PLEXUS Market Comments
MARKET COMMENTS – 12 May, 2022
NY futures had a mixed performance this week, as July gave back 323 points to close at 145.53 cents, while December added 123 points to close at 127.67 cents. The July/Dec inversion therefore narrowed by 446 to 1786 points.
After falling nearly 14 cents from a high of 155.95 cents on May 4 to a low of 142.10 cents on May 10, the July contract has found some support and was able to put in higher lows in the last two sessions.
December has fared a lot better, as it corrected only about half as much as July and closed today just a little over two cents below its record close of May 4.
The CFTC on-call report showed a slight improvement last week, as unfixed July on-call sales dropped 0.69 million to 5.57 million bales as of last Friday. However, that’s still a massive amount that needs to get squared away, with only about four weeks remaining until July options expire on June 10. At that time liquidity will dry up and it is not advisable to hold shorts past that date.
Assuming that we are down to about 5 million bales by now, mills would have to fix an average of around 2,400 contracts a day over the next 21 sessions. That adds up to a lot of support and remains the main reason why the market is holding up relatively well amidst all this financial carnage.
Unfixed on-call sales for the 2022/23-season continued to rise, up 0.36 million to 7.45 million bales. Mills still don’t seem to understand that they are causing the exact opposite of what they are trying to achieve by amassing such large amounts of on-call sales. The bigger this number grows, the more unlikely it becomes for prices to drop significantly!
Today’s WASDE gave us the first detailed look at the new season and the bottom line was slightly bullish due to a lower than expected US crop estimate. While the consensus was for a 17+ number, the USDA pegged the crop at just 16.5 million bales. We have no problem with this initial estimate and belief that it might even be a tad optimistic given the megadrought in the Southwest.
However, where we continue to take issue with the USDA is on global mill use. While it lowered mill use by 1.50 million bales to 122.94 million bales for the current season, it only sees it drop another 0.95 million bales to 121.99 million bales in the coming season.
That’s not realistic in our opinion, since the entire globe is currently slipping into a recession. The negative wealth effect that’s caused by the collapse of financial assets, be it bonds, stocks, cryptos and soon real estate as well, combined with the squeeze consumers feel by much higher living expenses, will almost certainly lead to a significant drop in discretionary spending. So far over USD 30 trillion have been wiped from global financial markets, with no end in sight.
The world numbers for 2022/23 look fairly balanced as presented, with production and mill use both showing a 121 million bale handle. ROW ending stocks are projected at 46.40 million bales at the end of next season, or just 0.67 million bales lower than at the end of this marketing year. And if mill use were to drop as we believe, we might actually end up with higher inventories next season.
US export sales finally slowed down last week, as just 123,100 running bales of Upland and Pima cotton were sold for all marketing years combined. There were just 14 markets buying, while 26 destinations received shipments of 372,800 running bales. The slowdown in sales was due to high prices as well as a lack of offers, as not much cotton remains unsold and/or cannot be offered for timely shipments.
For the current season commitments have now reached 15.65 million statistical bales, of which 9.6 million bales have so far been exported. This compares to 16.5 million in sales and 12.5 million bales shipped a year ago.
So where do we go from here?
The physical market has turned quiet, with the exception of India, where offers still find keen buyers. With the big price gap between July and December looming, and given all the macroeconomic headwinds, most buyers have become very cautious and are not willing to chase after these elevated prices.
However, NY futures are a different animal, because we have a showdown between spec longs and trade shorts, with the latter facing a time crunch as far as July positions are concerned.
Unless speculators are willing to part with their longs before the roll period, which might happen if financial markets were to deteriorate further, the shorts are facing a lack of sell-side liquidity and will have to push prices higher in order to find it.
Given all the uncertainty we are current facing in financial markets, we expect the cotton market to remain volatile, with a significant upside risk in July due to the large amount of unfixed on-call sales.
December is benefitting from the July situation, but if we are correct and demand for cotton falls apart, it might be difficult to defend these high prices once July is gone. We therefore believe that it is prudent to start hedging against downside risk via bearish options strategies.