive amount of unfixed on-call sales that has yet to get squared away over the next 2-3 weeks.
Open interest in March dropped another 9.0k to just 99.4k contracts since last week, which compares to an average of 132k contracts at this date in the previous five seasons. So far trade shorts have been successful in reducing their positions relatively unscathed.
However, the latest CFTC on-call report continues to paint a scary picture for the remaining trade shorts, as there were still 4.36 million bales in unfixed March sales as of last Friday. When we add the 2.50 million bales on May and the 5.18 million on July, we get to a total of 12.04 million bales in current crop sales that have to be fixed until the middle of June. Against that there are just 1.61 million bales in unfixed on-call purchases in current crop.
To put these 4.36 million bales in unfixed March sales into perspective, last year we had just 2.69 million bales open and two years ago it was 2.91 million bales. And the 10-year average is 2 million bales lower at 2.33 million bales.
As we head into the roll period, index fund and speculative long positions will get rolled forward by selling March and buying May. A roll doesn’t affect their position, as these index funds and specs maintain the same net long.
The situation is different for trade shorts, particularly the ones that are linked to March mill fixations. When shippers sell on-call to mills, they will in most cases sell futures to ‘fix’ the price in their books. Then, when a mill gives its fixation order, the shipper buys the short futures back.
This means that a lot of these 4.36 million in unfixed on-call sales on March have a short futures positions against them, which will have to get squared away over the coming weeks.
Since index funds and speculators are not selling net futures when they roll, but the trade needs to buy a futures position back, it can lead to sell-side illiquidity. Therefore, the market is often forced to move higher during this period in search of willing sellers.
The US export sales report showed a familiar picture with stellar sales and dismal shipments. For the week of January 20, total sales up Upland and Pima cotton rose by an impressive 501,700 running bales for both marketing years. There were a total of 20 markets participating in the buying, while shipments of just 202,200 running bales went to 24 destinations.
Of note is that India showed up as the 2nd strongest buyer, taking 64,300 running bales. Last week we mentioned that India would likely become a stronger importer during the second half of the season, putting the USDA’s net import estimate of 4.8 million statistical bales in doubt.
For the season we now have commitments of 12.35 million statistical bales, which compares to 13.45 million bales a year ago. The slow pace of shipments continues to be a big worry, as just 3.9 million statistical bales have so far left the US, which compares to 6.95 million bales last year and 5.4 million bales two seasons ago.
The end of January marks the halfway point of the season and we have so far shipped only 3.9 million bales in nearly six months. That means that in order to reach the USDA export estimate of 15 million statistical bales, we would have to ship 11.1 million bales in the remaining 6-plus months.
The situation is similar for other origins, like Brazil or West Africa, where shipments are severely backlogged as well. Let’s say, for argument’s sake, that all of these origins were suddenly able to ramp up their shipments and get all this backlogged cotton exported.
This would lead to a glut of cotton arriving at destination over the next six months, and continue thereafter when new crop Brazilian and Australian cotton joins the export party. These two origins are expected to produce a combined 18.8 million bales according to the USDA, versus just 13.6 million last season.
Global mill use has been suppressed in recent months, because cotton simply didn’t make it out of origin fast enough to feed mills at the usual pace. This may have been less of a problem for Pakistan, Turkey or India, who can feed mills with their own cotton in addition to imports. But there are 47 million bales exported this season, according to the USDA, and some markets like Bangladesh, Vietnam or Indonesia depend on timely shipments to keep their factories running.
So where do we go from here?
Supply chain bottlenecks, which still persist, have distorted the supply/demand picture and given us the impression that we are running out of cotton, when in fact we are only running out of readily available cotton at destination, while supplies are bunching up at origin.
There is plenty of cotton that has yet to cross the ocean and it will probably arrive at a time when economies are starting to show some signs of weakness, which we expect to weigh on the big inversion that currently exists between July and December once we head into the second quarter.
However, in the short term we could see this spread spike in the other direction, as trapped March shorts might get squeezed over the next couple of weeks. Only a further “risk off” move in financial markets that would prompt specs to dump some of their longs would alter this scenario in our opinion.